UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-K




(Mark
One)




S
            
            ANNUAL
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
              
              For
      the fiscal year ended June 30, 2010





£
              
              TRANSITION
      REPORT UNDER 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.
      27, Wang Gang Road,
                Jin
      Nan (Shuang Gang) Economic and Technology Development
                Area
                Tianjin,
      People’s Republic of China
              
              300350(Address
      of principal executive offices)
              
              (Zip
      Code)





Registrant’s
telephone number, including area code + (86)
22-2858-8899




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




Title
      of each class
            
            Name
      of each exchange on which registeredN/A
            
            N/A




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                                SNo





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act.


SYes                                £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.  SYes  £
No





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





Indicate
by check mark 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.S





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 S





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).


£Yes
                                SNo





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 $27,874,375 based upon the closing
price of the common stock ($5.15) as quoted by NASDAQ on December 31,
2009.




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 20, 2010, there were 23,191,165 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 years ended December 24, 1980).







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, 2010, $1.00 was equivalent to 6.7169 yuan.





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





References
to “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 “Southern Sauce
Company, Inc.,” “we,” “the Company”, “our” and “us” refer collectively to (i)
Shengkai Innovations, Inc. (formerly known as “Southern Sauce Company, 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) Shengkai.




References
to Shengkai’s “registered capital” are to the equity of 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.”


2





SHENGKAI
INNOVATIONS, INC.


FORM
10-K


For
the Fiscal Year Ended June 30, 2009





TABLE OF
CONTENTS





PAGEPART
      IItem
      1.
                  
                  Business
                  
                  4Item
      1A.
                  
                  Risk
      Factors
                  
                  22Item
      1B.
                  
                  Unresolved
      Staff Comments
                  
                  30Item
      2.
                  
                  Properties
                  
                  30Item
      3.
                  
                  Legal
      Proceedings
                  
                  31Item
      4.
                  
                  (Removed
      and Reserved)
                  
                  31PART
      IIItem
      5.
                  
                  Market
      for Registrant’s Common Equity, Related Shareholder Matters and Issuer
      Purchases of Equity Securities
                  
                  31Item
      6.
                  
                  Selected
      Financial Data
                  
                  32Item
      7.
                  
                  Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  
                  33Item
      7A.
                  
                  Quantitative
      and Qualitative Disclosures about Market Risk
                  
                  39Item
      8.
                  
                  Financial
      Statements and Supplementary Data
                  
                  39Item
      9.
                  
                  Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosures
                  
                  41Item
      9A.
                  
                  Controls
      and Procedures
                  
                  41Item
      9B.
                  
                  Other
      Information
                  
                  43PART
      IIIItem
      10.
                  
                  Directors,
      Executive Officers and Corporate Governance
                  
                  44Item
      11.
                  
                  Executive
      Compensation
                  
                  48Item
      12.
                  
                  Security
      Ownership of Certain Beneficial Owners and Management and Related
      Shareholder Matters
                  
                  51Item
      13.
                  
                  Certain
      Relationships and Related Transactions, and Director
      Independence
                  
                  53Item
      14.
                  
                  Principal
      Accountant Fees and Services
                  
                  54PART
      IVItem
      15.
                  
                  Exhibits
      and Financial Statement Schedules
                  
                  54Signatures
                  
                  58


3




PART
I




Item 1.   Business.




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.





Immediately
following the reverse merger transaction, our corporate structure was 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 was subsequently renamed as “Shengkai
(Tianjin) Limited” on April 15, 2010.





Shengkai,
our operating entity, was organized under the laws of the PRC in June 1994 under
the name Tianjin Shengkai Industrial Technology Development Company. 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.


4





Shengkai
(Tianjin) Trading Ltd., which is wholly-owned by SK WFOE, was organized as a
wholly foreign-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
Shengkai which we believe give us effective control over the business of
Shengkai, the entity through which we now operate our business. These agreements
are described above in the section entitled “Contractual Agreements with
Shengkai.”





Our
executive offices are located at No. 27, Wang Gang Road, Jin Nan (Shuang Gang)
Economic and Technology Development Area, Tianjin, PRC 300350, and our telephone
number is (86) 22-2859-8899. 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 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 Shengkai through two separate transactions: (i) a
restructuring transaction which granted control of 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
Shengkai which we believe gives us effective control over the business of
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 Shengkai (and in some cases the
shareholders of 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 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 Shengkai and operate our
business in the PRC through Shengkai, we are considered the primary beneficiary
of Shengkai.





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


5





Consigned Management
Agreement





The
Consigned Management Agreement, among SK WFOE, Shengkai, and all of the
shareholders of Shengkai, provides that SK WFOE will provide financial,
business, technical and human resources management services to Shengkai that
will enable SK WFOE to control Shengkai’s operations, assets and cash flow, and
in exchange, Shengkai will pay a management fee to SK WFOE equal to 2% of
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 Shengkai.





Technology
Service Agreement





The
Technology Service Agreement, among SK WFOE, Shengkai, and all of the
shareholders of Shengkai, provides that SK WFOE will provide technology
services, including the selection and maintenance of Shengkai’s computer
hardware and software systems and training of 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 Shengkai’s staff to increase productive use of
the new equipments and increase Shengkai’s overall production
capacity.





As
consideration for such services, Shengkai will pay a technology service fee to
SK WFOE equal to 1% of 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 Shengkai.




Loan Agreement





The Loan
Agreement, among SK WFOE and all of the shareholders of 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 Shengkai, each shareholder
receiving a share of the loan proceeds proportional to its shareholding in
Shengkai, and in exchange each shareholder agreed (i) to contribute all of its
proceeds from the loan to the registered capital of Shengkai in order to
increase the registered capital of Shengkai, (ii) to cause 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 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 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 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 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 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, Shengkai is not obligated to make such a
payment. The effect of this provision is that (insofar as allowable under PRC
law) 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 Shengkai that during
the term of the agreement, they will elect as directors of Shengkai only
candidates nominated by SK WFOE, and they will use their best efforts to ensure
that 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, Shengkai will promptly distribute all distributable dividends to
the shareholders of Shengkai.





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.


6





Exclusive Purchase Option
Agreement





The
Exclusive Purchase Option Agreement, among SK WFOE, Shengkai, and all of the
shareholders of Shengkai, provides that Shengkai will grant SK WFOE an
irrevocable and exclusive right to purchase all or part of Shengkai’s assets,
and the shareholders of Shengkai will grant SK WFOE an irrevocable and exclusive
right to purchase all or part of their equity interests in 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. 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 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 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 Shengkai or substantially all of the assets of
Shengkai. The exclusive purchase options were granted under the agreement on May
30, 2008.





Equity
Pledge Agreement





The
Equity Pledge Agreement, among SK WFOE, Shengkai, and all of the shareholders of
Shengkai, provides that the shareholders of Shengkai will pledge all of their
equity interests in Shengkai to SK WFOE as a guarantee of the performance of the
shareholders’ obligations and Shengkai’s obligations under each of the other PRC
restructuring agreements. The Equity Pledge Agreement contains promises from
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 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 Shengkai have also agreed (i) to
cause 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
Shengkai during the term of the agreement into an escrow account under the
supervision of SK WFOE, and (iii) to deliver 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 Shengkai
to exercise their shareholder's rights in 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, 2009,
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 Shengkai’s registered capital, and therefore the ownership of
Shengkai, took the form represented in the table below:





Name of Shareholder
                        
                        Amount of Contribution
                          (RMB)
                        
                        
                        Percent of Capital
                          ContributionWang Chen
                        
                        
                        45,689,600
                        
                        
                        
                        71.39Guo
      Wei
                        
                        
                        8,531,200
                        
                        
                        
                        13.33Zhao
      Yanqiu
                        
                        
                        4,192,000
                        
                        
                        
                        6.55Ji
      Haihong
                        
                        
                        4,192,000
                        
                        
                        
                        6.55Zhang
      Ying
                        
                        
                        307,200
                        
                        
                        
                        0.48Miao
      Yang
                        
                        
                        307,200
                        
                        
                        
                        0.48Chen
      Fang
                        
                        
                        307,200
                        
                        
                        
                        0.48Wu
      Yanping
                        
                        
                        236,800
                        
                        
                        
                        0.37Liu
      Naifan
                        
                        
                        236,800
                        
                        
                        
                        0.37Total
                        
                        RMB
                        64,000,000
                        
                        
                        
                        100
                        %




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).


7





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, Shengkai 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 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 Shengkai, preparing Shengkai’s business plan, and assisting in the
corporate restructuring and financial documentation.


8





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, 2010, 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, 2010, pursuant to the terms of the Securities Escrow Agreement,
all shares held in escrow had been released back to the Principal
Shareholder.





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, 2010, all of the $500,000 had been released back to the
Company.


9




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 Shengkai’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


·
            Liu
    Xiaoqian


·
            He
  Li


·
            Ruan
    Xiangyi


·
            Li
  Juan


10





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 Shengkai, preparing
Shengkai’s 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.





·
            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.




11




·
            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, 2010, 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, 2010, 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.





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.


12





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.





Subsidiaries





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




Business
Overview




We
believe that Shengkai is the 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 and other countries in the
Asia-Pacific region. Totaling over 400 customers, the company became a supplier
of China Petroleum & Chemical Corporation (“CPCC” or “Sinopec”) in 2005 and
a member of the PetroChina Co. Ltd. (“PetroChina”) supply network in 2006.
Shengkai is currently the only domestic ceramic valve manufacturer entering into
the CPCC and PetroChina supply system, after a six-year application
process.





Shengkai
develops ceramic products with more than 730 types and specifications in 34
series, under 9 categories. Of these, 22 national patents have been obtained for
its valve products. Shengkai’s product won the title of “National Key New
Product” four times from 1999-2003 and won a silver medal in the Shanghai
International Industry Fair in 2002. In 2003, Shengkai 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 other domestic and overseas industrial ceramic valves
manufacturers limits production to small-bore ball valves with pressure levels
below 2.5MPa. In contrast, Shengkai produces 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 700 specifications that sustain a
maximum pressure level of 42MPa. The largest ceramic valve caliber produced by
Shengkai is 1,000mm. Currently, we believe that other manufacturers in the world
only produce ceramic ball valves and ceramic adjustable valves with 150mm
caliber or less.





Business
History





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, 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 the Ceramic Valve Industry in China




At present, the world valve industry is in a position of stable
development. According to statistical data in “Industrial Valves: World Markets”
report published by the McIlvaine Company (the “McIlvaine Report”), as of 2008,
there are more than 50,000 valve manufacturers. Based on a 2008 Freedonia Group
Report, the worldwide industrial valve market is expected to increase 4.4%
annually through 2011 to $77.5 billion.


13





Since
reforming and opening its markets, China’s valve industry has developed rapidly.
According to the data from China Mechanical Electrical Data Online, at the end
of November 2008, the number of Chinese valve manufacturers was up to over
6,000, representing 8% of the world’s total suppliers; more than 1000 of them
have sales of over RMB5 million. According to statistical data from the China
Valve Industrial Association, gross industrial output value reached RMB114.74
billion in 2008, which increased 25.03% compared with the previous
year.





Market
dispersion is more pronounced in the valve industry than many other industries
and subjects to intense competition: according to a China Machinery Industry
Federation report, the top 15 of the world manufacturers had a sales volume less
than $8.93 billion in 2008 with a world market share of approximately 19%;
according to statistical data in “ Valve Communication” published by the China
Valve Industrial Association, the top 10 Chinese valve industry manufacturers
only had a sales volume of RMB6.34 billion, with a Chinese market share of less
than 5.5 percent.




Operations
of Shengkai




Shengkai
designs, manufactures and distributes ceramic valves in 34 series under 9
categories, covering almost every general type of valve available for industrial
use in the world. Shengkai’s 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 22,000 m2, with
131 sets of machine tools, of which 40 sets are for ceramics, and 91 sets of
digitally controlled machine tools. Ceramic valve output in fiscal year 2010 was
14,376 sets.





Ceramics
are friable and non-plastic and, given that to-date we believe that there is no
special equipment available for ceramic processing in the world, as such not
only can be difficult to process but also have a limited field of application.
Shengkai has overcome these disadvantages 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 Shengkai to apply cold-working techniques to
      its ceramic products.




Shengkai
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 effectively controls the contraction ratio during the
ceramic sintering process to greatly improve the rate of finished products.
Currently, the rate of sintered finished goods of various calibers of Shengkai’s
valve products has reached over 90%, and firing temperatures for Shengkai’s
products are 80°C-120°C lower than the world standard in the
industry.





Shengkai
has also developed various joint 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. Shengkai 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 Shengkai's ability to produce a comprehensive category of
high-quality ceramic products, together with its self-developed ceramic
processor, leak-proof valve sealing technology and strong technology development
capacity, distinguish it from its domestic and international
competitors.




Products




Shengkai
mainly produces industrial ceramic valves with calibers 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 are
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, 2010, Shengkai’s top 10 customers were as
follows:


14





Major
customers and sales amount for fiscal year 2010





Name
                          
                          Amount (RMB)Changsha
      Kaigao Valve Whole Set Co., Ltd.
                          
                          
                          14,817,952.95Jiangxi
      Xinghuo Machinery Company Changsha Branch
                          
                          
                          12,864,216.05Changchun
      Gaoneng Valve Co., Ltd.
                          
                          
                          10,057,417.93Shandong
      Keneng Power Chemical Equipment Sets Co., Ltd.
                          
                          
                          9,899,651.87Jilin
      Universal Valve Co., Ltd.
                          
                          
                          9,510,417.07Xiamen
      Sanhua Electrial Equipment Co., Ltd.
                          
                          
                          9,256,051.32Inner
      Mongolia DaiHai Electric Power Generation Co., Ltd
                          
                          
                          8,776,934.18Lanzhou
      High Pressure Valve Co., Ltd.
                          
                          
                          8,742,355.39Zhejiang
      Huanqiu Power Station Valve Co., Ltd., Changchun Branch
                          
                          
                          8,324,038.44Shanghai
      High & Medium Pressure Valves Co., Ltd., Hunan Branch
                          
                          
                          8,318,369.14





Our top
10 customers contributed approximately 27.17% of total sales in the fiscal year
ended June 30, 2010.  No customer individually accounted for more than
4.0% of total sales.





For the
year ended June 30, 2009, Shengkai’s top 10 customers were as
follows:





Major
customers and sales amount for fiscal year 2009





Name
                      
                      Amount (RMB)Lanzhou
      High Pressure Valve Co., Ltd.
                      
                      
                      17,094,017.11Jiangxi
      Xinghuo Machinery Company Changsha Branch
                      
                      
                      14,110,848.77Jiangxi
      Hydropower Engineering Bureau
                      
                      
                      13,335,232.60Shanghai
      High & Medium Pressure Valves Co., Ltd Hunan Branch
                      
                      
                      13,241,741.26Hunan
      Yiyang Power Generating Co., Ltd.
                      
                      
                      10,513,373.94Changsha
      Kaigao Valve Whole Set Co., Ltd.
                      
                      
                      10,400,280.34Shijiazhuang
      Jinshi Chemical Fertilizer Co., Ltd.
                      
                      
                      9,247,359.84Hunan
      Yiyang No. 2 Power Generating Co., Ltd.
                      
                      
                      8,820,941.21Zhejiang
      Huanqiu Power Station Valve Co., Ltd Changchun Branch
                      
                      
                      8,743,075.64Shanghai
      High & Medium Pressure Valves Co., Ltd Changchun
Branch
                      
                      
                      8,657,266.67




Our top
10 customers contributed approximately 42.5% of total sales in the fiscal year
ended June 30, 2009.  No customer individually accounted for more than
7% of total sales.





For the
year ended June 30, 2008, Shengkai’s top 10 customers were as
follows:





Major
customers and sales amount for fiscal year 2008





Name
                      
                      Amount (RMB)Datang
      Qitai River Power Generation Co., Ltd.
                      
                      
                      17,253,633.32Dezhou
      Power Plant under Huaneng Power International, Inc.
                      
                      
                      11,197,436.18Anhui
      Huainan Luoneng Power Generation Co., Ltd.
                      
                      
                      8,551,011.97Xinjiang
      Duzishan Petrochemical and Chemical Construction Co., Ltd.
                      
                      
                      7,653,468.38Zhenjiang
      Huanqiu Power Station Valve Co., Ltd. Changchun Branch
    Company
                      
                      
                      7,067,250.42Datang
      Chang Mountain Thermoelectricity Plant
                      
                      
                      6,709,399.98Hunan
      Yiyang No. 2 Power Generating Co., Ltd.
                      
                      
                      6,131,890.63Guodian
      Bengbu Power Plant
                      
                      
                      6,108,519.92Tianjin
      Chentang Thermoelectricity Co., Ltd.
                      
                      
                      5,781,399.08Beijing
      Guodian Longyuan Environmental Engineering Co., Ltd.
                      
                      
                      5,621,048.71




Our top
10 customers contributed approximately 34.79% of total sales in the fiscal year
ended June 30, 2008.  No customer individually accounted for more than
8.0% of total sales.


15





Suppliers





For the
year ended June 30, 2010, Shengkai’s top 10 suppliers were as
follows:





Suppliers
and purchase amount for fiscal year 2010





Name
                  
                  Amount (RMB)Changzhou
      Lanfa Gm Equipment Co., Ltd.
                  
                  
                  10,993,789.26Botou
      Alloy Casting Plant
                  
                  
                  8,873,372.42Tianjin
      Baifu Actuator Technique Co., Ltd.
                  
                  
                  8,083,136.77Jingning
      Zhenhua Alloy Steel Pump Manufactory, Ltd.
                  
                  
                  6,471,029.44Wuxi
      Minwei Hydraulic Pneumatic Manufactory, Ltd.
                  
                  
                  5,826,316.19Tianjin
      Dongrui Foundry Co., Ltd.
                  
                  
                  5,397,730.42Tianjin
      Tuocheng Metal Products Co., Ltd.
                  
                  
                  4,635,150.05Tianjin
      Zhiliang Metal Forging Co., Ltd.
                  
                  
                  4,619,397.82Cangzhou
      Changyuan Pipe Fittings Co., Ltd.
                  
                  
                  4,354,719.45Jiangsu
      Yangzhou Electric Power Equipment Manufacture Factory
                  
                  
                  4,337,680.41





For the
year ended June 30, 2009, Shengkai’s top 10 suppliers were as
follows:





Suppliers
and purchase amount for fiscal year 2009





Name
                      
                      Amount (RMB)Jiangxi
      Yongle Trading Co., Ltd.
                      
                      
                      6,529,539.19Botou
      Alloy Casting Plant
                      
                      
                      5,987,987.71Cangzhou
      Changyuan Pipe Fittings Co., Ltd.
                      
                      
                      5,451,979.45Changzhou
      Lanfa Gm Equipment Co., Ltd.
                      
                      
                      5,387,391.30Foshan
      Nanhai Leju Commercial Storage Co., Ltd.
                      
                      
                      5,308,656.51Foshan
      Nanhai Steel Co., Ltd.
                      
