UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION




Washington,
D.C. 20549





FORM
10-Q/A





(Mark
One)


x
            QUARTERLY REPORT UNDER SECTION 13
      OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
  1934


For
the quarterly period ended December 31, 2009





 ̈
            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 small business issuer as specified in its charter)





Florida
                
                11-3737500(State or other jurisdiction of incorporation or
                  organization)
                
                (IRS Employer identification No.)




NO.
27, WANG GANG ROAD


JIN
NAN (SHUANG GANG) ECONOMIC AND TECHNOLOGY DEVELOPMENT AREA


TIANJIN, PEOPLE’S REPUBLIC
OF CHINA


(Address
of principal executive offices)




(8622)
2858-8899


(Registrant’s
telephone number, including area code)




(Former
name, former address and former fiscal year, if changed since last
report)




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





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





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





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





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




APPLICABLE
ONLY TO ISSUERS INVOLVED IN BANKRUPTCY


PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:





Check
whether the registrant filed all documents and reports required to be filed by
Section l2, 13 or 15(d) of the Exchange Act after the distribution of securities
under a plan confirmed by a court. Yes o  No o





APPLICABLE
ONLY TO CORPORATE ISSUERS:





State the
number of shares outstanding of each of the issuer's classes of common equity,
as of the latest practicable date: 23,191,165 shares of common stock, $.001 par
value, were outstanding as of August 19, 2010.








EXPLANATORY
NOTE




This
quarterly report on Form 10-Q is being filed as Amendment No. 1 to our Quarterly
Report on Form 10-Q which was originally filed on February 11, 2010 with the
Securities and Exchange Commission.  We are amending and restating our
financial statements and notes thereto to reclassify outstanding Series A
warrants as a liability pursuant to ASC 815-40-15-7I, to reclassify the embedded
conversion option of the outstanding Series A preferred stock as a liability
pursuant to ASC 815-40-55-33, and to add disclosure of our accounting policy
regarding changes in fair value of instruments.




We have
also amended “Item 4 - Controls and Procedures” to disclose the ineffectiveness
in the Company’s disclosure controls and procedures as of December 31,
2009.





Except as
specifically referenced herein, this Amendment No. 1 to the Quarterly Report on
Form 10-Q does not reflect any event occurring subsequent to February 11, 2010,
the filing date of the original report.


TABLE
OF CONTENTS





PagePART
      I
                  3Item 1.
                  Financial
      Statements
                  3Item 2.
                  Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation
                  31Item 3.
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  38Item 4.
                  Controls
      and Procedures
                  39PART
      II
                  39Item 1.
                  Legal
      Proceedings
                  39Item 1A.
                  Risk
      Factors
                  39Item 2.
                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                  40Item 3.
                  Defaults
      Upon Senior Securities
                  40Item 4.
                  (Removed
      and Reserved)
                  40Item 5.
                  Other
      Information
                  40Item 6.
                  Exhibits
                  40SIGNATURES
                  41




2


PART
I – FINANCIAL INFORMATION




Item
1.                       Financial
Statements





SHENGKAI
INNOVATIONS, INC.


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


CONSOLIDATED
BALANCE SHEETS


AS
AT DECEMBER 31, 2009 (UNAUDITED) (RESTATED) AND JUNE 30, 2009
(AUDITED)


(Stated
in US Dollars)





Note
                                                                                                      
                                                                                                      
                                                                                                      December 31, 2009
                                                                                                      
                                                                                                      
                                                                                                      June 30, 2009(Unaudited)
                                                                                                      
                                                                                                      
                                                                                                      (Audited)(Restated)ASSETSCurrent
      assetsCash
      and cash equivalents
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      37,160,406
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      38,988,958Pledged
      deposits
                                                                                                      
                                                                                                      5
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      4,959,811
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      940,488Trade
      receivables
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      6,558,667
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      4,061,706Notes
      receivable
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      14,626
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      292,193Other
      receivables
                                                                                                      
                                                                                                      6
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      40,354
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      22,979Prepaid
      VAT
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      0
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      194,535Advances
      to suppliers
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      880,196
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      328,785Inventories
                                                                                                      
                                                                                                      7
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      903,820
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      907,799Total
      current assets
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      50,517,880
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      45,737,443Plant
      and equipment, net
                                                                                                      
                                                                                                      8
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      12,425,112
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      5,173,269Intangible
      assets, net
                                                                                                      
                                                                                                      9
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      8,894,270
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      9,342,322TOTAL
      ASSETS
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      71,837,262
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      60,253,034LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilitiesNotes
      payable
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      2,278,965
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      984,561Accounts
      payable
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,971,770
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,121,185Advances
      from customers
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,285,956
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      242,986Other
      payables
                                                                                                      