                      
                      5,103,563.64Shanghai
      Hexi Electrical & Mechanical Equipment Co., Ltd.
                      
                      
                      5,065,455.95Tianjin
      Tuocheng Metal Products Co., Ltd.
                      
                      
                      3,432,254.86Tianjin
      Zhiliang Metal Forging Co., Ltd.
                      
                      
                      3,181,679.55Tianjin
      Dongrui Foundry Co., Ltd.
                      
                      
                      2,938,489.38





For the
year ended June 30, 2008, Shengkai’s top 10 suppliers were as
follows:





Suppliers
and purchase amount for fiscal year 2008





Name
                      
                      Amount (RMB)Botou
      Alloy Casting Plant
                      
                      
                      9,164,139.73Tianjin
      Dongrui Foundry Co., Ltd.
                      
                      
                      6,801,853.11Tianjin
      Baili Ertong Machinery Co., Ltd.
                      
                      
                      4,122,075.62Nansuo
      Construct Plastic Produce (Shenzhen) Co., Ltd.
                      
                      
                      3,343,373.74Beijing
      Huasheng Weiye Industry Trade Company
                      
                      
                      2,873,239.50Tianjin
      Zhiliang Metal Forging Co., Ltd.
                      
                      
                      2,709,140.68Tianjin
      Jinwan’an Pneumatic Hydraulic Complete Equipment Co., Ltd.
                      
                      
                      2,438,064.95Tianjin
      Tiansha Haiyan Grinding Tools Manufacturing Co., Ltd.
                      
                      
                      2,041,233.64Beijing
      Zhongyuan Kaifa High Pressure Valve Co., Ltd.
                      
                      
                      2,009,471.76Shanghai
      Yuelong Material Co., Ltd.
                      
                      
                      1,863,865.19




Marketing
and Sales





In the
fiscal year ended June 30, 2010, Shengkai spent RMB1,795,022.13 for marketing
and sales efforts and in 2011 plans to invest an additional RMB2,500,000. Such
funding will be used 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, Shengkai 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. It will continue to increase its
sales force, enlarge investment in marketing and increase sales volume.
Department No. 2 engages in international sales and utilizes foreign agents to
conduct sales in international markets. We have already obtained approval and
authentication to export to Europe, North America, and the Asia-Pacific
region.


16





Sales training: Each member of
sales personnel in the company are 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: Shengkai
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.





New industries: Shengkai aims
to increase sales to customers in the petrochemical and chemical and electric
power industry. Shengkai will also dedicate its energies to expanding our market
into new fields like paper and pulp, metallurgy and ore mining. We have gained
the qualification of first-class supplier for PetroChina and CPCC and have made
inroads into the petrochemical industry. In the fiscal year 2010, revenue was
$54,148,954, with the power industry comprising approximately 65.2% of revenue,
and petrochemical and chemical, the aluminum, metallurgy and other industries
comprising approximately 29.3%, 1.6%, 2.1% and 1.8%, respectively. We anticipate
that in fiscal year 2011, the petrochemical industry will comprise approximately
40% of Shengkai's revenue, and the power industries and other industries will
comprise 55% and 5% of Shengkai's revenue, respectively.




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. According to
our estimates, sales volume for ceramic valves in China represented less than 1%
of the total volume for industrial valves in China in 2009.





Shengkai’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 most
cost-effective than metal valves. Primary Chinese metal valve competitors
include CNNC Sufa Technology Industry Co., Ltd, Neway Valve (Suzhou) Co., Ltd.,
Hunan Kefeng High-Pressure Valves Co., Ltd., and Lanzhou High-Pressure Valves
Co., Ltd.




Within
the ceramic valve industry, at present we estimate that we represent over 70% of
the Chinese market. The business of our primary ceramic valve competitors is
briefly described below:




Ceresist Inc. 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. There is no branch in China so far.





Fujikin of America
Inc. Primary line of business: semiconductor material 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. There is no branch in China so
far.





Shenzhen Nanbo Structure
Ceramics Co., Ltd. Primary line of business: series of high-quality
small-sized ceramic ball valves with ball, with favorable market share. Its
production mainly relies on imported ceramic equipment with single variety and
small caliber. The company conducts no research and development of ceramics and
does not have large-scale production capacity for ceramic 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 U.S. valve manufacturers Ceresist 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, there are fewer than 10 domestic
ceramic valve manufacturers, all of which have sales volumes below RMB5 million.
With the exception of Shenzhen Nanbo Structure Ceramics Co., Ltd., these
companies mainly depend on outsourcing for ceramic pieces.


17





Our
Competitive Advantages





At
present, we estimate that we represent over 70% of the market share in the
Chinese ceramic valve market. 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 valves
manufacturers limit production to small-bore ball valves with pressure levels
below 2.5MPa. In contrast, Shengkai produces 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 730 specifications that sustain a
maximum pressure level of 42MPa. The largest ceramic valve caliber produced by
Shengkai is 1,000mm; currently, we believe that other manufacturers in the world
only produce ceramic ball valves and ceramic adjustable valves with 150mm
caliber or less. We believe that Shengkai's ability to produce a comprehensive
category of high-quality ceramic products, together with its self-developed
ceramic processor, leak-proof valve sealing technology and strong technology
development capacity, set it apart from its domestic and international
competitors.





The
company will further strengthen cooperation with colleges and universities, so
as to realize a better integration of practical experience of the company and
intellectual resources of the universities.





Our
Future Goals and Expansion Plans





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. We will keep expanding market
      share in the international market via well-known foreign agents, so as to
      enhance sales volume and profit in the international
      market.





We broke
ground for our new facility in March 2009. Construction of the new manufacturing
plant was completed in June 2010 and commercial production at this new facility
began in September 2010. Our headquarters building was also completed in
September 2010. The new facility is expected to increase production capacity to
24,000 sets of 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.  Should we
reach 100% production capacity at the new facility, we may further increase our
production capacity by adding shifts for some of the production processes and
acquire additional machines to support the additional capacity.





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





Shengkai
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. Shengkai 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 June 2010, Shengkai has
introduced digital-control processing centers that will greatly enhance process
precision and efficiency and will improve the overall quality of Shengkai’s
valves. We anticipate that digitalization will also reduce the need for a
larger, highly skilled workforce.





Intellectual
Property




Shengkai
has certain intellectual property rights as listed below:


18




Patents





We have
applied for and obtained 22 patents in the PRC for the following
products:


No.
              
              Utility Models
              
              Utility Models No.
              
              Designer
              
              Application
                Date
              
              Authorized
                Announcement
                Date
              
              Owner1
              
              High
      temperature and high Pressure ceramic check valves in power
      station
              
              ZL
      200420029890.0
              
              Wang
      Chen
              
              10/10/2004
              
              2/1/2006
              
              Shengkai2
              
              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
              
              Shengkai3
              
              Anti-fouling
      ceramic seal discharge valves
              
              ZL
      200420029887.9
              
              Wang
      Chen
              
              10/10/2004
              
              12/7/2005
              
              Shengkai4
              
              Reciprocating
      sliding dual- plate ceramic sealing valves
              
              ZL
      200420029886.4
              
              Wang
      Chen
              
              10/10/2004
              
              2/1/2006
              
              Shengkai5
              
              New
      ceramic replica valves
              
              ZL
      200420029885.X
              
              Wang
      Chen
              
              10/10/2004
              
              11/9/2005
              
              Shengkai6
              
              External
      composite armor plate for tank
              
              ZL
      2004 2 0029600.2
              
              Wang
      Chen
              
              8/24/2004
              
              8/3/2005
              
              Shengkai7
              
              The
      new V-shaped channel spherical valves
              
              ZL
      2004 2 0029601.7
              
              Wang
      Chen
              
              8/3/2004
              
              8/3/2005
              
              Shengkai8
              
              Cavitation
      and erosion-resistant high-pressure adjusting valves
              
              ZL
      2004 2 0029602.1
              
              Wang
      Chen
              
              8/24/2004
              
              8/3/2005
              
              Shengkai9
              
              New
      ceramic three links valves
              
              ZL
      2004 2 0029603.6
              
              Wang
      Chen
              
              8/24/2004
              
              8/3/2005
              
              Shengkai10
              
              Ceramic
      valves with purge devices
              
              ZL
      200820002560
              
              Wang
      Chen
              
              1/22/2008
              
              2/1/2008
              
              Shengkai11
              
              Throttle
      ceramic valves
              
              ZL
      200820002561.5
              
              Wang
      Chen
              
              1/22/2008
              
              2/1/2008
              
              Shengkai12
              
              Fast-opening
      ceramic adjusting valves
              
              ZL
      200820002565.3
              
              Wang
      Chen
              
              1/22/2008
              
              2/1/2008
              
              Shengkai13
              
              Eccentric
      anti-seize abrasion-resistant spherical valves
              
              ZL
      200820002564.9
              
              Wang
      Chen
              
              1/22/2008
              
              2/1/2008
              
              Shengkai14
              
              Spherical
      ceramic adjusting valves
              
              ZL
      200820002562.X
              
              Wang
      Chen
              
              1/22/2008
              
              2/1/2008
              
              Shengkai15
              
              Ceramic
      butterfly valves
              
              ZL
      200820002563.4
              
              Wang
      Chen
              
              1/22/2008
              
              2/1/2008
              
              Shengkai16
              
              Ceramic
      seal switching valves
              
              ZL
      200820002566.8
              
              Wang
      Chen
              
              1/22/2008
              
              2/1/2008
              
              Shengkai17
              
              Fine-tuning
      ceramic adjusting valves
              
              ZL
      200820002567.2
              
              Wang
      Chen
              
              1/22/2008
              
              2/1/2008
              
              Shengkai18
              
              Hemispherical
      ceramic adjusting valves
              
              ZL
      200820002559.8
              
              Wang
      Chen
              
              1/22/2008
              
              2/1/2008
              
              Shengkai19
              
              Ceramic
      ball check valves
              
              200920179548.1
              
              Wang
      Chen
              
              10/12/2009
              
              11/4/2009
              
              Shengkai20
              
              Three
      links switching ceramic cut-off valves
              
              200920179544.3
              
              Wang
      Chen
              
              10/12/2009
              
              11/4/2009
              
              Shengkai21
              
              Pneumatic
      ceramic seal shut-off valve
              
              200920179546.2
              
              Wang
      Chen
              
              10/12/2009
              
              11/4/2009
              
              Shengkai22
              
              An
      enhanced ceramic sphere
              
              200920179545.8
              
              Wang
      Chen
              
              10/12/2009
              
              11/4/2009
              
              Shengkai




Shengkai has patent applications
pending for the following products:





Name
                
                Patent No.
                
                Application DateCeramic
      ball cut-off valves
                
                200920179547.7
                
                October
      12, 2009Ceramic
      seal swing check valves
                
                200920179549.6
                
                October
      12, 2009High
      pressure ceramic flat gate valve
                
                200920179550.9
                
                October
      12, 2009Throttle
      ceramic cut-off valve
                
                200920179551.3
                
                October
      12, 2009





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:


19





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
                            
                            Shengkai
                            
                            2/21/2002
      to 2/20/2012No.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
                            
                            Shengkai
                            
                            5/7/2007
      to 5/6/2017No.4152532
                            
                            No.20:
      non-metallic valves, non-metallic ball valves, plastic water pipe valves,
      plastic drip valves
                            
                            Shengkai
                            
                            5/7/2007
      to 5/6/2017No.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
                            
                            Shengkai
                            
                            10/14/2006
      to 10/13/2016No.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
                            
                            Shengkai
                            
                            10/14/2006
      to 10/13/2016No.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
                            
                            Shengkai
                            
                            10/14/2006
      to
10/13/2016




20





Shengkai
has registered the following domain names:





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





Employees





As of
September 20, 2010, Shengkai had 184 employees, 85 of which possess a diploma
over junior college level, representing 46.2% of the work force recruited. We
currently have 26 senior-level professionals and 12 mid-level professionals with
graduate 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, 2010, our average compensation per employee per month was
RMB3,500, or approximately $515. 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.





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.


21





·
            Business License (No.
      120191000015144) reissued on August 17, 2009 by Tianjin Administration for
      Industry and Commerce.





·
            Organization
      Code Certificate issued by Tianjin Quality Supervision and Inspection
      Bureau (code No. 23967678-2, and registration No. Zu Dai Guan
      120191-030551), the valid period of which is from October 19, 2006 to
      October 18, 2010. The company has passed the 2007 annual
      inspection.





·
            Taxation Registration Certificate
      (Jin Guo Shui Zi No. 120115239676782) issued by the Tianjin
      Economic-Technological Development Area Branch of the State Administration
      of Taxation on October 30,
2006.





·
            Taxation Registration Certificate
      (Jin Di Shui Zi No. 120115239676782) issued by the Tianjin
      Economic-Technological Development Area Branch of the Local Tax Bureau on
      October 26, 2006.





·
            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.





·
            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.





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





·
            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 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 5,
2008.





·
            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.





·
            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.





Item
1A. Risk Factors.




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 Shengkai. Under the present
structure, although there is no change in personnel, we have agreements with
Shengkai pursuant to which we manage and derive the profit from Shengkai’s
business by providing the exclusive supporting services from SK WFOE to
Shengkai. It is possible that the change in our business structure may impair
our ability to operate our business.


22





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 75.03% of our
common stock as of September 20, 2010. 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.




Because
we may require additional financing to expand our operations, our failure to
obtain necessary financing may impair our operations.





At June
30, 2010, we had working capital of approximately $23,613,693.
Our capital requirements in connection with the development of our business are
significant. During the fiscal year ended June 30, 2010, we spent approximately
$47,320,868 for the purchase of raw materials and supplies and equipment and
other fixed assets, of which $20,809,955 was used to purchase raw materials and
supplies and $26,510,913 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.




Shengkai
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. Three 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.


23





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.




Our
business and operations are experiencing rapid growth. If we fail to effectively
manage our growth, our business and operating results could be
harmed.




We have
experienced, and continue to experience, rapid growth in our operations, which
has placed, and will continue to place, significant demands on our management,
operational and financial infrastructure. If 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.




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.


24





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
Chen Wang, 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 75.03% 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 Shengkai, the entity through which we operate our business.





Mr. Wang
Chen currently serves as executive director of Shengkai. Shengkai’s Articles of
Association provides for its governance by an executive director, instead of a
board of directors, to be appointed by 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 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 Shengkai by a single executive director
could result in inadequately vetted business decisions that could negatively
affect the performance of our operations.





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;


25




·
            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 of
      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;





·
            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 encourage 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.


26





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 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.


27





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.





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.


28





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 Incentive Stock Plan or
outside of the 2010 Incentive Stock Plan, 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, 2010, management has  detected a material
weakness and certain deficiencies in our internal control with respect to the
assessment of the internal control for the year then ended, and 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 16,452,211 shares of common stock
so issuable would constitute approximately 41.5% 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.


29




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.





Item
1B. Unresolved Staff Comments.




Not
Applicable.




Item 2.   Properties.




Our main office and our manufacturing facilities are located in Tianjin,
China, on a plot of land approximately 10,023 square meters in size. We have
been issued a Land Use Right Certificate for the land until September 21, 2048
by the municipal government of Tianjin, which may be renewed. We currently own
and lease six buildings on the property as listed below. We believe that our
existing facilities are well maintained and in good operating
condition.





In
October 2008, we successfully won a bid on a 50-year land use right over a plot
of land approximately 43,566.3 square meters in size. The land is located in
Tianjin, China and the bid price is RMB12.6 million (approximately $1.8
million). The formal contract was signed with the government on Jan 23, 2009,
and we settled the bid price in full in March 2009.  The purpose of
the acquisition of land was to build a new plant to enable us to expand our
production capacity.  Such expansion of production capacity, completed
in June 2010, will substantially increase our capital expenditures.





Our land
use rights are set forth below:





Land
Use Rights through Grants from Land Management Authority





Plot A
                    
                    Plot BLand
      No.
                    
                    No.
      01-17-(3)-8
                    
                    No.
      1201104020180020001Land
      Use Right Certificate No.
                    
                    Jin
      Nan Dan Guo Yong (2001) Geng 2 Zi No.045
                    
                    Bao
      Dan Guo Yong (2009) No. 022User
      of the Land
                    
                    Shengkai
                    
                    SK
      WFOELocation
                    
                    Wang
      Gang Road, Shuangang, Jinnan Economic & Technology Development Area,
      Tianjin
                    
                    Tianjin
      Airport Logistics Processing Zone, No. 2008-21Usage
                    
                    Commercial
      Services
                    
                    Commercial
      ServicesArea ( m2
      )
                    
                    10,023.0
                    
                    43,566.3Form
      of Acquisition
                    
                    Grant
      from related Land Management Authority
                    
                    Grant
      from related Land Management AuthorityExpiration
      Date
                    
                    September
      21, 2048
                    
                    January
      23, 2059Encumbrances
                    
                    N/A
                    
                    N/A





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





Owned
Premises





Part 1
                      
                      
                      Part 2
                      
                      
                      Part 3
                      
                      
                      Part 4
                      
                      
                      Part 5Certificate
      No.
                      
                      No.
      11230902147Owner
                      
                      ShengkaiLocation
                      
                      Wang
      Gang Road, Shuangang, Jinnan Economic& Technology Development Area,
      TianjinCategory
                      
                      PrivateArea (   m2
        )
                      
                      
                      931.06
                      
                      
                      
                      1192.90
                      
                      
                      
                      493.64
                      
                      
                      
                      824.74
                      
                      
                      
                      2691.41Usage
      of Design
                      
                      Industry
                      
                      
                      Industry
                      
                      
                      Industry
                      
                      
                      Industry
                      
                      
                      IndustryStructure
                      
                      Mixture
                      
                      
                      Mixture
                      
                      
                      Mixture
                      
                      
                      Mixture
                      
                      
                      MixtureEncumbrances
                      
                      Up
      to 6133.75 m2
      are subject to a security interest held by Industrial Bank Co.,
      Ltd.,
                        Tianjin
      Branch, from December 12, 2009 through October 22, 2010


30


Leased Premises





No.
                        
                        Lessor
                        
                        Location
                        
                        Term
                        
                        Rent per Year
                          (USD)1
                        
                        Tianjin Jinbin Nanhua Premises Purchasing Co., Ltd.
                        
                        Room324, 3/F, 1st Street, Tianjin Economic-Technological Development
      Area
                        
                        January
      12, 2008 to January 11, 2010
                        
                        $
                        2,084.32
                        
                        Tianjin
      Development Zone Binhai Investment Service Co., Ltd.
                        
                        Room
      325, Part I, 122 Dongting Road, Tianjin Development Zone
                        
                        August
      17, 2010 to October 16, 2011
                        
                        $
                        610.40




Item 3.
            Legal Proceedings.




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.




Item 4.
            (Removed and
      Reserved).





PART
II




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




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 under the symbol
“SKII”, “SOSA,” and “SSAU” prior to December 23, 2009.




The range
of high and low bid quotations by quarter from July 1, 2008 through June 30,
2010 is listed below. The range of high and low bid quotations for the quarters
of the last two years ended June 30, 2010 is listed below. The quotations are
taken from the Over-the-Counter Bulletin Board and NASDAQ. They reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may
not necessarily represent actual transactions.




Fiscal Quarter
                    
                    Low Bid
                    
                    High Bid2009
      First Quarter
                    
                    
                    4.50
                    
                    1.752009
      Second Quarter
                    
                    
                    3.00
                    
                    1.052009
      Third Quarter
                    
                    
                    2.50
                    
                    1.272009
      Fourth Quarter
                    
                    
                    2.90
                    
                    1.852010
      First Quarter
                    
                    
                    4.00
                    
                    2.852010
      Second Quarter
                    
                    
                    5.70
                    
                    3.602010
      Third Quarter
                    
                    
                    10.56
                    
                    5.272010
      Fourth Quarter
                    
                    
                    9.00
                    
                    7.27





As of
September 20, 2010, we had approximately 927 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.





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.


31


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 Incentive Stock Plan 2010 Incentive Stock Planas
of June 30, 2010. 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.




Equity Compensation Plan InformationPlan 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
                                    
                                    $
                                    7.29
                                    
                                    -Equity
      compensation plans not approved by security holdersTotal
                                    
                                    2,211,250
                                    
                                    $
                                    7.29
                                    
                                    -




Recent
Sales of Unregistered Securities




On June
9, 2008, we issued an aggregate of 97,250 shares of our common stock to various
consultants and employees as compensation for services.





On June
9, 2008, we entered into the Merger Agreement and on June 11, 2008 consummated
the June 2008 Purchase Agreement, each as described in the section “REVERSE
MERGER AND PRIVATE PLACEMENTS - Private Placement (June 2008 Financing)”
above.





On July
18, 2008, we consummated the July 2008 Purchase Agreement, as described in the
section entitled “REVERSE MERGER AND PRIVATE PLACEMENTS - Private Placement
(July 2008 Financing)” above.




The
issuance of shares of common stock, Units, Series A Preferred Stock and Warrants
under the Merger Agreement, the June 2008 Purchase Agreement and July 2008
Purchase Agreement was exempt from registration pursuant to Section 4(2) of the
Securities Act based upon our compliance with Regulation D as promulgated by the
SEC under the Securities Act of 1933, as amended (the “Securities
Act”).





In
connection with the foregoing, we relied upon the exemption from securities
registration afforded by Rule 506 of Regulation D and/or Section 4(2) of the
Securities Act, and transfers of such shares were restricted by the Company in
accordance with the requirements of the Securities Act. All of the
above-referenced persons were provided with access to our Securities and
Exchange Commission filings.




Item 6.
            Selected Financial
      Data.





The
following selected statement of operations data contains statement of operations
data and balance sheet data of Shengkai, the entity through which we operate our
business, for the fiscal years ended June 30, 2010, 2009, and 2008. 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.


32


Statements of Operation Data





Twelve months ended June 30,2010
                                                  
                                                  
                                                  2009
                                                  
                                                  
                                                  2008Net revenues
                                                  
                                                  $
                                                  54,148,954
                                                  
                                                  
                                                  $
                                                  39,297,235
                                                  
                                                  
                                                  $
                                                  32,355,693Cost
      of sales
                                                  
                                                  
                                                  (21,916,944
                                                  )
                                                  
                                                  
                                                  (15,267,244
                                                  )
                                                  
                                                  
                                                  (13,211,608
                                                  )Gross profit
                                                  
                                                  $
                                                  32,232,010
                                                  
                                                  
                                                  $
                                                  24,029,991
                                                  
                                                  
                                                  $
                                                  19,144,085Other
      income - disposal of property, plant and equipment
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  31,712Other
      miscellaneous income
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  112,758
                                                  
                                                  
                                                  $
                                                  -Operating
      expenses:Selling
                                                  
                                                  
                                                  (5,093,859
                                                  )
                                                  
                                                  
                                                  (3,760,970
                                                  )
                                                  
                                                  
                                                  (2,951,888
                                                  )General
      and administrative
                                                  
                                                  
                                                  (6,530,876
                                                  )
                                                  
                                                  
                                                  (2,474,872
                                                  )
                                                  
                                                  
                                                  (1,973,331
                                                  )Stock
      compensation expense
                                                  
                                                  
                                                  (15,971,920
                                                  )
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Income
      from operations
                                                  
                                                  $
                                                  4,635,355
                                                  
                                                  
                                                  $
                                                  17,906,907
                                                  
                                                  
                                                  $
                                                  14,250,578Other
      income - material sales and government grant
                                                  
                                                  
                                                  223,127
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Other
      income - tax refund
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Other
      expense - transaction costs for reverse merger
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (43,209
                                                  )Other
      expense
                                                  
                                                  
                                                  (17,629
                                                  )
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (32
                                                  )Interest
      income
                                                  
                                                  
                                                  387,675
                                                  
                                                  
                                                  
                                                  193,149
                                                  
                                                  
                                                  
                                                  18,562Changes
      in fair value of instruments - (loss)/gain
                                                  
                                                  
                                                  (56,910,599
                                                  )
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -(Loss)
      Income before income taxes
                                                  
                                                  $
                                                  (51,682,071
                                                  )
                                                  
                                                  $
                                                  18,100,056
                                                  
                                                  
                                                  $
                                                  14,225,899Income
      taxes
                                                  
                                                  
                                                  (4,703,494
                                                  )
                                                  
                                                  
                                                  (4,522,362
                                                  )
                                                  
                                                  
                                                  (4,138,860
                                                  )Net
      (Loss) income
                                                  
                                                  $
                                                  (56,385,565
                                                  )
                                                  
                                                  $
                                                  13,577,694
                                                  
                                                  
                                                  $
                                                  10,087,039




Balance Sheet Data





As at June 30,2010
                
                
                2009
                
                
                2008Cash
      and cash equivalents
                
                $
                20,995,182
                
                
                $
                38,988,958
                
                
                $
                21,313,484Working
      capital
                
                
                23,613,693
                
                
                
                40,990,996
                
                
                
                23,592,880Total
      assets
                
                
                84,605,949
                
                
                
                60,253,034
                
                
                
                39,767,207Total
      liabilities
                
                
                86,887,128
                
                
                
                4,746,447
                
                
                
                2,585,665Total
      shareholders’ equity
                
                
                (2,281,179
                )
                
                
                55,506,587
                
                
                
                37,181,542





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, 2009 and 2008 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





Shengkai,
the entity through which we run our operations, is a prominent ceramic valve
manufacturer. We have more than 15 years of experience and possess a unique
method for creating ceramic valves.





We
believe that Shengkai is the one of the few ceramic valve manufacturers in the
world with research and development, engineering, and production capacity for
structural ceramics. Shengkai’s product categories include a broad range of
valves in all industries that are sold throughout China, to Europe, North
America, and other countries in the Asia-Pacific region. Totaling over 400
customers, Shengkai became a supplier of the CPCC in 2005 and a member of the
PetroChina supply network in 2006, after a six-year application
process.


33


Results
of Operations




Comparison
of the Years Ended June 30, 2010 and 2009




Revenue





Revenue
for the fiscal year ended June 30, 2010 was $54,148,954, an increase of
$14,851,719 or 37.8% from $39,297,235 for the comparable period in
2009.  The product output has increased due to increased equipment and
shifts of operation, as well as improved ceramic production technology to
shorten the production cycle of some of our ceramic products. Approximately
94.5% of our revenue came from customers in the electric power, petrochemical
and chemical industries for the fiscal year ended June 30, 2010. The electric
power industry was still the most significant market to our revenue,
contributing approximately 65.2% of total revenue for the fiscal year ended June
30, 2010. Revenue from the electric power industry was approximately $35.3
million for the fiscal year ended June 30, 2010, an increase of approximately
$5.8 million or 19.7% from approximately $29.5 million for the comparable period
in 2009. The increase was primarily attributable to the broadening of our
customer base and increased orders from existing customers. Revenue from the
petrochemical and chemical industry, our potentially biggest market, was
approximately $15.9 million for the fiscal year ended June 30, 2010, an increase
of approximately $8.0 million or 101.3% from approximately $7.9 million for the
comparable period in 2009. The increase was primarily due to our heightened
efforts to develop the market of the petrochemical industry. Revenue from other
industries, including the aluminum and metallurgy industries, was approximately
$3.0 million for the fiscal year ended June 30, 2010, an increase of
approximately $1.1 million or 54.6% from approximately $1.9 million for the
comparable period in 2009.





Gross
Profit





Gross
profit for the fiscal year ended June 30, 2010 was $32,232,010, an increase of
$8,202,019 or 34.1% compared to $24,029,991 for the comparable period in
2009. The increase was primarily attributable to the revenue increase. The
gross profit margin for the fiscal year ended June 30, 2010 was 59.5%, compared
to 61.1% for the comparable period in 2009. The
decrease was attributable to several new large projects started in March and
April 2009with new
customers, which
were set at a higher pricethan
those projectswith
existing customers and temporarily raised our overall gross margin
in fiscal year 2009.





Selling
Expenses





Selling
expenses for the fiscal year ended June 30, 2010 was $5,093,859, an increase of
$1,332,889 or 35.4%, from $3,760,970 for the comparable period in 2009. The
major component of selling expense was commission paid to agents for introducing
new sales, which was approximately $4.4 million for the year ended June 30,
2010, an increase of approximately $1.3 million or 41.9% from approximately $3.1
million for the year ended June 30, 2009. This increase was primarily
attributable to increase of sales revenues. Selling expenses as a percentage of
total sales revenue decreased to 9.4% for the fiscal year ended June 30, 2010
from 9.6% for the comparable period in 2009, primarily attributable to the
revenue increase, as well as to the decrease in media advertisements incurred in
the current period.





General and Administrative
Expenses





General
and administrative expenses for the fiscal year ended June 30, 2010 were
$6,530,876, an increase of $4,056,004 or 163.9% compared to $2,474,872 for the
comparable period in 2009. The increase was primarily attributable to the
recognition of $3,054,332 share-based compensation cost on the options to
independent directors and management granted on March 31, 2010 and June 22, 2010
under the Company’s 2010 Incentive Stock Plan. The increase in general and
administrative expenses was also attributed to the increase over the comparable
periods of fiscal 2009 and 2010 in (i) audit fees due to change of independent
auditor; (ii) research and development expenses; (iii) cash compensation to
independent directors and management staff due to new appointments and hirings;
as well as (iv) expenses for the U.S. capital market related activities such as
NYSE Amex and Nasdaq application and listing fees, costs for participation of
investment conferences and professional consulting fees for corporate internal
control system and U.S. securities regulations compliance.




Stock compensation
expense
 
 Stock
compensations expense for amount of $15,971,920 for the year ended June 30, 2010
resulted from the return of shares of common stock to Long Sunny Limited
pursuant to the Securities Escrow Agreements in the June 2008 and July 2008
Financings and amendments thereto. Long Sunny Limited is wholly-owned by Mr.
Chen Wang, our chief executive officer, and as such the return of the escrowed
shares to Long Sunny Limited within the year ended June 30, 2010 was accounted
for as stock compensation expense, a separate item under general and
administrative expenses, in accordance with Accounting Standards
Update-2010-05.


Interest
expense




There was
no interest expense for the fiscal year ended June 30, 2010 or the comparable
period in fiscal 2009. No short or long term loans were outstanding for the
fiscal years ended June 30, 2010 or 2009.





Changes in fair value of
instruments




For the
fiscal year ended June 30, 2010, the Company incurred non-cash expense for the
aggregate amount of approximately $56.9 million related to its issuance of
Series A warrants and Series A convertible preferred stock in the private
placements in June and July 2008 pursuant to provision of FASB ASC Topic
815,”Derivative and Hedging”(“ASC 815”) as adopted on July 1, 2009. The change
in 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 US Dollars. The change in accounting treatment
of the preferred stock resulted from a down-round provision providing
anti-dilution protection to the preferred stockholders. Both Series A 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 fiscal year ended June 30, 2010.





Provision for Income
Taxes





Provision
for income tax for the fiscal year ended June 30, 2010 was $4,703,494, an
increase of $181,132 or 4.0% from $4,522,362 for the comparable period in 2009.
Excluding the $3.1 million share-based compensation cost and the $56.9 million
charges for changes in fair value of instruments, income before taxes was
approximately $19.6 million for the fiscal year ended June 30, 2010 compared
with approximately $13.6 million for the comparable period in 2009. The less
increase in provision for income taxes was attributable to the new preferential
income tax rate in calendar 2010. In April 2010, Shengkai, the Company’s
operating subsidiary in Tianjin, China, was newly awarded the status of
“high technology” enterprise for the calendar years 2009 through 2011. Hence
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 calendar year 2009. The
applicable income tax rate was 25% for the periods from July 1, 2009 through
December 31, 2009, and for the whole fiscal 2009.


34


Liquidity
and Capital Resources





Cash
and Cash Equivalent




Our cash
and cash equivalents as at the beginning of the fiscal year ended June 30, 2010
was $38,988,958 and decreased to $20,995,182 by the end of the period, a
decrease of $17,993,776 or 46.2%. The net change in cash and cash
equivalents represented a decrease of $17,675,474 or 89.2% from $21,313,484 for
the comparable period in 2009. The decrease was primarily attributable to the
investment in the new manufacturing facility.




Net
cash provided by operating activities




Net cash
provided by operating activities was $21,275,938 for the fiscal year ended June
30, 2010, an increase of $5,386,922 or 33.9% from $15,889,016 for the comparable
period in 2009. Net income plus the non-cash share-based compensation cost and
the charge for changes in fair value of instruments was $19,551,286 for the
fiscal year ended June 30, 2010, an increase of $5,973,592 or 44.0% from
$13,577,694 for the comparable period in 2009. In addition, the net increase in
cash from operating activities was also attributable to an increase of accounts
payable, notes payable and other current liabilities over the comparable
periods.





Net
cash used in investing activities





Net cash
used in investing activities was $39,490,349 for the fiscal year ended June 30,
2010, compared to $2,899,940 for the fiscal year ended June 30, 2009, an
increase of $42,390,289 or 1461.8%. Cash was primarily invested in construction
and equipment related to the new manufacturing facility during the fiscal year
ended June 30, 2010.





Net
cash provided by financing activities





Net cash
provided by financing activities was $89,799 for the fiscal year ended June 30,
2010, a decrease of $4,523,991 from $4,613,790 for the fiscal year ended June
30, 2009. The fund of $89,799 was proceeds from exercise of warrants in the last
quarter of fiscal 2010. For the comparable period of 2009, $4,613,790 was raised
from the private placement transaction in July 2008.





Capital
Expenditures




In
October 2008, we successfully won a bid on a land use right over a plot of land
approximately 43,566.3 square meters (approximately 468,944 square feet) in
size. The land is located in Tianjin, China and the bid price was approximately
$1.8 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 with plans to construct corporate
headquarters and to build a new manufacturing facility to expand our production
capacity. Expenditures committed under related construction contracts
totaled $32,587,834 (RMB 221,597,271), of which $ 24,072,627 (RMB 163,693,864)
had been paid as of June 30, 2010. The balance of $8,515,207 (RMB 57,903,407)
will be settled by the end of calendar year 2010. Certain equipment and
machinery contracts have also been executed, total amount of which was
approximately $15,370,647 (RMB 104,520,400), of which $11,973,235 (RMB
81,418,000) had been paid as of June 30, 2010. The balance of $3,397,412 (RMB
23,102,400) will be settled by the end of calendar year 2010.





Trends





We are
not aware of any trends, events or uncertainties that have or are reasonably
likely to have a material impact on our short-term or long-term
liquidity.





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.


35


The
following table summarizes our contractual obligations as of June 30, 2010, 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
                                
                                ThereafterCapital
      expenditures (1)
                                
                                $
                                15,826,746
                                
                                
                                $
                                15,826,746
                                
                                
                                $
                                -




(1)
Capital expenditure is commitment for the construction of a new manufacturing
facility and for the purchase of new equipment and machinery. See Note 14-
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 $32,587,834 of which
$24,072,627 was paid as at the fiscal year ended June 30, 2010. The construction
of the manufacturing facility was substantially completed during fiscal 2010,
and the new headquarters were completed by September 2010. The Company has also
executed certain equipment and machinery contracts. The total amount of executed
contracts was $15,370,647, of which $11,973,235 had been paid as of June 30,
2010.





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.





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.





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.


36


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 of 6 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 June
2009, the Company adopted Financial Accounting Standards Board ("FASB")
Accounting Standards Codification ("ASC") 105-10 (formerly Statement of
Financial Accounting Standards ("SFAS") No. 168, “The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162). ASC 105-10 establishes the FASB ASC as
the source of authoritative accounting principles recognized by the FASB to be
applied in preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America. The adoption of
this standard has no impact on the Company’s Consolidated Financial Statements.
However, reference to specific accounting standards have been changed to refer
to appropriate section of the ASC. Subsequent revision to GAAP by the FASB will
be incorporated into ASC through issuance of Accounting Standards Updates
("ASU").




Effective
January 1, 2009, the Company adopted ASC 805 (formerly SFAS No. 141 R, Business
Combinations). ASC 805 requires an acquirer to measure the identifiable assets
acquired, the liabilities assumed, and any non-controlling interest in the
acquiree at their fair values on the acquisition date, with goodwill being the
excess value over the net identifiable assets acquired. The adoption of ASC 805
did not have a material effect on the Company's consolidated financial
statements.




Effective
January 1, 2009, the Company adopted ASC 810-10 (formerly SFAS No. 160,
Non-controlling Interests in Consolidated Financial Statements). This Statement
establishes accounting and reporting standards that acquire the ownership
interests in subsidiaries' non-parent owners be clearly presented in the equity
section of the balance sheet, requires the amount of consolidated net income
attributable to the parent and to the non-controlling interest be clearly
identified and presented on the face of the consolidated statement of income;
requires that changes in a parent's ownership interest while the parent retains
its controlling financial interest in its subsidiary be accounted for
consistency; requires that when a subsidiary is deconsolidated, any retained
non-controlling equity investment in the former subsidiary be initially measured
at fair value and the gain and loss on the deconsolidation of the subsidiary be
measured using the fair value of any non-controlling equity; requires that
entities provide disclosure that clearly identify the interests of the parent
and the interests of the non-controlling owners. The adoption of ASC 810-10 did
not have a significant effect on the Company's consolidated financial
statements.




On April
1, 2009, the FASB approved ASC 805 (formerly SFAS No. 141R-1, Accounting for
Assets Acquired and Liabilities Assumed in Business Combination That Arise from
Contingencies), which amends Statement 141R and eliminates the distinction
between contractual and non-contractual contingencies. Under ASC 805, an
acquirer is required to recognize at fair value an asset acquired or liability
assumed in a business combination that arises from a contingency if the
acquisition-date fair value of that asset or liability can be determined during
the measurement period. If the acquisition-date fair value cannot be determined,
the acquirer applies the recognition criteria in SFAS No.5, Accounting for
Contingencies and Interpretation 14, "Reasonable Estimation of the amount of a
Loss and interpretation of FASB Statement No. 5," to determine whether the
contingency should be recognized as of the acquisition date or after it. The
adoption of ASC 805 did not have a material effect on the Company's consolidated
financial statements.