                                                                                                      10
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,087,502
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      794,754Accruals
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      75,746
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      131,581Income
      tax payable
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,387,544
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      1,471,380Total
      current liabilities
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      8,087,483
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      4,746,447Warrant
      liabilities
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      19,812,799Preferred
      (conversion option) liabilities
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      25,158,016TOTAL
      LIABILITIES
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      53,058,298
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      4,746,447Commitments
      and contingencies
                                                                                                      
                                                                                                      16
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      -
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      -STOCKHOLDERS’
      EQUITYPreferred
      Stock – $0.001 par value 15,000,000 share authorized ; 7,187,368 and
      7,887,368 issued and outstanding as of December 31,2009 and June 30, 2009
      respectively.
                                                                                                      
                                                                                                      11
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      7,187
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      7,887Common
      stock - $0.001 par value 50,000,000 shares authorized;22,812,500 and
      22,112,500 shares issued and outstanding as of  December 31,2009
      and June 30, 2009 respectively.
                                                                                                      
                                                                                                      12
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      22,813
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      22,113Additional
      paid-in capital
                                                                                                      
                                                                                                      12
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      13,326,544
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      30,666,631Statutory
      reserves
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      7,081,706
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      4,693,020Retained
      earnings
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      (4,369,031
                                                                                                      )
                                                                                                      
                                                                                                      
                                                                                                      17,456,857Accumulated
      other comprehensive income
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      2,709,745
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      2,660,079$
                                                                                                      18,778,964
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      55,506,587TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      71,837,262
                                                                                                      
                                                                                                      
                                                                                                      $
                                                                                                      60,253,034





See
accompanying notes to consolidated financial statements


3


SHENGKAI
INNOVATIONS, INC.


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


CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME


FOR
THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2009 (RESTATED) AND
2008


(Stated
in US Dollars) (Unaudited)





Six months ended December 31,
                              
                              
                              Three months ended December 31,Notes
                              
                              2009
                              
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008(restated)
                              
                              
                              
                              
                              
                              (restated)Net
      revenues
                              
                              
                              
                              $
                              23,652,020
                              
                              
                              $
                              17,340,054
                              
                              
                              $
                              12,541,851
                              
                              
                              $
                              8,142,807Cost
      of sales
                              
                              
                              
                              
                              (9,482,017
                              )
                              
                              
                              (7,011,661
                              )
                              
                              
                              (5,161,926
                              )
                              
                              
                              (3,404,087
                              )Gross
      profit
                              
                              
                              
                              $
                              14,170,003
                              
                              
                              $
                              10,328,393
                              
                              
                              $
                              7,379,925
                              
                              
                              $
                              4,738,720Operating
      expenses:Selling
                              
                              
                              
                              
                              (2,117,990
                              )
                              
                              
                              (1,756,476
                              )
                              
                              
                              (1,116,378
                              )
                              
                              
                              (885,639
                              )General
      and administrative
                              
                              
                              
                              
                              (1,514,850
                              )
                              
                              
                              (1,102,185
                              )
                              
                              
                              (767,122
                              )
                              
                              
                              (505,699
                              )Operating
      income
                              
                              
                              
                              $
                              10,537,163
                              
                              
                              $
                              7,469,732
                              
                              
                              $
                              5,496,425
                              
                              
                              $
                              3,347,382Other
      income
                              
                              
                              
                              
                              15,595
                              
                              
                              
                              7,316
                              
                              
                              
                              15,595
                              
                              
                              
                              -Interest
      income
                              
                              
                              
                              
                              308,511
                              
                              
                              
                              66,111
                              
                              
                              
                              20,799
                              
                              
                              
                              43,265Changes
      in fair value of instrument - (loss)/gain
                              
                              
                              
                              
                              (22,261,851
                              )
                              
                              
                              
                              
                              
                              
                              (15,358,928
                              )Income
      (loss) before income tax
                              
                              
                              
                              $
                              (11,400,582
                              )
                              
                              $
                              7,543,159
                              
                              
                              $
                              (9,826,109
                              )
                              
                              $
                              3,390,647Income
      tax
                              
                              12
                              
                              
                              (2,667,743
                              )
                              
                              
                              (1,884,281
                              )
                              
                              
                              (1,387,740
                              )
                              
                              
                              (858,086
                              )Net
      income (loss)
                              
                              
                              
                              $
                              (14,068,325
                              )
                              
                              $
                              5,658,878
                              
                              
                              $
                              (11,213,849
                              )
                              
                              $
                              2,532,561Foreign
      currency translation adjustment
                              
                              
                              
                              
                              49,666
                              
                              
                              
                              74,279
                              
                              
                              
                              (10,437
                              )
                              
                              
                              5,373Comprehensive
      income (loss)
                              
                              
                              