ASC
320-10 (formerly FSP FAS 115-2 and FAS 124-2) amends the other-than-temporary
impairment guidance in U.S. GAAP for debt securities to make the guidance more
operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements. It did not amend existing recognition and measurement guidance
related to other-than-temporary impairments of equity securities. We are
required to adopt ASC 320-10 for our interim and annual reporting periods ending
after June 15, 2009. ASC 320-10 does not require disclosures for periods
presented for comparative purposes at initial adoption. ASC 320-10 requires
comparative disclosures only for periods ending after initial adoption. The
adoption of ASC 320-10 did not have a material effect on the Company's
consolidated financial statements.




On April
9, 2009, the FASB also approved ASC 825-10 (formerly FSP FAS 107-1 and APB 28-1,
Interim Disclosures about Fair
Value of Financial Instruments) to require disclosures about fair value
of financial instruments in interim period financial statements of publicly
traded companies and in summarized financial information required by APB Opinion
No. 28, Interim Financial
Reporting. We are required to adopt ASC 825-10 for our interim and annual
reporting periods ending after June 15, 2009. ASC 825-10 does not require
disclosures for periods presented for comparative purposes at initial adoption.
ASC 825-10 requires comparative disclosures only for periods ending after
initial adoption. The adoption of ASC 125-10 did not have a material effect on
the Company's consolidated financial statements.


37


In April
2009, the FASB issued FSP No. FAS 157-4, "Determining Fair Value When the Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased
and Identifying Transactions That Are Not Orderly" as incorporated into FASB ASC
820, "Fair Value Measurements and Disclosures". The guidance relates to
determining fair values when there is no active market or where the price inputs
being used represent distressed sales. It reaffirms what FASB ASC 820 states is
the objective of fair value measurement to reflect how much an asset would be
sold for in an orderly transaction (as opposed to a distressed or forced
transaction) at the date of the financial statements under current market
conditions. Specifically, it reaffirms the need to use judgment to ascertain if
a formerly active market has become inactive and in determining fair values when
markets have become inactive. This guidance is effective for interim and annual
periods ended after June 15, 2009, but entities may early adopt this guidance
for the interim and annual periods ended after March 15, 2009. The adoption of
such standard did not have a material impact on the Company's consolidated
financial statements.




Effective
July 1, 2009, the Company adopted ASC 815-40 (formerly Emerging Issues Task
Force ("EITF") Issue No. 07-05, Determining Whether an Instrument (or Embedded
Feature) Is Indexed to an Entity's Own Stock ("EITF 07-05"). ASC 815-40
addresses the determination of whether an instrument (or an embedded feature) is
indexed to an equity's own stock, which is the first part of the scope exception
in paragraph 11(a) of FASB SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS 133"). If and instrument (or an embedded feature)
that has the characteristics of a derivative instrument under paragraph 6-9 of
SFAS 133 is indexed to an entity's own stock, it is still necessary to evaluate
whether it is classified in stockholders' equity (or would be classified in
stockholders' equity if it were a freestanding instrument). Other applicable
authoritative accounting literature, including Issues EITF 00-19, Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock, and EITF 05-2, The Meaning of "Conventional Debt
Instrument" in Issue No. 00-19, provides guidance for determining whether an
instrument (or an embedded feature) is classified in stockholders' equity (or
would be classified in stockholders' equity if it were a freestanding
instrument). ASC 815-40 does not address that second part of the scope exception
in paragraph 11(a) of SFAS 133. As a result of the adoption of ASC 815-40, the
Company adjusted its accounting effective from the beginning of fiscal year
2010, i.e. July 1, 2009, on which date ASC 815-40 was 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.




In August
2009, the FASB issued FASB ASU 2009-05, "Measuring Liabilities at Fair Value".
FASB ASU 2009-05 amends FASB ASC 820, "Fair Value Measurements". Specifically,
FASB ASU 2009-05 provides clarification that in circumstances in which a quoted
price in an active market for the identical liability is not available, a
reporting entity is required to measure fair value using one or more of the
following methods: 1) a valuation technique that uses a) the quoted price of the
identical liability when traded as an asset or b) quoted prices for similar
liabilities or similar liabilities when traded as assets and/or 2) a valuation
technique that is consistent with the principles of FASB ASC 820 of the
Accounting Standards Codification (e.g. an income approach or market approach).
FASB ASU 2009-05 also clarifies that when estimating the fair value of a
liability, a reporting entity is not required to adjust to include inputs
relating to the existence of transfer restrictions on that liability. The
adoption of such standard did not have a material impact on the Company's
consolidated financial statements.




In May
2009, the FASB issued SFAS No. 165, "Subsequent Event", ("FASB ASC 855-10")
which establishes general standards of accounting for and disclosure of events
that occur after the balance sheet date but before financial statements. The
statement is effective for interim and annual periods ended after June 15, 2009.
The standard was subsequently amended by FASB ASU 2010-09 which exempts an
entity that is an SEC filer from the requirement to disclose the date through
which subsequent events have been evaluated.




In
September 2009, the Emerging Issues Task Force reached final consensus on FASB
ASU 2009-13, "Revenue Arrangements with Multiple Deliverables". FASB ASU 2009-13
addresses how to determine whether an arrangement involving multiple
deliverables contains more than one unit of accounting, and how the arrangement
consideration should be allocated among the separate units of accounting. This
ASU will be effective prospectively for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010. Early
adoption is permitted. The adoption of such standard is not expected to have a
material impact on the Company's consolidated financial statements.




In
December 2009, the FASB issued FASB ASU 2009-17, Consolidation of Variable
Interest Entities ("FASB ASC 810"): improvements to Financial Reporting by
Enterprises involved with Variable Interest Entities. This ASU amends the FASB
Accounting Standards Codification for statement No.167. In June 2009, the FASB
issued SFAS No.167, Amendments to FASB Interpretation No. 46(R), which requires
an enterprise to perform an analysis and ongoing reassessments to determine
whether the enterprises variable interest or interests give it a controlling
financial interest in a variable interest entity und amends certain guidance for
determining whether an entity is a variable interest entity. It also requires
enhanced disclosures that will provide users of financial statements with more
transparent information about an enterprises involvement in a variable interest
entity. SFAS No.167 is effective as of the beginning of each reporting entity's
first annual reporting period that begins after November 15, 2009 and for all
interim reporting periods after that, with early application prohibited. The
adoption of such standard did not have a material impact on the Company's
consolidated financial statements.




In
January 2010, the FASB issued Accounting Standards Update 2010-05 (ASU 2010-05),
"Compensation - Stock Compensation (Topic 718)". This standard codifies EITF
Topic D-110 Escrowed Share Arrangements and the Presumption of Compensation and
is effective immediately. The provisions of ASU 2010-05 did not have a material
effect on the Company's consolidated financial statements and is effective
immediately.


38


In
January 2010, the FASB issued Update No. 2010-6, “Improving Disclosures About
Fair Value Measurements” (“ASU 2010-6”), which requires reporting entities to
make new disclosures about recurring or nonrecurring fair-value measurements
including significant transfers into and out of Level 1 and Level 2 fair-value
measurements and information on purchases, sales, issuances, and settlements on
a gross basis in the reconciliation of Level 3 fair-value measurements. ASU
2010-6 is effective for annual reporting periods beginning after December 15,
2009, except for Level 3 reconciliation disclosures, which are effective for
annual periods beginning after December 15, 2010. The Company is currently
evaluating the effect of this update on its financial position, results of
operations and liquidity.




In
February 2010, the FASB issued Accounting Standards Update 2010-09 (ASU
2010-09), "Subsequent Events (Topic 855)." The amendments remove the
requirements for an SEC filer to disclose a date, in both issued and revised
financial statements, through which subsequent events have been reviewed.
Revised financial statements include financial statements revised as a result of
either correction of an error or retrospective application of U.S. GAAP. ASU
2010-09 is effective for interim or annual financial periods ending after June
15, 2010. The provisions of ASU 2010-09 did not have a material effect on the
Company's consolidated financial statements.




In
February 2010, the FASB issued Accounting Standards Update 2010-10 (ASU
2010-10), "Consolidation (Topic 810)." The amendments to the consolidation
requirements of Topic 810 resulting from the issuance of Statement 167 are
deferred for a reporting entity's interest in an entity (1) that has all the
attributes of an investment company or (2) for which it is industry practice to
apply measurement principles for financial reporting purposes that are
consistent with those followed by investment companies. An entity that qualifies
for the deferral will continue to be assessed under the overall guidance on the
consolidation of variable interest entities in Subtopic 810-10 (before the
Statement 167 amendments) or other applicable consolidation guidance, such as
the guidance for the consolidation of partnerships in Subtopic 810-20. The
deferral is primarily the result of differing consolidation conclusions reached
by the International Accounting Standards Board ("IASB") for certain investment
funds when compared with the conclusions reached under Statement 167. The
deferral is effective as of the beginning of a reporting entity's first annul
period that begins after November 15, 2009, and for interim periods within that
first annual reporting period, which coincides with the effective date of
Statement 167. Early application it not permitted. The provisions of ASU 2010-10
are effective for the Company beginning in 2010. The adoption of ASU 2010-10 did
not have a material impact on the Company's consolidated financial
statements.




In March
2010, the FASB issued Accounting Standards Update 2010-11 (ASU 2010-11),
"Derivative and Hedging (Topic 815)." All entities that enter into contracts
containing an embedded credit derivative feature related to the transfer of
credit risk that is not only in the form of subordination of one financial
instrument to another will be affected by the amendments in this Update because
the amendments clarify that the embedded credit derivative scope exception in
paragraph 815-15-15-8 through 15-9 does not apply to such contracts. ASU 2010-11
is effective at the beginning of the reporting entity's first fiscal quarter
beginning after June 15, 2010. The Company is currently evaluating the impact of
this accounting update on its consolidated financial statements.




In April
2010, the FASB issued Accounting Standards Update 2010-13 (ASU 2010-13),
"Compensation - Stock Compensation (Topic 718)." This Update provides amendments
to Topic 718 to clarity that an employee share-based payment award with an
exercise price denominated in the currency of a market in which a substantial
portion of the entity's equity securities trades should not be considered to
contain a condition that is not a market, performance, or service condition.
Therefore, an entity would not classify such an award as a liability if it
otherwise qualifies as equity. The amendments in ASU 2010-13 are effective for
fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2010. The provisions of ASU 2010-13 are not expected to have
a material effect on the Company's consolidated financial
statements




In July
2010, the FASB issued 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. 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 Company is currently
evaluating the impact of this accounting update on its financial
disclosures.







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





Not
Applicable.





Item 8.   Financial Statements and
Supplementary Data.


39


SHENGKAI INNOVATIONS,
INC.




CONTENTS
                    
                    PAGESINDEPENDENT
      AUDITOR’S REPORT
                    
                    F-1CONSOLIDATED
      BALANCE SHEETS
                    
                    F-2
      – F-3CONSOLIDATED
      STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
                    
                    F-4CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS’ EQUITY
                    
                    F-5CONSOLIDATED
      STATEMENTS OF CASH FLOWS
                    
                    F-6
      – F-7CONSOLIDATED
      NOTES TO FINANCIAL STATEMENTS
                    
                    F-8
      – F-29





SHENGKAI INNOVATIONS,
INC.


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





CONTENTS
                      
                      PAGESREPORTS
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
                      
                      1CONSOLIDATED
      BALANCE SHEETS
                      
                      3-4CONSOLIDATED
      STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
                      
                      5CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS’ EQUITY
                      
                      6CONSOLIDATED
      STATEMENTS OF CASH FLOWS
                      
                      7-8NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS
                      
                      9-40







REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To
the Board of Directors and Stockholders of
 Shengkai
Innovations, Inc.
 Tianjin
 China
 
 We have
audited the accompanying consolidated balance sheet of Shengkai Innovations,
Inc. and subsidiaries as of June 30, 2010 and the related consolidated
statements of income and other comprehensive income, shareholders’ equity, and
cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Company’s management. Our responsibility is to express
an opinion on these consolidated financial statements based on our
audit.
 
 We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Shengkai Innovations, Inc.
and subsidiaries as of June 30, 2010 and the results of its operations and its
cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States of America.
  /s/
BDO China Li Xin Da Hua CPA Co.,Ltd.
 
 Shenzhen,
China
 
 September
28, 2010


1




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., LL.B., P.C.LL., Barrister-at-law, C.P.A.(Practising).





The Board
of Directors and Stockholders of


Shengkai
Innovations, Inc.


(F/K/A
Southern Sauce Company, Inc.)





Independent Auditor’s
Report





We have
audited the accompanying consolidated balance sheets of Shengkai Innovations,
Inc. (F/K/A Southern Sauce Company, Inc.) as of June 30, 2009 and 2008 and the
related consolidated statements of income, stockholders' equity and cash flows
for the years then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.





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.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Shengkai
Innovations, Inc. (F/K/A Southern Sauce Company, Inc.) as of June 30, 2009 and
2008 and the results of its operations and its cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States of America.





/s/
      Albert Wong & Co.Hong
      Kong, China
                Albert
      Wong & Co.August
      31, 2009
                Certified
      Public Accountants


2


SHENGKAI
INNOVATIONS, INC.


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


CONSOLIDATED
BALANCE SHEETS


(Stated
in US Dollars)


June 30,Note
                                                                  
                                                                  
                                                                  2010
                                                                  
                                                                  
                                                                  2009ASSETSCurrent
      assetsCash
      and cash equivalents
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  $
                                                                  20,995,182
                                                                  
                                                                  
                                                                  $
                                                                  38,988,958Restricted
      cash
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  1,849,958
                                                                  
                                                                  
                                                                  
                                                                  940,488Trade
      receivables
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  6,490,110
                                                                  
                                                                  
                                                                  
                                                                  4,061,706Notes
      receivable
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  73,437
                                                                  
                                                                  
                                                                  
                                                                  292,193Other
      receivables
                                                                  
                                                                  4
                                                                  
                                                                  
                                                                  
                                                                  325,183
                                                                  
                                                                  
                                                                  
                                                                  22,979Deposits
      and prepaid expenses
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  194,535Advances
      to suppliers
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  408,110
                                                                  
                                                                  
                                                                  
                                                                  328,785Inventories
                                                                  
                                                                  5
                                                                  
                                                                  
                                                                  
                                                                  2,556,166
                                                                  
                                                                  
                                                                  
                                                                  907,799Total
      current assets
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  32,698,146
                                                                  
                                                                  
                                                                  
                                                                  45,737,443Property,
      plant and equipment, net
                                                                  
                                                                  6
                                                                  
                                                                  
                                                                  
                                                                  6,120,056
                                                                  
                                                                  
                                                                  
                                                                  4,858,452Construction
      in progress
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  25,185,643
                                                                  
                                                                  
                                                                  
                                                                  314,817Land
      use rights, net
                                                                  
                                                                  7
                                                                  
                                                                  
                                                                  
                                                                  2,480,929
                                                                  
                                                                  
                                                                  
                                                                  2,485,655Other
      Intangible assets, net
                                                                  
                                                                  8
                                                                  
                                                                  
                                                                  
                                                                  6,001,411
                                                                  
                                                                  
                                                                  
                                                                  6,856,667Advances
      to suppliers for purchase of equipment and construction
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  12,119,764
                                                                  
                                                                  
                                                                  
                                                                  -TOTAL
      ASSETS
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  $
                                                                  84,605,949
                                                                  
                                                                  
                                                                  $
                                                                  60,253,034LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilitiesNotes
      payable
                                                                  
                                                                  9
                                                                  
                                                                  
                                                                  $
                                                                  2,652,095
                                                                  
                                                                  
                                                                  $
                                                                  984,561Accounts
      payable
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  2,848,600
                                                                  
                                                                  
                                                                  
                                                                  1,121,185Advances
      from customers
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  1,256,777
                                                                  
                                                                  
                                                                  
                                                                  242,986Other
      payables
                                                                  
                                                                  10
                                                                  
                                                                  
                                                                  
                                                                  1,244,839
                                                                  
                                                                  
                                                                  
                                                                  794,754Accruals
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  20,359
                                                                  
                                                                  
                                                                  
                                                                  131,581Income
      tax payable
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  1,061,783
                                                                  
                                                                  
                                                                  
                                                                  1,471,380Total
      current liabilities
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  9,084,453
                                                                  
                                                                  
                                                                  
                                                                  4,746,447Warrant
      liabilities
                                                                  
                                                                  11
                                                                  
                                                                  
                                                                  
                                                                  37,424,035
                                                                  
                                                                  
                                                                  
                                                                  -Preferred
      (conversion option) liabilities
                                                                  
                                                                  11
                                                                  
                                                                  
                                                                  
                                                                  40,378,640
                                                                  
                                                                  
                                                                  
                                                                  -Total
      non-current liabilities
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  77,802,675
                                                                  
                                                                  
                                                                  
                                                                  -TOTAL
      LIABILITIES
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  $
                                                                  86,887,128
                                                                  
                                                                  
                                                                  $
                                                                  4,746,447Commitments
      and contingencies
                                                                  
                                                                  15


3




SHENGKAI
INNOVATIONS, INC.


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


CONSOLIDATED
BALANCE SHEETS (Continued)


(Stated
in US Dollars)





June 30,Note
                      
                      
                      2010
                      
                      
                      2009STOCKHOLDERS’
      EQUITYPreferred
      Stock – $0.001 par value 15,000,000 share authorized ; 6,987,368 and
      7,887,368 issued and outstanding as of June 30, 2010 and 2009,
      respectively.
                      
                      11
                      
                      
                      $
                      6,987
                      
                      
                      $
                      7,887Common
      stock - $0.001 par value 50,000,000 shares authorized; 23,191,165 and
      22,112,500 shares issued and outstanding as of June 30, 2010 and 2009,
      respectively
                      
                      
                      
                      
                      
                      23,192
                      
                      
                      
                      22,113Additional
      paid-in capital
                      
                      
                      
                      
                      
                      34,259,304
                      
                      
                      
                      30,666,631Statutory
      reserves
                      
                      
                      
                      
                      
                      7,081,706
                      
                      
                      
                      4,693,020(Accumulated
      loss) retained earnings
                      
                      
                      
                      
                      
                      (46,686,271
                      )
                      
                      
                      17,456,857Accumulated
      other comprehensive income
                      
                      
                      
                      
                      
                      3,033,903
                      
                      
                      
                      2,660,079TOTAL
      STOCKHOLDER’S EQUITY
                      
                      
                      
                      
                      
                      (2,281,179
                      )
                      
                      
                      55,506,587TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                      
                      
                      
                      
                      $
                      84,605,949
                      
                      
                      $
                      60,253,034





See
accompanying notes to consolidated financial statements


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
                          
                          
                          2010
                          
                          
                          2009Revenues
                          
                          
                          
                          
                          $
                          54,148,954
                          
                          
                          $
                          39,297,235Cost
      of sales
                          
                          
                          
                          
                          
                          (21,916,944
                          )
                          
                          
                          (15,267,244
                          )Gross
      profit
                          
                          
                          
                          
                          
                          32,232,010
                          
                          
                          
                          24,029,991Other
      miscellaneous income
                          
                          
                          
                          
                          
                          -
                          
                          
                          
                          112,758Operating
      expenses:Selling
                          
                          
                          
                          
                          
                          (5,093,859
                          )
                          
                          
                          (3,760,970
                          )General
      and administrative
                          
                          
                          
                          
                          
                          (6,530,876
                          )
                          
                          
                          (2,474,872
                          )Stock
      compensation expense
                          
                          
                          
                          
                          
                          (15,971,920
                          )
                          
                          
                          -Total
      Operating expenses
                          
                          
                          
                          
                          
                          (27,596,655
                          )
                          
                          
                          (6,235,842
                          )Income
      from operations
                          
                          
                          
                          
                          
                          4,635,355
                          
                          
                          
                          17,906,907Other
      income, net
                          
                          
                          
                          
                          
                          205,498
                          
                          
                          
                          -Interest
      income, net
                          
                          
                          
                          
                          
                          387,675
                          
                          
                          
                          193,149Changes
      in fair value of instruments - (loss)/gain
                          
                          
                          
                          
                          
                          (56,910,599
                          )
                          
                          
                          -(Loss)
      Income before income taxes
                          
                          
                          
                          
                          
                          (51,682,071
                          )
                          
                          
                          18,100,056Provision
      for Income taxes
                          
                          12
                          
                          
                          
                          (4,703,494
                          )
                          
                          
                          (4,522,362
                          )Net
      (loss) income
                          
                          
                          
                          
                          
                          (56,385,565
                          )
                          
                          
                          13,577,694Foreign
      currency translation adjustment
                          
                          
                          
                          
                          
                          373,824
                          
                          
                          
                          133,561Comprehensive
      (loss) income
                          
                          
                          
                          
                          $
                          (56,011,741
                          )
                          
                          $
                          13,711,255Basic
      (loss) earnings per share
                          
                          13
                          
                          
                          $
                          (2.483
                          )
                          
                          $
                          0.498Diluted
      (loss) earnings per share
                          
                          13
                          
                          
                          $
                          (2.483
                          )
                          
                          $
                          0.367Basic
      weighted average shares outstanding
                          
                          13
                          
                          
                          
                          22,704,492
                          
                          
                          
                          22,112,500Diluted
      weighted average shares outstanding
                          
                          13
                          
                          
                          
                          22,704,492
                          
                          
                          
                          29,999,868





See
accompanying notes to consolidated financial statements


5





SHENGKAI
INNOVATIONS, INC.


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


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’EQUITY


(Stated
in US Dollars)




AccumulatedCommon stock
                                                                                                                        
                                                                                                                        
                                                                                                                        Preferred
      stock
                                                                                                                        
                                                                                                                        
                                                                                                                        Additional
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        otherNumber
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        Number
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        paid-in
                                                                                                                        
                                                                                                                        
                                                                                                                        Statutory
                                                                                                                        
                                                                                                                        
                                                                                                                        Retained earnings
                                                                                                                        
                                                                                                                        
                                                                                                                        comprehensiveof shares
                                                                                                                        
                                                                                                                        Amount
                                                                                                                        
                                                                                                                        
                                                                                                                        of
      shares
                                                                                                                        
                                                                                                                        
                                                                                                                        Amount
                                                                                                                        
                                                                                                                        
                                                                                                                        capital
                                                                                                                        
                                                                                                                        
                                                                                                                        reserves
                                                                                                                        
                                                                                                                        
                                                                                                                        (Accumulated losses)
                                                                                                                        
                                                                                                                        
                                                                                                                        Income
                                                                                                                        
                                                                                                                        
                                                                                                                        TotalBalance,
      July 1,2007
                                                                                                                        
                                                                                                                        20,550,000
                                                                                                                        
                                                                                                                        $
                                                                                                                        20,550
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        10,452,168
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        1,665,187
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        7,122,377
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        1,155,685
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        20,415,967Reduction
      of registered capital of a subsidiary
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (8,662,637
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (8,662,637
                                                                                                                        )Net
      income
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        10,087,039
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        10,087,039Reverse
      acquisition
                                                                                                                        
                                                                                                                        1,562,500
                                                                                                                        
                                                                                                                        
                                                                                                                        1,563
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        243,777
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        245,340Proceeds
      from sharesissued
      in privateplacement,
      net oftransaction
      costs of$1,275,000
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        5,915,526
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        5,916
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        13,719,084
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        13,725,000Appropriations
      tostatutory
      reserves
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        1,209,879
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (1,209,879
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -Dividends
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        7,742,234
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (7,742,234
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -Foreign
      currencytranslation
      adjustment
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        1,370,833
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        1,370,833Balance,
      June 30, 2008
                                                                                                                        
                                                                                                                        22,112,500
                                                                                                                        
                                                                                                                        $
                                                                                                                        22,113
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        5,915,526
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        5,916
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        23,494,626
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        2,875,066
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        8,257,303
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        2,526,518
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        37,181,542Net
      income
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        13,577,694
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        13,577,694Proceeds
      from sharesissued
      in privateplacement,
      net oftransaction
      costs of$386,210
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        1,971,842
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        1,971
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        4,611,819
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        4,613,790Appropriations
      tostatutory
      reserves
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        1,817,954
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (1,817,954
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -Dividends
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        2,560,186
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (2,560,186
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -Foreign
      currencytranslation
      adjustment
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        133,561
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        133,561Balance,
      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
                                                                                                                        
                                                                                                                        
                                                                                                                        $
                                                                                                                        55,506,587Net
      loss
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (56,385,565
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (56,385,565
                                                                                                                        )Conversion
      from preferred stock to common stock
                                                                                                                        
                                                                                                                        900,000
                                                                                                                        
                                                                                                                        
                                                                                                                        900
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (900,000
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        (900
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -Appropriation
      of statutory reserve
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        2,388,686
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (2,388,686
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -Issuance
      of stock options
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        3,054,332
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        3,054,332Exercise
      of warrants
                                                                                                                        
                                                                                                                        178,665
                                                                                                                        
                                                                                                                        
                                                                                                                        179
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        1,206,446
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        1,206,625Reclassification
      of warrants and preferred stock to liabilities
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (16,640,025
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (5,368,877
                                                                                                                        )
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        (22,008,902
                                                                                                                        )Stock
      compensation expense
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        15,971,920
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        15,971,920Foreign
      currency translation adjustment
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        -
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        373,824
                                                                                                                        
                                                                                                                        
                                                                                                                        
                                                                                                                        373,824Balance,
      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




6





SHENGKAI
INNOVATIONS, INC.


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


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Stated
in US Dollars)





Year Ended June 30,2010
                    
                    
                    2009Cash
      flows from operating activitiesNet
      (loss) income
                    
                    $
                    (56,385,565
                    )
                    
                    $
                    13,577,694Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
                    
                    
                    508,023
                    
                    
                    
                    172,185Amortization
                    
                    
                    917,384
                    
                    
                    
                    778,115Loss
      on disposal of property, plant and equipment
                    
                    
                    1,849
                    
                    
                    
                    -Stock
      - compensation expense
                    
                    
                    15,971,920
                    
                    
                    
                    -Changes
      in fair value of instruments - loss/(gain)
                    
                    
                    56,910,599
                    
                    
                    
                    -Stock
      based compensation
                    
                    
                    3,054,332
                    
                    
                    
                    -Changes
      in operating assets and liabilities:(Increase)
      decrease in assets:Trade
      receivables
                    
                    
                    (2,396,926
                    )
                    
                    
                    (450,979
                    )Notes
      receivable
                    
                    
                    219,405
                    
                    
                    
                    (283,286
                    )Other
      receivables
                    
                    
                    (300,842
                    )
                    
                    
                    (3,108
                    )Deposits
      and prepaid expenses
                    
                    
                    194,766
                    
                    
                    
                    444,628Advances
      to suppliers
                    
                    
                    (77,279
                    )
                    
                    
                    (316,230
                    )Inventories
                    
                    
                    (1,636,793
                    )
                    
                    
                    (179,522
                    )Increase
      (decrease) in liabilities:Notes
      payable
                    
                    
                    1,655,474
                    
                    
                    
                    984,074Accounts
      payable
                    
                    
                    1,714,386
                    
                    
                    
                    178,912Advances
      from customers
                    
                    
                    1,008,342
                    
                    
                    
                    212,911Other
      payables
                    
                    
                    444,030
                    
                    
                    
                    242,840Accruals
                    
                    
                    (111,461
                    )
                    
                    
                    14,440Income
      tax payable
                    
                    
                    (415,706
                    )
                    
                    
                    516,342Net
      cash provided by operating activities
                    
                    
                    21,275,938
                    
                    
                    
                    15,889,016Cash
      flows from investing activitiesProceeds
      from disposition of property, plant and equipment
                    
                    
                    3,291
                    
                    
                    
                    -Purchase
      of property, plant and equipment
                    
                    
                    (26,510,913
                    )
                    
                    
                    (564,609
                    )Purchase
      of intangible assets
                    
                    
                    (11,465
                    )
                    
                    
                    (1,895,099
                    )Advances
      to suppliers for purchase of equipment and construction
                    
                    
                    (12,070,002
                    )
                    
                    
                    -Increase
      in restricted cash
                    
                    
                    (901,260
                    )
                    
                    
                    (440,232
                    )Net
      cash used in investing activities
                    
                    
                    (39,490,349
                    )
                    
                    
                    (2,899,940
                    )Cash
      flows from financing activitiesProceeds
      from exercise of warrants
                    
                    $
                    89,799
                    
                    
                    $
                    -Proceeds
      from stock issued, net of transaction costs of $386,210
                    
                    
                    -
                    
                    
                    
                    4,613,790Net
      cash provided by financing activities
                    
                    $
                    89,799
                    
                    
                    $
                    4,613,790


See
accompanying notes to consolidated financial statements





7




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 30,2010
                
                
                2009Net
      increase (decrease) in cash and cash equivalents
                
                $
                (18,124,612
                )
                
                $
                17,602,866Effect
      of exchange rate changes on cash and cash equivalents
                
                
                130,836
                
                
                
                72,608Cash
      and cash equivalents–beginning of year
                
                
                38,988,958
                
                
                
                21,313,484Cash
      and cash equivalents–end of year
                
                $
                20,995,182
                
                
                $
                38,988,958Supplementary
      cash flow information:Cash
      paid during the year:Interest
      received
                
                $
                387,675
                
                
                $
                193,149Taxes
      paid
                
                $
                5,119,200
                
                
                $
                4,088,651Non-cash
      transaction:Preferred
      stock conversion to common stock
                
                $
                900
                
                
                $
                -Dividends
                
                $
                -
                
                
                $
                2,560,186Cashless
      exercise of warrants
                
                $
                1,016,536
                
                
                $
                -




See
accompanying notes to consolidated financial statements


8


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





1.
            ORGANIZATION AND PRINCIPAL
      ACTIVITIES





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





On June
9, 2008, the Company executed a reverse-merger with Shen Kun International
Limited (“Shen Kun”) by an exchange of shares whereby the Company 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, 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 became our wholly-owned
subsidiary.





The
exchange transaction was accounted for as a reverse acquisition in accordance
with generally accepted accounting principles of America. For financial
reporting purposes, this transaction is classified as a recapitalization of the
Company and Shen Kun. The accompanying audited consolidated financial statements
were retroactively adjusted to reflect the effects of the recapitalization of
the financial statements of the Company 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 for the years ended
June 30, 2010 and 2009.





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) Consolidated of Variable Interest Entities, and
Interpretation of ARB No. 51).





In
connection with the reverse merger transaction, on June 11, 2008 the Company
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, the Company 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 (the “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 Preferred Shares.





The
Company, through its subsidiaries and Shengkai, (hereinafter, collectively
referred to as “the Group”), is now in the business of manufacturing and selling
of ceramic valves.


9


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY OF SIGNIFICANT ACCOUNTING
      POLICIES





(a)
            Method of
      Accounting





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 generally accepted accounting principles in the United
States of America and have been consistently applied in the presentation of
financial statements.





(b)
            Principles of
      Consolidation





The
consolidated financial statements, which include the Company and its
subsidiaries, are complied in accordance with generally accepted accounting
principles in the United States of America. 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
wholly-owned subsidiaries.





The
Company owned four subsidiaries since its reverse-merger on June 9, 2008. The
detailed identities of the consolidating subsidiaries would have been as
follows:





Name of Company
                        
                        Place of
                          incorporation
                        
                        Attributable
                          interestShen
      Kun International Limited
                        
                        British
      Virgin Islands
                        
                        
                        100
                        %Shengkai
      (Tianjin) Limited, formerly Sheng Kai (Tianjin) Ceramic Valves Co.,
      Ltd
                        
                        PRC
                        
                        
                        100
                        %*Tianjin
      Shengkai Industrial TechnologyDevelopment
      Co., Ltd
                        
                        PRC
                        
                        
                        100
                        %*Deemed
      variable interest entity memberShengkai
      (Tianjin) Trading Ltd.
                        
                        PRC
                        
                        
                        100
                        %





(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.


10


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY OF SIGNIFICANT ACCOUNTING
      POLICIES (Continued)





(d)
            Economic and political
      risks





The
Group’s operations are conducted in the People’s Republic of China (“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
Group’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
Group’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 twelve months.





(f)
            Accounts
      receivable





Accounts
receivable are carried at net realizable value.  An allowance for doubtful
accounts will be recorded in the period when loss is probable based on an
assessment of specific evidence indicating troubled collection, historical
experience, accounts aging and other factors.  Accounts are written off
after exhaustive efforts at collection.  If accounts receivable are to be
provided for, or written off, they would be recognized in the consolidated
statement of operations within operating expense.  The Company did not
provide allowance for doubtful accounts at June 30, 2010 and 2009, respectively,
as per the management's judgment based on their best knowledge.





(g)
            Property, plant and
      equipment





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 yearsMachinery
      and equipment
                
                3 –
      20 yearsOffice
      equipment
                
                3 –
      10 yearsMotor
      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 income. The cost of maintenance and repairs is charged to income as incurred,
whereas significant renewals and betterments are capitalized.


11


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY OF SIGNIFICANT ACCOUNTING
      POLICIES (Continued)





(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 lease term 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 of 6 years.





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





The Group
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.


12


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY OF SIGNIFICANT ACCOUNTING
      POLICIES (Continued)





(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 30,2010
                    
                    
                    2009Cash
      on hand
                    
                    $
                    5,348
                    
                    
                    $
                    6,236Bank
      deposits:Agricultural
      Bank of China
                    
                    
                    -
                    
                    
                    
                    -Bank
      of China
                    
                    
                    889,600
                    
                    
                    
                    21,081Industrial
      and Commercial Bank of China
                    
                    
                    307,818
                    
                    
                    
                    750,757Industrial
      Bank Co. Ltd.
                    
                    
                    1,326,844
                    
                    
                    
                    2,962,345Shanghai
      Pudong Development Bank
                    
                    
                    18,043,632
                    
                    
                    
                    35,232,842The
      Hong Kong and Shanghai Banking Corporation Limited
                    
                    
                    15,483
                    
                    
                    
                    15,697JPMORGAN
      CHASE BANK
                    
                    
                    406,457
                    
                    
                    
                    -$
                    20,995,182
                    
                    
                    $
                    38,988,958





(n)
            Fair Value of Financial
      Instruments





FASB ASC
820 (formerly Statement of Financial Accounting Standard (“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,
short-term bank loans, accounts payable, notes payable, other payables and
accrued expenses and due to related parties, approximate their fair values
because of the short maturity of these instruments.


13


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY OF SIGNIFICANT ACCOUNTING
      POLICIES (Continued)





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 our 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, 2010 and
2009 are as follows:





June 30, 2010Instrument
                  
                  Fair Value
                  
                  
                  Carrying Value
                  
                  
                  Level
                  
                  Valuation
                    MethodologyDerivative
      warrant liabilities
                  
                  $
                  37,424,035
                  
                  
                  $
                  37,424,035
                  
                  
                  
                  3
                  
                  Black-ScholesEmbedded
      conversion liability
                  
                  $
                  40,378,640
                  
                  
                  $
                  40,378,640
                  
                  
                  
                  3




June 30, 2009Instrument
                  
                  Fair Value
                  
                  
                  Carrying Value
                  
                  
                  Level
                  
                  Valuation
                    MethodologyDerivative
      warrant liabilities
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  3Embedded
      conversion liability
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  3


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, 2010 and
2009:





June 30, 2010
                              
                              
                              June 30, 2009Beginning
      balance: Derivative liabilities
                              
                              $
                              —
                              
                              
                              $
                              —Adoption
      of change in accounting principle
                              
                              
                              20,892,076
                              
                              
                              
                              —Total
      (gains) losses
                              
                              
                              56,910,599
                              
                              
                              
                              —Ending
      balance: Derivative liabilities
                              
                              $
                              77,802,675
                              
                              
                              $
                              —


14


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(o)
            Revenue
      recognition





Revenue
represents the invoiced value of goods sold and are 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.





Revenues
are recognized when customer takes delivery and acceptance of products, the
price is fixed or determinable as stated on sales contract, and the
collectability is reasonably assured. The products are not subject to
returns.





(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, 2010 and
2009 were $82,913 and $17,845, respectively.





(r)
            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, 2010 and 2009 were
$865,098 and $559,097, respectively.





(s)
            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 income as
incurred. The retirement benefit expenses included in general and administrative
expenses for the years ended June 30, 2010 and 2009 were $142,568 and $130,574,
respectively.


15





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(t)
            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) common stock awards granted to
consultants which are accounted for under FASB ASC 505-50 "Equity - Equity-Based
Payment to Non-employees".





All
grants of common stock awards and stock options to employees and directors 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 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.





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 was recorded only for those
stock options and common stock awards that are expected to vest.





(u)
            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 income 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.


16





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





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 FIN 48,
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, 2010 and
2009, the Company did not have a liability for unrecognized tax
benefits.





(v)
            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 People’s Republic of China (“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 included in prepaid VAT on the balance sheet
represent the excess of VAT paid on purchases over the VAT due on sales at June
30, 2010, which can be used to offset future VAT that is due on
sales.





(w)
            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.





June 30,2010
                  
                  
                  2009Year
      ended RMB: US$ exchange rate
                  
                  
                  6.8086
                  
                  
                  
                  6.8448Average
      yearly RMB: US$ exchange rate
                  
                  
                  6.8367
                  
                  
                  
                  6.8482





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.


17





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(x)
            Cash
      and concentration of risk





Cash
includes cash on hand and demand deposits in bank accounts.  Total
cash in the banks at June 30, 2010 and 2009 amounted to $20,995,182 and
$38,982,722 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.