                              $
                              (14,018,659
                              )
                              
                              $
                              5,733,157
                              
                              
                              
                              (11,224,286
                              )
                              
                              
                              2,537,934Basic
      earnings (loss) per share
                              
                              13
                              
                              $
                              (0.629
                              )
                              
                              $
                              0.14
                              
                              
                              $
                              (0.497
                              )
                              
                              $
                              0.115Diluted
      earnings (loss) per share
                              
                              13
                              
                              $
                              (0.629
                              )
                              
                              $
                              0.103
                              
                              
                              $
                              (0.497
                              )
                              
                              $
                              0.084Basic
      weighted average sharesoutstanding
                              
                              13
                              
                              
                              22,382,719
                              
                              
                              
                              22,112,500
                              
                              
                              
                              22,572,742
                              
                              
                              
                              22,112,500Diluted
      weighted averageshares
    outstanding
                              
                              13
                              
                              
                              22,382,719
                              
                              
                              
                              29,999,868
                              
                              
                              
                              22,572,742
                              
                              
                              
                              29,999,868





See
accompanying notes to consolidated financial statements


4


SHENGKAI
INNOVATIONS, INC.


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


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 (RESTATED) AND 2008


(Stated
in US Dollars) (Unaudited)





six months ended December 31,2009
                
                
                2008(Restated)Cash
      flows from operating activitiesNet
      income (loss)
                
                $
                (14,068,325
                )
                
                $
                5,658,878Depreciation
                
                
                209,176
                
                
                
                83,329Amortization
                
                
                458,345
                
                
                
                382,544Changes
      in fair value of instrument - loss/(gain)
                
                
                22,261,851Adjustments
      to reconcile net income to net cash provided by operating
      activities:Trade
      receivables
                
                
                (2,491,947
                )
                
                
                (262,560
                )Notes
      receivable
                
                
                277,836
                
                
                
                8,756Other
      receivables
                
                
                (17,346
                )
                
                
                9,631Prepaid
      VAT
                
                
                194,712
                
                
                
                -Deposits
      and prepaid expenses
                
                
                0
                
                
                
                2,550Advances
      to suppliers
                
                
                (550,935
                )
                
                
                (266,158
                )Inventories
                
                
                4,987
                
                
                
                (544,614
                )Notes
      payable
                
                
                1,293,051
                
                
                
                128,862Accounts
      payable
                
                
                849,169
                
                
                
                (36,621
                )Advances
      from customers
                
                
                1,042,491
                
                
                
                200,458Other
      payables
                
                
                291,807
                
                
                
                (13,607
                )Accruals
                
                
                (55,970
                )
                
                
                (4,541
                )Income
      tax payable
                
                
                (85,454
                )
                
                
                (95,522
                )Net
      cash provided by operating activities
                
                $
                9,613,448
                
                
                $
                5,251,385Cash
      flows from investing activitiesPurchase
      of property, plant and equipment
                
                $
                (7,453,817
                )
                
                $
                (103,563
                )Deposit
      for land use right auction
                
                
                0
                
                
                
                (379,392
                )Increase
      in pledged deposits
                
                
                (4,017,931
                )
                
                
                (128,862
                )Net
      cash used in investing activities
                
                $
                (11,471,748
                )
                
                $
                (611,817
                )Cash
      flows from financing activitiesProceeds
      from stock issued, net of transaction costs of $386,210
                
                $
                0
                
                
                $
                4,613,790Net
      cash provided by financing activities
                
                $
                0
                
                
                $
                4,613,790Net
      cash and cash equivalents (used) / sourced
                
                $
                (1,858,300
                )
                
                $
                9,253,358Effect
      of foreign currency translation on cash  and cash
      equivalents
                
                
                29,748
                
                
                
                34,982Cash
      and cash equivalents–beginning of the period
                
                
                38,988,958
                
                
                
                21,313,484Cash
      and cash equivalents–end of the period
                
                $
                37,160,406
                
                
                $
                30,601,824Supplementary
      cash flow information:Interest
      received
                
                $
                308,511
                
                
                $
                66,111Tax
      paid
                
                $
                2,753,197
                
                
                $
                1,979,803





See
accompanying notes to consolidated financial statements


5


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





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  common shares at $0.001 par value in exchange for all Shen
Kun shares.





The
exchange transaction was accounted for as a reverse acquisition in accordance
with Accounting Standards Codification (“ASC”) 805, “Business Combinations”
(formerly included under Statement of Financial Accounting Standards No. 141
(revised 2007), Business Combinations). For financial reporting purposes, this
transaction is classified as a recapitalization of 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 income include the results of operations of Tianjin Shengkai Industrial
Technology Development Co., Ltd for the period ended December 31, 2009 and
2008.