(y)
            Statutory
      reserves





As
stipulated by the PRC’s Company Law and as provided in the 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 $7,081,706 as at June
30, 2010.





(z)
            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.


18





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(ai)
            Recent
      accounting pronouncements





In June
2009, the Company adopted FABS ASC 105-10 (formerly Statement of Financial
Accounting Standards ("SFAS") No. 168, “The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162). ASC 105-10 establishes the FASB ASC as
the source of authoritative accounting principles recognized by the FASB to be
applied in preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America. The adoption of
this standard has no impact on the Company’s Consolidated Financial Statements.
However, reference to specific accounting standards have been changed to refer
to appropriate section of the ASC. Subsequent revision to GAAP by the FASB will
be incorporated into ASC through issuance of Accounting Standards Updates
("ASU").





Effective
January 1, 2009, the Company adopted ASC 805 (formerly SFAS No. 141 R, Business
Combinations). ASC 805 requires an acquirer to measure the identifiable assets
acquired, the liabilities assumed, and any non-controlling interest in the
acquiree at their fair values on the acquisition date, with goodwill being the
excess value over the net identifiable assets acquired. The adoption of ASC 805
did not have a material effect on the Company's consolidated financial
statements.





Effective
January 1, 2009, the Company adopted ASC 810-10 (formerly SFAS No. 160,
Non-controlling Interests in Consolidated Financial Statements). This Statement
establishes accounting and reporting standards that acquire the ownership
interests in subsidiaries' non-parent owners be clearly presented in the equity
section of the balance sheet, requires the amount of consolidated net income
attributable to the parent and to the non-controlling interest be clearly
identified and presented on the face of the consolidated statement of income;
requires that changes in a parent's ownership interest while the parent retains
its controlling financial interest in its subsidiary be accounted for
consistency; requires that when a subsidiary is deconsolidated, any retained
non-controlling equity investment in the former subsidiary be initially measured
at fair value and the gain and loss on the deconsolidation of the subsidiary be
measured using the fair value of any non-controlling equity; requires that
entities provide disclosure that clearly identify the interests of the parent
and the interests of the non-controlling owners. The adoption of ASC 810-10 did
not have a significant effect on the Company's consolidated financial
statements.





On April
1, 2009, the FASB approved ASC 805 (formerly SFAS No. 141R-1, Accounting for
Assets Acquired and Liabilities Assumed in Business Combination That Arise from
Contingencies), which amends Statement 141R and eliminates the distinction
between contractual and non-contractual contingencies. Under ASC 805, an
acquirer is required to recognize at fair value an asset acquired or liability
assumed in a business combination that arises from a contingency if the
acquisition-date fair value of that asset or liability can be determined during
the measurement period. If the acquisition-date fair value cannot be determined,
the acquirer applies the recognition criteria in SFAS No.5, Accounting for
Contingencies and Interpretation 14, "Reasonable Estimation of the amount of a
Loss and interpretation of FASB Statement No. 5," to determine whether the
contingency should be recognized as of the acquisition date or after it. The
adoption of ASC 805 did not have a material effect on the Company's consolidated
financial statements.


19





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(ai)
            Recent
      accounting pronouncements
(Continued)





ASC
320-10 (formerly FSP FAS 115-2 and FAS 124-2) amends the other-than-temporary
impairment guidance in U.S. GAAP for debt securities to make the guidance more
operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements. It did not amend existing recognition and measurement guidance
related to other-than-temporary impairments of equity securities. We are
required to adopt ASC 320-10 for our interim and annual reporting periods ending
after June 15, 2009. ASC 320-10 does not require disclosures for periods
presented for comparative purposes at initial adoption. ASC 320-10 requires
comparative disclosures only for periods ending after initial adoption. The
adoption of ASC 320-10 did not have a material effect on the Company's
consolidated financial statements.





On April
9, 2009, the FASB also approved ASC 825-10 (formerly FSP FAS 107-1 and APB 28-1,
Interim Disclosures about Fair
Value of Financial Instruments) to require disclosures about fair value
of financial instruments in interim period financial statements of publicly
traded companies and in summarized financial information required by APB Opinion
No. 28, Interim Financial
Reporting. We are required to adopt ASC 825-10 for our interim and annual
reporting periods ending after June 15, 2009. ASC 825-10 does not require
disclosures for periods presented for comparative purposes at initial adoption.
ASC 825-10 requires comparative disclosures only for periods ending after
initial adoption. The adoption of ASC 125-10 did not have a material effect on
the Company's consolidated financial statements.





In April
2009, the FASB issued FSP No. FAS 157-4, "Determining Fair Value When the Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased
and Identifying Transactions That Are Not Orderly" as incorporated into FASB ASC
820, "Fair Value Measurements and Disclosures". The guidance relates to
determining fair values when there is no active market or where the price inputs
being used represent distressed sales. It reaffirms what FASB ASC 820 states is
the objective of fair value measurement to reflect how much an asset would be
sold for in an orderly transaction (as opposed to a distressed or forced
transaction) at the date of the financial statements under current market
conditions. Specifically, it reaffirms the need to use judgment to ascertain if
a formerly active market has become inactive and in determining fair values when
markets have become inactive. This guidance is effective for interim and annual
periods ended after June 15, 2009, but entities may early adopt this guidance
for the interim and annual periods ended after March 15, 2009. The adoption of
such standard did not have a material impact on the Company's consolidated
financial statements.


20





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(ai)
            Recent
      accounting pronouncements
(Continued)





Effective
July 1, 2009, the Company adopted ASC 815-40 (formerly Emerging Issues Task
Force ("EITF") Issue No. 07-05, Determining Whether an Instrument (or Embedded
Feature) Is Indexed to an Entity's Own Stock ("EITF 07-05"). ASC 815-40
addresses the determination of whether an instrument (or an embedded feature) is
indexed to an equity's own stock, which is the first part of the scope exception
in paragraph 11(a) of FASB SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS 133"). If and instrument (or an embedded feature)
that has the characteristics of a derivative instrument under paragraph 6-9 of
SFAS 133 is indexed to an entity's own stock, it is still necessary to evaluate
whether it is classified in stockholders' equity (or would be classified in
stockholders' equity if it were a freestanding instrument). Other applicable
authoritative accounting literature, including Issues EITF 00-19, Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock, and EITF 05-2, The Meaning of "Conventional Debt
Instrument" in Issue No. 00-19, provides guidance for determining whether an
instrument (or an embedded feature) is classified in stockholders' equity (or
would be classified in stockholders' equity if it were a freestanding
instrument). ASC 815-40 does not address that second part of the scope exception
in paragraph 11(a) of SFAS 133. As a result of the adoption of ASC 815-40, the
Company adjusted its accounting effective from the beginning of fiscal year
2010, i.e. July 1, 2009, on which date ASC 815-40 was 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.





In August
2009, the FASB issued FASB ASU 2009-05, "Measuring Liabilities at Fair Value".
FASB ASU 2009-05 amends FASB ASC 820, "Fair Value Measurements". Specifically,
FASB ASU 2009-05 provides clarification that in circumstances in which a quoted
price in an active market for the identical liability is not available, a
reporting entity is required to measure fair value using one or more of the
following methods: 1) a valuation technique that uses a) the quoted price of the
identical liability when traded as an asset or b) quoted prices for similar
liabilities or similar liabilities when traded as assets and/or 2) a valuation
technique that is consistent with the principles of FASB ASC 820 of the
Accounting Standards Codification (e.g. an income approach or market approach).
FASB ASU 2009-05 also clarifies that when estimating the fair value of a
liability, a reporting entity is not required to adjust to include inputs
relating to the existence of transfer restrictions on that liability. The
adoption of such standard did not have a material impact on the Company's
consolidated financial statements.





in May
2009, the FASB issued SFAS No. 165, "Subsequent Event", ("FASB ASC 855-10")
which establishes general standards of accounting for and disclosure of events
that occur after the balance sheet date but before financial statements. The
statement is effective for interim and annual periods ended after June 15, 2009.
The standard was subsequently amended by FASB ASU 2010-09 which exempts an
entity that is an SEC filer from the requirement to disclose the date through
which subsequent events have been evaluated.





In
September 2009, the Emerging Issues Task Force reached final consensus on FASB
ASU 2009-13, "Revenue Arrangements with Multiple Deliverables". FASB ASU 2009-13
addresses how to determine whether an arrangement involving multiple
deliverables contains more than one unit of accounting, and how the arrangement
consideration should be allocated among the separate units of accounting. This
ASU will be effective prospectively for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010. Early
adoption is permitted. The adoption of such standard is not expected to have a
material impact on the Company's consolidated financial
statements.


21





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(ai)
            Recent
      accounting pronouncements
(Continued)





In
December 2009, the FASB issued FASB ASU 2009-17, Consolidation of Variable
Interest Entities ("FASB ASC 810"): improvements to Financial Reporting by
Enterprises involved with Variable Interest Entities. This ASU amends the FASB
Accounting Standards Codification for statement No.167. In June 2009, the FASB
issued SFAS No.167, Amendments to FASB Interpretation No. 46(R), which requires
an enterprise to perform an analysis and ongoing reassessments to determine
whether the enterprises variable interest or interests give it a controlling
financial interest in a variable interest entity und amends certain guidance for
determining whether an entity is a variable interest entity. It also requires
enhanced disclosures that will provide users of financial statements with more
transparent information about an enterprises involvement in a variable interest
entity. SFAS No.167 is effective as of the beginning of each reporting entity's
first annual reporting period that begins after November 15, 2009 and for all
interim reporting periods after that, with early application prohibited. The
adoption of such standard did not have a material impact on the Company's
consolidated financial statements.





In
January 2010, the FASB issued Accounting Standards Update 2010-05 (ASU 2010-05),
"Compensation - Stock Compensation (Topic 718)". This standard codifies EITF
Topic D-110 Escrowed Share Arrangements and the Presumption of Compensation and
is effective immediately. The provisions of ASU 2010-05 did not have a material
effect on the Company's consolidated financial statements and is effective
immediately.





In
January 2010, the FASB issued Update No. 2010-6, “Improving Disclosures About
Fair Value Measurements” (“ASU 2010-6”), which requires reporting entities to
make new disclosures about recurring or nonrecurring fair-value measurements
including significant transfers into and out of Level 1 and Level 2 fair-value
measurements and information on purchases, sales, issuances, and settlements on
a gross basis in the reconciliation of Level 3 fair-value measurements. ASU
2010-6 is effective for annual reporting periods beginning after December 15,
2009, except for Level 3 reconciliation disclosures, which are effective for
annual periods beginning after December 15, 2010. The Company is currently
evaluating the effect of this update on its financial position, results of
operations and liquidity.





In
February 2010, the FASB issued Accounting Standards Update 2010-09 (ASU
2010-09), "Subsequent Events (Topic 855)." The amendments remove the
requirements for an SEC filer to disclose a date, in both issued and revised
financial statements, through which subsequent events have been reviewed.
Revised financial statements include financial statements revised as a result of
either correction of an error or retrospective application of U.S. GAAP. ASU
2010-09 is effective for interim or annual financial periods ending after June
15, 2010. The provisions of ASU 2010-09 did not have a material effect on the
Company's consolidated financial statements.


22





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(ai)
            Recent
      accounting pronouncements
(Continued)





In
February 2010, the FASB issued Accounting Standards Update 2010-10 (ASU
2010-10), "Consolidation (Topic 810)." The amendments to the consolidation
requirements of Topic 810 resulting from the issuance of Statement 167 are
deferred for a reporting entity's interest in an entity (1) that has all the
attributes of an investment company or (2) for which it is industry practice to
apply measurement principles for financial reporting purposes that are
consistent with those followed by investment companies. An entity that qualifies
for the deferral will continue to be assessed under the overall guidance on the
consolidation of variable interest entities in Subtopic 810-10 (before the
Statement 167 amendments) or other applicable consolidation guidance, such as
the guidance for the consolidation of partnerships in Subtopic 810-20. The
deferral is primarily the result of differing consolidation conclusions reached
by the International Accounting Standards Board ("IASB") for certain investment
funds when compared with the conclusions reached under Statement 167. The
deferral is effective as of the beginning of a reporting entity's first annul
period that begins after November 15, 2009, and for interim periods within that
first annual reporting period, which coincides with the effective date of
Statement 167. Early application it not permitted. The provisions of ASU 2010-10
are effective for the Company beginning in 2010. The adoption of ASU 2010-10 did
not have a material impact on the Company's consolidated financial
statements.





In March
2010, the FASB issued Accounting Standards Update 2010-11 (ASU 2010-11),
"Derivative and Hedging (Topic 815)." All entities that enter into contracts
containing an embedded credit derivative feature related to the transfer of
credit risk that is not only in the form of subordination of one financial
instrument to another will be affected by the amendments in this Update because
the amendments clarify that the embedded credit derivative scope exception in
paragraph 815-15-15-8 through 15-9 does not apply to such contracts. ASU 2010-11
is effective at the beginning of the reporting entity's first fiscal quarter
beginning after June 15, 2010. The Company is currently evaluating the impact of
this accounting update on its consolidated financial statements.





In April
2010, the FASB issued Accounting Standards Update 2010-13 (ASU 2010-13),
"Compensation - Stock Compensation (Topic 718)." This Update provides amendments
to Topic 718 to clarity that an employee share-based payment award with an
exercise price denominated in the currency of a market in which a substantial
portion of the entity's equity securities trades should not be considered to
contain a condition that is not a market, performance, or service condition.
Therefore, an entity would not classify such an award as a liability if it
otherwise qualifies as equity. The amendments in ASU 2010-13 are effective for
fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2010. The provisions of ASU 2010-13 are not expected to have
a material effect on the Company's consolidated financial
statements





In July
2010, the FASB issued 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. 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 Company is currently
evaluating the impact of this accounting update on its financial
disclosures.


23





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





3.
            CONCENTRATIONS
      OF CREDIT RISK AND MAJOR CUSTOMERS





Financial
instruments which potentially expose the Group to concentrations of credit risk,
consists of cash and accounts receivable as of June 30, 2010, and 2009. The
Group performs ongoing evaluations of its cash position and credit evaluations
to ensure sound collections and minimize credit losses exposure.





As of
June 30, 2010, and 2009, almost all the Group’s bank deposits were conducted
with banks in the PRC where there is currently no rule or regulation mandated on
obligatory insurance of bank accounts. A minimal bank deposit was maintained
with the banks in the U.S.A and Hong Kong.





For the
years ended June 30, 2010, and 2009, more than 90% of the Group’s sales were
generated from the PRC. In addition, nearly all accounts receivable as of June
30, 2010, and 2009, also arose in the PRC.





The
maximum amount of loss exposure due to credit risk that the Group would bear if
the counter parties of the financial instruments failed to perform represents
the carrying amount of each financial asset in the balance sheet.





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





For the
years ended June 30, 2010, and 2009, there was no customer who accounts for 10%
or more of the Group’s revenue.





Details
of customer account for 10% or more of the Group’s accounts receivable were as
follows:





Year ended June 30,2010
                  
                  
                  2009Customer
      A
                  
                  $
                  *
                  
                  
                  $
                  655,755Customer
      B
                  
                  
                  *
                  
                  
                  $
                  438,067Customer
      C
                  
                  
                  *
                  
                  
                  $
                  380,115





*: No
customer accounts for 10% or more of the Group’s accounts receivable for the
year ended June 30, 2010.





4.
            OTHER
      RECEIVABLES





Other
receivables consist of the followings:





June 30,2010
                          
                          
                          2009Advance
      to employees
                          
                          $
                          24,935
                          
                          
                          $
                          12,268Tender
      deposits
                          
                          
                          37,304
                          
                          
                          
                          10,227Sundry
                          
                          
                          32,656
                          
                          
                          
                          484VAT
      recoverable
                          
                          
                          230,288
                          
                          
                          
                          -$
                          325,183
                          
                          
                          $
                          22,979




24





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





5.
            INVENTORIES





Inventories
consist of the followings:





June 30,2010
                    
                    
                    2009Finished
      goods
                    
                    $
                    592,034
                    
                    
                    $
                    236,574Work
      in process
                    
                    
                    -
                    
                    
                    
                    49,607Raw
      materials
                    
                    
                    1,964,132
                    
                    
                    
                    621,618$
                    2,556,166
                    
                    
                    $
                    907,799




6.
            PROPERTY,
      PLANT AND EQUIPMENT, NET





Property,
plant and equipment consist of the followings:





June 30,2010
                              
                              
                              2009At
      costBuildings
                              
                              $
                              2,119,449
                              
                              
                              $
                              2,050,980Machinery
      and equipment
                              
                              
                              4,598,723
                              
                              
                              
                              3,056,646Office
      equipment
                              
                              
                              175,507
                              
                              
                              
                              166,748Motor
      vehicles
                              
                              
                              507,346
                              
                              
                              
                              416,1637,401,025
                              
                              
                              
                              5,690,537Less:
      accumulated depreciationBuildings
                              
                              
                              (338,732
                              )
                              
                              
                              (280,907
                              )Machinery
      and equipment
                              
                              
                              (666,345
                              )
                              
                              
                              (294,726
                              )Office
      equipment
                              
                              
                              (132,066
                              )
                              
                              
                              (117,807
                              )Motor
      vehicles
                              
                              
                              (143,826
                              )
                              
                              
                              (138,645
                              )(1,280,969
                              )
                              
                              
                              (832,085
                              )Property,
      plant and equipment, net
                              
                              
                              6,120,056
                              
                              
                              
                              4,858,452





Depreciation
expenses included in the cost of sales for the years ended June 30, 2010 and
2009 were $357,931 and $113,751, respectively; and in the general and
administrative expenses for the years ended June 30, 2010 and 2009 were $150,092
and $58,434, respectively.


25





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





7.
            LAND
      USE RIGHTS





June
      30,2010
                          
                          
                          2009Cost
      of land use rights
                          
                          $
                          2,803,194
                          
                          
                          $
                          2,788,369Less:
      Accumulated amortization
                          
                          
                          (322,265
                          )
                          
                          
                          (302,714
                          )Land
      use rights, net
                          
                          $
                          2,480,929
                          
                          
                          $
                          2,485,655





Amortization
expenses for the years ended June 30, 2010 and 2009 were $19,551 and $18,966
respectively.





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





2011
                        
                        $
                        56,0642012
                        
                        
                        56,0642013
                        
                        
                        56,0642014
                        
                        
                        56,0642015
                        
                        
                        56,064Thereafter
                        
                        
                        2,200,609$
                        2,480,929





8.
            OTHER
      INTANGIBLE ASSETS





June
      30,2010
                        
                        
                        2009At
      cost:Patent
      rights
                        
                        $
                        7,490,527
                        
                        
                        $
                        8,949,335Software
                        
                        
                        1,537,921
                        
                        
                        
                        19,9139,028,448
                        
                        
                        
                        8,969,248Less:
      Accumulated amortizationPatent
      rights
                        
                        $
                        (2,858,219
                        )
                        
                        $
                        (2,098,012
                        )Software
                        
                        
                        (168,818
                        )
                        
                        
                        (14,569
                        )(3,027,037
                        )
                        
                        
                        (2,112,581
                        )Other
      intangible assets, net
                        
                        $
                        6,001,411
                        
                        
                        $
                        6,856,667





Amortization
expenses for the years ended June 30, 2010 and 2009 were $914,456 and $765,965
respectively.


26





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





8.
            OTHER
      INTANTIGBLE ASSETS (CONTINUED)





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





2011
                      
                      
                      904,6262012
                      
                      
                      902,3462013
                      
                      
                      902,0532014
                      
                      
                      901,4672015
                      
                      
                      901,319Thereafter
                      
                      
                      1,489,6006,001,411





9.
            NOTES
      PAYABLE





Notes
payable consists of the following:


27




June 30,2010
                      
                      
                      2009Due
      December 30,2010
                      
                      $
                      130,423
                      
                      
                      $
                      -Due
      December 30,2010
                      
                      
                      53,939
                      
                      
                      
                      -Due
      December 30,2010
                      
                      
                      144,055
                      
                      
                      
                      -Due
      December 28,2010
                      
                      
                      549,188
                      
                      
                      
                      -Due
      December 3,2010
                      
                      
                      25,115
                      
                      
                      
                      -Due
      December 3,2010
                      
                      
                      56,840
                      
                      
                      
                      -Due
      December 3,2010
                      
                      
                      247,628
                      
                      
                      
                      -Due
      November 28,2010
                      
                      
                      29,375
                      
                      
                      
                      -Due
      November 28,2010
                      
                      
                      14,687
                      
                      
                      
                      -Due
      November 28,2010
                      
                      
                      8,812
                      
                      
                      
                      -Due
      November 28,2010
                      
                      
                      20,562
                      
                      
                      
                      -Due
      November 28,2010
                      
                      
                      8,812
                      
                      
                      
                      -Due
      November 28,2010
                      
                      
                      29,375
                      
                      
                      
                      -Due
      November 28,2010
                      
                      
                      28,200
                      
                      
                      
                      -Due
      October 15,2010
                      
                      
                      123,814
                      
                      
                      
                      -Due
      October 14,2010
                      
                      
                      204,888
                      
                      
                      
                      -Due
      October 6,2010
                      
                      
                      19,916
                      
                      
                      
                      -Due
      October 2,2010
                      
                      
                      18,653
                      
                      
                      
                      -Due
      September 15,2010, subsequently repaid on due dates
                      
                      
                      69,265
                      
                      
                      
                      -Due
      September 9,2010, subsequently repaid on due dates
                      
                      
                      2,910
                      
                      
                      
                      -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
                      
                      
                      
                      -Due
      December 24,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      1,496Due
      December 24,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,209Due
      December 24,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      3,487Due
      December 24,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      6,501Due
      December 24,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      8,110Due
      December 24,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,254Due
      November 27,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      1,713Due
      November 27,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,787Due
      November 27,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,024Due
      November 27,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,022Due
      November 27,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,772Due
      November 27,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      4,918Due
      November 8,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      29,219Due
      November 6,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,321Due
      November 6,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      6,018Due
      November 6,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      12,397Due
      November 6,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      7,773Due
      November 6,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      5,230Due
      November 6,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      43,617Due
      September 18,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      13,657Due
      September 18,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,957Due
      September 18,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      4,383Due
      September 18,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      11,346Due
      September 18,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      38,817Due
      August 16,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      9,329Due
      August 16,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      9,559Due
      August 16,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      14,097Due
      August 16,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      3,335Due
      August 16,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      22,210Due
      August 16,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      7,911Due
      August 6,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      30,019Due
      July 22,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,206Due
      July 22,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      10,480Due
      July 22,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      2,449Due
      July 22,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      38,813Due
      July 22,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      31,741Due
      July 21,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      292,192Due
      July 21,2009, subsequently repaid on its due date
                      
                      
                      -
                      
                      
                      
                      292,192Total
                      
                      $
                      2,652,095
                      
                      
                      $
                      984,561





All the
notes payable are subject to bank charges of 0.05% of the principal amount as
commission on each loan transaction.  Bank charges for notes payable
were $2,194 and $915 for the year ended June 30, 2010 and 2009,
respectively.




28




The
interest-free notes payable are secured by $1,849,958 and $940,488 restricted
cash as of June 30, 2010 and December 31, 2009.


29





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





10.
            OTHER
      PAYABLES





June 30,2010
                      
                      
                      2009Commissions
      payables
                      
                      $
                      441,860
                      
                      
                      $
                      312,365Accrued
      expenses
                      
                      
                      127,975
                      
                      
                      
                      12,389Deposit
      for project
                      
                      
                      266,134
                      
                      
                      
                      467,508Sundry
      PRC taxes payables
                      
                      
                      379,588
                      
                      
                      
                      -Sundry
                      
                      
                      29,282
                      
                      
                      
                      2,492$
                      1,244,839
                      
                      
                      $
                      794,754





11.
            PREFERRED
      STOCK AND WARRANTS IN CONNECTION WITH PRIVATE
  PLACEMENTS





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





Series of warrant
                  
                  Number of shares
                  
                  
                  Exercise price
                  
                  Contractual termSeries
      A
                  
                  
                  7,098,632
                  
                  
                  $
                  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 Series A Preferred Share.  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 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 Series A
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 Series A 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.


30





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 Stock. 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.


31





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





11.
            PREFERRED
      STOCK AND WARRANTS IN CONNECTION WITH PRIVATE PLACEMENT
      (CONTINUED)





The gross
proceeds of the transaction were $15 million. The proceeds from the transaction
were originally allocated to 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
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 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
Series A 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 various stock
purchase warrants for cash consideration totaling $5 million dollars (the “July
2008 Financing”). The exercise price, expiration date and number of share
eligible to be purchased with the Warrants are summarized in the following
table:





Series of warrant
                  
                  Number of shares
                  
                  
                  Exercise price
                  
                  Contractual termSeries
      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 Series A Preferred Share.  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.


32





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





11.
            PREFERRED
      STOCK AND WARRANTS IN CONNECTION WITH PRIVATE PLACEMENT
      (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.





During
the fiscal year ended June 30, 2010, a total of 900,000 shares of Preferred
Share have been converted into 900,000 share of Common Stock; a total of 284,091
Warrants have been exercised at an exercise price of $3.52 per share, of which a
net issuance of 153,154 shares of Common Stock was based on cashless exercise,
and another 25,511 shares of Common Stock were issued for cash proceeds of
$89,799.





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 originally
not 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 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.


33





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





11.
            PREFERRED
      STOCK AND WARRANTS IN CONNECTION WITH PRIVATE PLACEMENT
      (CONTINUED)





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.





During
the course of internal evaluation, the Company re-evaluated its accounting
treatment as of July 1, 2009 for the warrants issued in the Private Placements
in June and July, 2008, 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 subsidiary, Tianjin
Shengkai Industrial Technology Development Company Limited, 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.





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 and
July 2008 Private Placements.  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, reversing the prior accounting related to
the treatment of the beneficial conversion feature and recording a
cumulative-effect adjustment to the opening balance of retained
earnings.




ESCROW
ACCOUNT
 
 In
connection with the June 2008 Private Placement, on June 10, 2008 we entered
into and on June 11, 2008 consummated a securities escrow agreement with Vision
Opportunity China LP, the Company’s principal shareholder, and Loeb & Loeb
LLP, as escrow agent (the “Securities Escrow Agreement A”).  In the
Securities Escrow Agreement A, as an inducement to the purchasers to enter into
the June 2008 Private Placement, 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 years ended June 30, 2009 and June 30,
2008.
 
 In
connection with the July 2008 Private Placement, on July 18, 2008, we
consummated a securities escrow agreement with Blue Ridge Investments, LLC, the
Company’s principal shareholder, and Loeb & Loeb LLP, as escrow agent (the
“Securities Escrow Agreement B”).  In the Securities Escrow Agreement
B, as an inducement to Blue Ridge Investments, LLC to enter into the July 2008
Private Placement, 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 years ended June 30, 2009 and
2008.
 
 As the
Company achieved the financial performance thresholds for the years ended June
30, 2009 and 2008, 5,915,526 Vision Escrow Shares and 1,971,842 Blue Ridge
Escrow Shares were released from the escrow accounts on December 1, 2009 and
January 18, 2010, respectively.  As a result, the Company recorded
stock compensation expense of $15,971,920 in total for the year ended June 30,
2010 in accordance with Accounting Standards Update-2010-05.




34





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





12.  SHARE-BASED
COMPENSATION





The
Company’s 2010 Incentive Stock Plan (the “Plan”) was adopted by our Board of
Directors and approved by our shareholders, permits the grant of incentive stock
options, non-statutory stock options; stock awards, restricted stock purchase
offer, to our officers, employees and non-employee directors. The 2010 Incentive
Stock 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.





On March
31, 2010, the Company issued 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 issued to key employees vest
in three equal annual installments of 33.3%, with exercise price of $7.97 per
share.  Options issued 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 financial
statements over the requisite service period of the grants. Total compensation
expense related to the stock options for the year ended June 30, 2010 was
$3,054,332 and was recorded as general and administrative expense.  As
of June 30, 2010, there was $9,383,652 of unrecognized compensation costs
related to nonvested share-based compensation arrangements granted under the
Plan.  That cost is expected to be recognized over a weighted average
period of approximately 2.8 years.  There were 476,667 options vested
during the fiscal year ended June 30, 2010.





The fair
value of the stock option grant for the year ended June 30, 2010 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.


35




SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





12.  SHARE-BASED
COMPENSATION (CONTINUED)


A summary
of the Company’s stock option activity as of June 30, 2010, and changes during
fiscal year ended June 30, 2010 is presented in the following
table:





Options
                                
                                
                                Weighted-Average Exercise
                                  PriceOutstanding
      at July 1, 2009
                                
                                
                                -
                                
                                
                                
                                -Granted
                                
                                
                                2,211,250
                                
                                
                                $
                                7.29Exercised
                                
                                
                                -
                                
                                
                                
                                -Forfeited
      or Expired
                                
                                
                                -
                                
                                
                                
                                -Outstanding
      at June 30, 2010
                                
                                
                                2,211,250
                                
                                
                                $
                                7.29Vested
      at June 30, 2010
                                
                                
                                476,667
                                
                                
                                $
                                7.97





The
following table summarizes information about stock options outstanding at June
30, 2010:





Options Outstanding
                      
                      
                      Options ExercisableExercise Price
                      
                      Number
                        Outstanding
                      
                      
                      Weighted Average
                        Remaining Contractual Life
                        (years)
                      
                      
                      Weighted Average
                        Exercise Price
                      
                      
                      Number
                        Exercisable
                      
                      
                      Weighted
                        Average
                        Exercise
                        Price$
                      8.13
                      
                      
                      250,125
                      
                      
                      
                      4.98
                      
                      
                      $
                      8.13
                      
                      
                      
                      -
                      
                      
                      $
                      -$
                      3.00
                      
                      
                      310,000
                      
                      
                      
                      4.75
                      
                      
                      $
                      3.00
                      
                      
                      
                      -
                      
                      
                      $
                      -$
                      7.97
                      
                      
                      1,651,125
                      
                      
                      
                      4.75
                      
                      
                      $
                      7.97
                      
                      
                      
                      476,667
                      
                      
                      $
                      7.972,211,250
                      
                      
                      
                      4.78
                      
                      
                      $
                      7.29
                      
                      
                      
                      476,667
                      
                      
                      $
                      7.97





A summary
of the status of the Company’s nonvested shares as of June 30, 2010, and changes
during the fiscal year ended June 30, 2010, is presented below:





Nonvested Shares
                      
                      Shares
                      
                      
                      Weighted Average Grant Date Fair ValueNonvested
      at July 1, 2009
                      
                      
                      -
                      
                      
                      $
                      -Granted
                      
                      
                      2,211,250
                      
                      
                      
                      5.63Vested
                      
                      
                      476,667
                      
                      
                      
                      5.37Forfeited
                      
                      
                      -
                      
                      
                      
                      -Nonvested
      at June 30, 2010
                      
                      
                      1,734,583
                      
                      
                      $
                      5.70




36





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





13.
            INCOME
      TAXES





(a)
            The
      Company 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 subsidiary, SK
      and VIE, Shengkai (see note 1).





SK, and
Shengkai, being registered in the PRC, are subject to PRC’s Enterprise Income
Tax. Pursuant to the PRC Income Tax Laws, Enterprise Income Taxes (“EIT”) is
generally imposed at 25% since January 1, 2008.





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 year ended June 30, 2010, 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 and for the period from January 1, 2010 to June 30, 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,
2010 as we are not sure whether the overpaid income tax expenses during the
calendar year 2009 would be approved by the local tax bureau .





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 is 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, 2010, no detailed interpretation or
guidance has been issued to define “place of effective
management”.  Furthermore, as of June 30, 2010, 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, as of June 30, 2010, and the Company has not
accrued for PRC tax on such basis.  The Company will continue to
monitor changes in the interpretation or guidance of this law.  Income
taxes payable was $1,061,783 and $1,471,380 at June 30, 2010 and 2009,
respectively.





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.  The foreign invested enterprise is subject to the
withholding tax starting from January 1, 2008.  There were no such
dividends distributed in the year ended June 30, 2010 or 2009.


37





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





13.
            INCOME
      TAXES (CONTINUED)





Income
tax expenses consist of the following:





Year Ended June 30,2010
                  
                  
                  2009Current
                  
                  $
                  4,703,494
                  
                  
                  $
                  4,522,362Deferred
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  $
                  4,703,494
                  
                  
                  $
                  4,522,362





Reconciliation
from the expected income tax expenses calculated with reference to the statutory
tax rate in the PRC of 25% for 2010 and 2009 is as follows:





Year Ended June 30,2010
                  
                  
                  2009Income
      tax (benefits) expenses computed at the PRC statutory rate of 25% based on
      (loss) income before tax of $(51,682,071) for the year ended June 30, 2010
      and $18,100,056 for the year ended June 30, 2010.
                  
                  $
                  (12,920,518
                  )
                  
                  $
                  4,525,014Valuation
      allowance
                  
                  
                  12,920,518
                  
                  
                  
                  -Income
      tax for income from China subsidiary for the year ended June 30, 2010
      (Based on income before tax of $24,240,561)
                  
                  
                  6,060,140
                  
                  
                  
                  -Preferential
      tax rate effect of 10% for the period from January 1, 2010 to June 20,
      2010 (Based on income before tax of $13,566,669)
                  
                  
                  (1,356,646
                  )
                  
                  
                  -Permanent
      difference
                  
                  
                  -
                  
                  
                  
                  (2,652
                  )$
                  4,703,494
                  
                  
                  $
                  4,522,362




38





SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





14.
            EARNINGS
      (LOSS) PER SHARE





The
calculation of the basic and diluted earnings (loss) per share attributable to
the common stock holders is based on the following data:





Earnings
      (Loss):
                      
                      2010
                      
                      
                      2009Net
      (loss) income for the year
                      
                      $
                      (56,385,565)
                      
                      
                      $
                      13,577,694Non-Cash
      Dividends on convertible preferred stock
                      
                      
                      -
                      
                      
                      
                      (2,560,186
                      )(Loss)
      earnings for the purpose of basic earnings per share
                      
                      $
                      (56,385,565)
                      
                      
                      $
                      11,017,508Effect
      of dilutive potential common stock
                      
                      
                      -
                      
                      
                      
                      -(Loss)
      earnings for the purpose of dilutive earnings (loss) per
    share
                      
                      $
                      (56,385,565)
                      
                      
                      $
                      11,017,508Number
      of shares:Weighted
      average number of common stock for the purpose of basic earnings (loss)
      per share
                      
                      
                      22,704,492
                      
                      
                      
                      22,112,500Effect
      of dilutive potential common stock-
      conversion of convertible preferred stock
                      
                      
                      -
                      
                      
                      
                      7,887,368-
      exercise of warrants
                      
                      
                      --
      exercise of options
                      
                      
                      -Weighted
      average number of common stock for the purpose of dilutive earnings (loss)
      per share
                      
                      
                      22,704,492
                      
                      
                      
                      29,999,868Earnings
      (loss) per share:Basic
      earnings (loss) per share
                      
                      $
                      (2.483)
                      
                      
                      $
                      0.498Dilutive
      earnings (loss) per share
                      
                      $
                      (2.483)
                      
                      
                      $
                      0.367




39




SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED JUNE 30, 2010 AND 2009


(Stated
in US Dollars)





15.  COMMITMENTS AND
CONTINGENCY





A new
manufacturing facility and a headquarters’ building are under construction on a
plot of land in Tianjin, China which was obtained in October, 2008. Certain
construction contracts including the main superstructure were executed. The
total amount of executed contracts was $32,587,834 (RMB 221,597,271), of which $
24,072,627 (RMB 163,693,864) had been paid as of June 30, 2010. The balance of
$8,515,207 (RMB 57,903,407) will be settled by the end of calendar year
2010.





Certain
equipment and machinery contracts were executed. The total amount of executed
contracts was $15,370,647 (RMB 104,520,400), of which $11,973,235 (RMB
81,418,000) had been paid as of June 30, 2010. The balance of $3,397,412 (RMB
23,102,400) will be settled by the end of calendar year 2010.




16.  SEGMENT INFORMATION





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





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





For the Year Ended June 30,Customer industry
                      
                      2010
                      
                      
                      2009Electric
      power
                      
                      $
                      35,291,530
                      
                      
                      $
                      29,483,317Petrochemical
      and chemical
                      
                      
                      15,886,538
                      
                      
                      
                      7,891,971Aluminum,
      metallurgy and others
                      
                      
                      2,970,886
                      
                      
                      
                      1,921,947Total
      Sales
                      
                      $
                      54,148,954
                      
                      
                      $
                      39,297,235





17.   
 SUBSEQUENT EVENTS





We have
evaluated all events or transactions that occurred after June 30, 2010 up
through the date we issued the consolidated financial statements. There were no
significant subsequent events occurred.


40




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





Previous
Independent Accountants





On June
28, 2010, Albert Wong & Co. (“AW”) resigned as our registered independent
public accounting firm.





The audit
reports of AW on our financial statements for each of the past two fiscal years
ended June 30, 2008, and 2009, contained no adverse opinions or disclaimers of
opinion, and were not qualified or modified as to uncertainty, audit scope, or
accounting principles.




During
the fiscal years ended June 30, 2008, and 2009, and through the date of
termination, we have had no disagreements with AW 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 AW, 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
the fiscal years ended June 30, 2008, and 2009, and through the date of
termination, there have been no reportable events as defined under Item
304(a)(1)(v) of Regulation S-K adopted by the SEC.




We
provided AW with a copy of this disclosure before its filing with the SEC. We
requested that AW 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 AW
stating that it agrees with the above statements.





New
Independent Accountants




On June
28, 2010, our Audit Committee of the Board of Directors approved the appointment
of BDO China Li Xin Da Hua CPA Co., Ltd. (“BDO”) as our new registered
independent public accounting firm, effective as of June 28, 2010, for the year
ending June 30, 2010, and to conduct review engagements on the Company’s
non-annual quarterly financial statements on an ongoing basis
thereafter.  BDO is registered with the Public Company Accounting
Oversight Board.





During
the two most recent fiscal years ended June 30, 2008, and 2009 and through the
date of our engagement of BDO, we did not consult with BDO regarding either (1)
the application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
our financial statements, or (2) any matter that was either the subject of a
disagreement (as defined in Regulation S-K Item 304(a)(1)(v)), during the two
most recent fiscal years.





Prior to engaging BDO, BDO did not
provide our Company with either written or oral advice that was an important
factor considered by our Company in reaching a decisionas to any
accounting, auditing or financial reporting issue at hand.





Item
9A.               Controls
and Procedures.





(a)
            Evaluation
      of Disclosure Controls and
Procedures





The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in reports filed by the Company
under the Securities Exchange Act of 1934 (“Exchange Act”), as amended, is
recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission (“SEC”)’s rules and forms
and that such information is accumulated and communicated to the Company’s
management, including its Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow for timely decisions regarding required
disclosure.





Our Chief
Executive Officer and Chief Financial Officer evaluated, with
the participation of other members of management, the effectiveness of the
Company’s disclosure controls and procedures (as defined in Rules 13a-15(e)
and 15d-15(e) of the Exchange Act) as of June 30, 2010 and as covered
by this Annual Report on Form 10-K.  Based on this evaluation, our
Chief Executive Officer and Chief Financial Officer noted a material weakness
(see Management’s Report on Internal Control over Financial Reporting
below) and concluded that the Company’s disclosure controls and procedures
were not effective.  The management has since implemented
corrective actions designed to ensure that material information required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act is recorded processed, summarized and reported within the time
periods specified in the SEC’s rules and regulations and accumulated and
communicated to them as appropriate to allow timely decisions regarding required
disclosure.


41





(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:





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, 2010.  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 at June 30, 2010 there was a material weakness
and therefore, the internal control over financial reporting was not
effective.  A material weakness is a deficiency, or a combination of
control deficiencies, in internal control over financial reporting such that
there is a reasonable possibility that a material misstatement of the Company’s
annual or interim financial statements will not be prevented or detected on a
timely basis.





The
Company’s material weakness in its internal control over financial reporting is
related to a lack of technical accounting expertise.  The Company
became a reporting company in June 2008.  The Company began preparing
to be in compliance with the internal control obligations, including Section
404, for our fiscal year ending June 30, 2008.  Until that time, the
Company’s internal accounting staff was primarily engaged in ensuring compliance
with PRC accounting and reporting requirements for our operating affiliates and
was not required to meet or apply U.S. GAAP requirements.   As a
result, with the exception of certain additional persons hired in March 2010 to
address these deficiencies, including the hiring of our CFO, our current
internal accounting department responsible for financial reporting of the
Company, on a consolidated basis, is relatively new to U.S. GAAP and the related
internal control procedures required of U.S. public
companies.  Although the Company’s accounting staff is professional
and experienced in accounting requirements and procedures generally accepted in
the PRC, management has determined that they require additional training and
assistance in U.S. GAAP matters. In order to mitigate this material weakness to
the fullest extent possible, external consultants were used and the Company’s
review process was strengthened.  Therefore, the management believes
that the consolidated financial statements and other information presented
herewith are materially correct.  The material weakness identified did
result in the amendment of previously reported condensed consolidated financial
statements for the quarters ended March 31, 2010, December 31, 2009 and
September 30, 2009 but not to any other related financial disclosure, nor does
the management believe that the weakness had any effect on the accuracy of the
Company’s consolidated financial statements for the current reporting
period.





Management
has also determined that our internal audit function is significantly deficient
due to insufficient qualified resources to perform internal audit
functions.A
significant deficiency is a deficiency, or a combination of deficiencies, in
internal control over financial reporting that is less severe than a material
weakness, yet important enough to merit attention by those responsible for
oversight of the company’s financial reporting. In order to correct the
foregoing deficiency, we have set up an internal control department with
qualified accounting staff, including a qualified chief financial officer, which
directly reports to the Company’s independent Audit Committee.We believe that the
foregoing steps will remediate the significant deficiency identified above, and
we will continue to monitor the effectiveness of these steps and make any
changes that our management deems appropriate.





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.


42





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, 2010 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.




Item 9B.   Other
Information.





None.


43





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
                        
                        AgeWang
      Chen
                        
                        Chief
      Executive Officer, Chairman
                        
                        46David
      Ming He
                        
                        Chief
      Financial Officer
                        
                        40Wei
      Guo
                        
                        Director
                        
                        44Michael
      Marks
                        
                        Director
                        
                        38Jun
      Leng
                        
                        Director
                        
                        40Ruizhu
      Mu
                        
                        Director
                        
                        38





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





Mr. Chen Wang was appointed
chief executive officer and chairman of the board of the Company on June 9,
2008.  Mr. Wangfounded
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 detail below.





Mr. David Ming Hewas
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 Guowas 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 detail
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 real
estate investment bank, in January 2003, and until December 2007 served as China
managing director and regional principal of the firm.  In September
2002, Mr. Marks founded the Shanghai office of Horwath Asia Pacific, a
hotel and tourism advisory firm affiliated with Horwath International, and
currently serves as its director and Shanghai representative.  Mr.
Marks currently serves as a director of Pypo China Holdings Limited and
previously served as the president and director of Middle Kingdom from January
2006 through July 2009. Mr. Marks also serves as an independent director of
Jiangbo Pharmaceuticals, Inc., a manufacturer and distributor of chemical and
herbal drugs throughout China, and China Housing & Land Development,
Inc., a developer of residential and commercial property in Shaanxi Province,
China.  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.


44


Mr. Jun Leng was appointed
director of the Company on November 5, 2009.  Mr. Leng has served as
Vice President of J.P. Morgan Asia Consulting (Beijing) Ltd. since August
2008.  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. Hu 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.





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 Shengkai





Under
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 Shengkai’s Articles of Association and PRC law, 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 Shengkai:


45





Directors and Executive Officers
                      
                      Position/Title
                      
                      AgeWang
      Chen
                      
                      Chief
      Executive Officer, Chief Technology Officer, Executive
      Director
                      
                      46Guo
      Wei
                      
                      VP
      International Sales
                      
                      44Guo
      Chuanji
                      
                      Supervisor
                      
                      80He
      Li
                      
                      Chief
      Operating Officer
                      
                      34Liu
      Xiaoqian
                      
                      Chief
      Marketing Officer
                      
                      31




The
following is a summary of the biographical information of those
directors and officers of Shengkai whose biographical information does not
appear above:





Mr. Liu
Xiaoqian joined 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 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 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 401(h) 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.


46


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. 27, Wang Gang Road,
Jin Nan (Shuang Gang) Economic and Technology Development
Area, Tianjin, People’s Republic of China 300350, 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, 2010:




Board
      of Directors
            1Audit
      Committee
            2Compensation
      Committee
            0Nominating
      Committee
            0





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 did not meet in executive session during
2010.





Board
Leadership Structure and Role in Risk Oversight





Chen Wang
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 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.


47





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, 2010, 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 except that
Michael Marks was late in filing a Form 3 and each of Chen Wang and Li Shaoqing
were late in filing a Form 4.





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, 2010 and 2009. No executive officer received
compensation in excess of $100,000 for any of those years.




Summary
Compensation Table


Name and
                                      Principal
                                      Position
                                    
                                    Fiscal
                                      Year
                                    
                                    Salary
                                      ($)
                                    
                                    Bonus
                                      ($)
                                    
                                    Stock
                                      Awards
                                      ($)
                                    
                                    Option
                                      Awards
                                      (3)
                                      ($)
                                    
                                    Non-equity
                                      Incentive Plan
                                      Compensation
                                      ($)
                                    
                                    Change in
                                      Pension
                                      Value and
                                      Nonqualified
                                      Deferred
                                      Compensation
                                      Earnings
                                      ($)
                                    
                                    All Other
                                      Compensation
                                      ($)
                                    
                                    Total
                                      ($)Chen
      Wang (CEO)(1)
                                    
                                    
                                    2010
                                    
                                    18,000
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    6,655
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    24,6552009
                                    
                                    18,000
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    18,000David
      Ming He (CFO)(2)
                                    
                                    
                                    2010
                                    
                                    40,000
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    99,758
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    139,7582009
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    -0-
                                    
                                    
                                    -0-





(1)
            Chen
      Wang 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)
            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.


48




Employment
Agreements





We, via
our operating entity, Shengkai, have an employment agreement with Mr. Chen Wang
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, 2010 and 2009:




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)
                                    
                                    2010
                                    
                                    $
                                    18,000
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    4,443
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    22,4432009
                                    
                                    $
                                    15,000
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    15,000Michael
      Marks,
                                      Director(2)
                                    
                                    2010
                                    
                                    $
                                    26,667
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    213,566
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    240,2332009
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Jun
      Leng,
                                      Director(3)
                                    
                                    2010
                                    
                                    $
                                    16,667
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    87,261
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    103,9282009
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Ruizhu
      Mu,
                                      Director(4)
                                    
                                    2010
                                    
                                    $
                                    16,667
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    87,261
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    103,9282009
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -





(1)
Compensation attributed to Wei Guo includes salary of $18,000 in the fiscal year
ended June 30, 2010 and $15,000 in the fiscal year ended June 30, 2009, received
by Ms. Guo in her capacity at 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.





(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.


49





(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 2010:




Outstanding
Equity Awards At Fiscal Year-End


OPTION
AWARDS


STOCK
AWARDS




Name
                          (a)
                        
                        Number
                          of
                          Securities
                          Underlying
                          Unexercised
                          options
                          (#)
      (b)
                        
                        
                        Equity
                          Incentive
                          Plan
                          Awards:
                          Number
      of
                          Securities
                          Underlying
                          Unexercised
                          Earned
                          Options
                          (#)
                          (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)Chen
      Wang
                        
                        
                        150,000
                        
                        
                        
                        1,096
                        
                        
                        
                        148,904
                        
                        
                        
                        8.13
                        
                        6/22/2015
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -David
      Ming He
                        
                        
                        221,125
                        
                        
                        
                        24,569
                        
                        
                        
                        196,556
                        
                        
                        
                        7.97
                        
                        3/31/2015
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -





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.


50





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, 2010.





Amount and Nature of Beneficial Ownership (1)Name and Address of
                                        Beneficial Owner
                                      
                                      Common
                                        Stock
                                      
                                      Options
                                      
                                      Preferred
                                        Shares
                                        (2)(13)
                                      
                                      
                                      Warrants
                                        (3)(13)
                                      
                                      
                                      Total (4)
                                      
                                      
                                      Percentage of
                                        Common
                                        Stock (%)Owner of More than 5% of ClassVision
      Opportunity China LP
                                        520
      Madison Avenue, 12th Floor
                                        New
      York, NY 10022 (5)
                                      
                                      
                                      267,089
                                      
                                      
                                      0
                                      
                                      
                                      5,015,526
                                      (13)
                                      
                                      
                                      7,098,632
                                      (13)
                                      
                                      
                                      12,381,247
                                      (13)
                                      
                                      
                                      9.9
                                      (13)%Hare
      & Co., as custodian for
                                        Blue
      Ridge Investments, LLC
                                        214
      N. Tryon Street
                                        Charlotte,
      NC 28255 (6)
                                      
                                      
                                      0
                                      
                                      
                                      0
                                      
                                      
                                      1,971,842
                                      (13)
                                      
                                      
                                      2,366,211
                                      (13)
                                      
                                      
                                      4,338,053
                                      (13)
                                      
                                      
                                      9.9
                                      (13)%Long
      Sunny Limited (7)(11)
                                        P.O.
      Box 957
                                        Offshore
      Incorporations Centre
                                        Road
      Town, Tortola
                                        British
      Virgin Islands
                                      
                                      
                                      17,400,000
                                      
                                      
                                      0
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      17,400,000
                                      
                                      
                                      
                                      75.03
                                      %Groom
      Profit Holdings Limited (8)
                                        PO
      Box 957
                                        Offshore
      Incorp Center
                                        Road
      Town
                                        Tortola
                                      
                                      
                                      1,350,000
                                      
                                      
                                      0
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      1,350,000
                                      
                                      
                                      
                                      5.82
                                      %Right
      Idea Holdings Limited (9)
                                        PO
      Box 957
                                        Offshore
      Incorp Center
                                        Road
      Town
                                        Tortola
                                      
                                      
                                      1,350,000
                                      
                                      
                                      0
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      1,350,000
                                      
                                      
                                      
                                      5.82
                                      %Directors
      and Executive Officers (10)Mr.
      Wang Chen (Chairman and CEO) (11)
                                      
                                      
                                      17,400,000
                                      
                                      
                                      250,125
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      17,400,000
                                      (11)
                                      
                                      
                                      75.03
                                      %David
      Ming He (CFO) (17)
                                      
                                      
                                      0
                                      
                                      
                                      221,125
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      (17)
                                      
                                      
                                      0Ms.
      Guo Wei (director) (12)
                                      
                                      
                                      17,400,000
                                      
                                      
                                      250,125
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      17,400,000
                                      (12)
                                      
                                      
                                      75.03
                                      %Mr.
      Michael Marks (14)
                                      
                                      
                                      0
                                      
                                      
                                      150,000
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      50,000
                                      (14)
                                      
                                      
                                      *Mr.
      Leng Jun (15)
                                      
                                      
                                      0
                                      
                                      
                                      80,000
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      20,000
                                      (15)
                                      
                                      
                                      *Mr.
      Mu Ruizhu (16)
                                      
                                      
                                      0
                                      
                                      
                                      80,000
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      20,000
                                      (16)
                                      
                                      
                                      *All
      Directors and Executive Officers (5 persons)
                                      
                                      
                                      17,400,000
                                      
                                      
                                      781,250
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      17,490,000
                                      
                                      
                                      
                                      75.
      13
                                      %




(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, 2010, (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 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, 2010 (23,191,165), 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 12 below. Unless otherwise stated, each beneficial
owner has sole power to vote and dispose of its shares.


51





(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, 2010, we had outstanding (i) 23,191,165 shares of
common stock, (ii) 6,987,368 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 12 below) in the June
2008 Financing that closed on June 11, 2008. As of September 20, 2010, Vision
Opportunity China LP owns Series A Preferred Stock convertible into 5,015,526
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)
  Blue Ridge Investments, LLC acquired Series A Preferred Stock convertible
into 1,971,842 shares of common stock and Warrants to purchase up to 2,366,211
shares of common stock in the July 2008 Financing that closed on July 18, 2008.
Blue Ridge Investments, LLC’s ownership is subject to a 9.9% limitation on
beneficial ownership of common stock as more fully described in note 13
below.  Peter Santry has sole voting and dispositive power over the
shares of Blue Ridge Investments, LLC. Mr. Santry disclaims beneficial ownership
of these shares.




(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)  Zhao
Yanqiu, the sole owner of Groom Profit Holdings Limited, has the sole power to
vote and dispose of the shares owned by Groom Profit Holdings
Limited.




(9)  Ji
Haihong, the sole owner of Right Idea Holdings Limited, has the sole power to
vote and dispose of the shares owned by Right Idea Holdings
Limited.




(10)
  The address of each of the officers and directors named in the table is
No. 27, Wang Gang Road, Jin Nan (Shuang Gang) Economic and Technology
Development Area, Tianjin, People’s Republic of China 300350.




(11)
  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, 2010,
no part of the option had vested or was exercisable within 60 days.





(12)
  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, 2010, no part of
the option had vested or was exercisable within 60 days.


52





(13)
  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.




(14)  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, 2010, the option to purchase 50,000
shares had vested or was exercisable within 60 days.




(15)
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, 2010, the option to purchase 20,000
shares had vested or was exercisable within 60 days.




(16)
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 209, 2010, the option to
purchase 20,000 shares had vested or was exercisable within 60
days.




(17)  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, 2010, no part of the option had vested
or was exercisable within 60 days.





* Under 1
percent of the issued and outstanding shares as of September 20,
2010.





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.


53





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
aggregate 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, 2010 were approximately
$170,000.





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,
2010.





Tax Fees





The Company did not incur any fees from its independent registered
public accounting firms for tax compliance or tax consulting services during the
year ended June 30, 2010.





All
Other Fees





The
Company incurred approximately $8,400 in fees from its formal independent
registered public accounting firms for services rendered to the Company, other
than the services covered in "Audit Fees" for the fiscal year ended June 30,
2010.





PART
IV





Item 15. Exhibits, Financial Statements
Schedules





Footnote
                          
                          Exhibit
      No.
                          
                          Description(1)
                          
                          3.1
                          
                          Articles
      of Incorporation.(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.(3)
                          
                          3.5
                          
                          Specimen
      of common stock certificate.(3)
                          
                          4.1
                          
                          Form
      of Series A Warrant, June 2008
Financing.




54




(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.(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.(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.




55




(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.10.24
                                                  
                                                  Line
      of Credit Loan Agreement dated December 10, 2009, by and between Shengkai
      and Industrial Bank Co., Ltd., Tianjin Branch.10.25
                                                  
                                                  Mortgage
      Agreement, dated December 10, 2009, by and between Shengkai and Industrial
      Bank Co., Ltd., Tianjin Branch.10.26
                                                  
                                                  Guarantee,
      dated November 5, 2009, by and between Industrial Bank Co., Ltd., Tianjin
      Branch, and Wang Chen.10.27
                                                  
                                                  Guarantee,
      dated November 9, 2009, by and between Industrial Bank Co., Ltd., Tianjin
      Branch, and Guo Wei.10.28
                                                  
                                                  Property
      Lease Agreement, dated August 17, 2010, by and between Shengkai and
      Tianjin Development Zone Binhai Investment Service Co.,
    Ltd.(7)
                                                  
                                                  14.1
                                                  
                                                  Code
      of Ethics.21.1
                                                  
                                                  List
      of Subsidiaries.23.1
                                                  
                                                  Consent
      of Independent Registered Public Acconting Firm (BDO China Li Xin Da Hua
      CPA Co., Ltd.).23.2
                                                  
                                                  Consent
      of Independent Registered Public Acconting 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.




56





(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.





57





SIGNATURES





In
accordance with 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 28thday of
September, 2010.





SHENGKAI
      INNOVATIONS, INC.By:
                    /s/
      Wang ChenWang
      ChenChief
      Executive Officer and
Chairman





In
accordance with 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
      28, 2010Wang
      ChenChief
      Executive Officer (principal executive officer) and
    Chairman/s/ David Ming He
              
              September
      28, 2010David
      Ming HeChief
      Financial Officer (principal financial and accounting
    officer)/s/ Guo Wei
              
              September
      28, 2010Guo
      WeiDirector/s/ Michael Marks
              
              September
      28, 2010Michael
      MarksDirector/s/ Jun Leng
              
              September
      28, 2010Jung
      LengDirector/s/ Ruizhu Mu
              
              September
      28, 2010Ruizhu
      MuDirector





58