Shen Kun
formed Sheng Kai (Tianjin) Ceramic Valves Co., Ltd. (“SK Ceramic Valves” 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 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, 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 valve.





6


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





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 the three 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
                          %Sheng
      Kai (Tianjin) Ceramic Valves Co., Ltd
                          
                          PRC
                          
                          
                          100
                          %*Tianjin
      Shengkai Industrial TechnologyDevelopment
      Co., Ltd
                          
                          PRC
                          
                          
                          100
                          %*Deemed
      variable interest entity member





(c)
            Use of
      estimates





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


7


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





2.   
 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





(d)
            Economic and political
      risks





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





The
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)
            Pledged
      deposits





Pledged
deposits represents deposits on account to secure notes payable and deposit for
investor relation or public relation affairs as at the period ended December 31,
2009 and June 30, 2009 respectively.





(f)
            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 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.





(g)
            Intangible
      assets





Intangible
assets represent land use rights, patent rights and others 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.


8


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





2.   
 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





(h)
            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
ASC350. 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.





(i)
            Inventories





Inventories
consist of finished goods, work in progress and raw materials, and stated at the
lower of cost or market value. Substantially all inventory costs are determined
using the weighted average basis. Finished goods are comprised of direct
materials, direct labor and an appropriate proportion of overhead. The
management regularly evaluates the composition of its inventory to identify
slow-moving and obsolete inventories to determine if additional write-downs are
required.





(j)
            Cash and cash
      equivalents





The
Company considers all highly liquid investments purchased with original
maturities of six months or less to be cash equivalents. The Company maintains
bank accounts in the PRC and Hong Kong. The Company does not maintain any bank
accounts in the United States of America.





December 31, 2009
                  
                  
                  June 30,
                    2009Cash
      on hand
                  
                  $
                  1,699
                  
                  
                  $
                  6,236Bank
      of China
                  
                  
                  21,718
                  
                  
                  
                  21,081Industrial
      and Commercial Bank of China
                  
                  
                  638,982
                  
                  
                  
                  750,757Industrial
      Bank Co. Ltd.
                  
                  
                  2,252,418
                  
                  
                  
                  2,962,345Shanghai
      Pudong Development Bank
                  
                  
                  34,229,985
                  
                  
                  
                  35,232,842The
      Hong Kong and Shanghai BankingCorporation
      Limited
                  
                  
                  15,604
                  
                  
                  
                  15,697$
                  37,160,406
                  
                  
                  $
                  38,988,958


9


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





2.    
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





(k)
            Revenue
      recognition





Revenue
represents the invoiced value of goods sold 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.





Net
revenue is 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.





(l)
            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.  Written-down of inventory to lower of cost or market is
also reflected in cost of revenues.




(m)
            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 six months ended December 31, 2009 and 2008
were $347,107 and $222,167 respectively.





(n)
            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 and the general and
administrative expenses for the six months ended December 31, 2009 and 2008 were
$61,399 and $34,043 respectively.


10


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





2.    
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





(o)
            Income
  tax





The Group
accounts for income tax using an asset and liability approach and allows for
recognition of deferred tax benefits in future years.  Under the asset
and liability approach, deferred taxes are provided for the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes.  A valuation allowance is provided for deferred tax assets
if it is more likely than not these items will either expire before the Group is
able to realize their benefits, or that future realization is
uncertain.





(p)
            Foreign currency
      translation





The
accompanying financial statements are presented in United States dollars. SK
Ceramic Valves and Shengkai use its local currency, Renminbi (RMB), as its
functional currency. Results of operations and cash flow are translated at
average exchange rates during the period, and assets and liabilities are
translated at the end of period exchange rates. Translation adjustments
resulting from this process are included in accumulated other comprehensive
income in stockholders’ equity. Transaction gains and losses that arise from
exchange rate fluctuations from transactions denominated in a currency other
than the functional currency are included in the results of operations as
incurred.





The PRC
government imposes significant exchange restrictions on fund transfers out of
the PRC that are not related to business operations. These restrictions have not
had a material impact on the Group because it has not engaged in any significant
transactions that are subject to the restrictions.





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





December
      31, 2009Balance
      sheet
                RMB 6.83720 to US$1.00Statement
      of income and comprehensive income
                RMB 6.83857 to US$1.00June
      30, 2009Balance
      sheet
                RMB 6.84480 to US$1.00Statement
      of income and comprehensive income
                RMB 6.84819 to US$1.00December
      31, 2008Balance
      sheet
                RMB 6.85420 to US$1.00Statement
      of income
                RMB 6.85307 to US$1.00




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


11


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





2.    
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





(q)
            Cash and concentration of
      risk





Cash
includes cash on hand and demand deposits in bank accounts maintained within
PRC.  Total cash in the banks at December 31, 2009 and June 30, 2009
amounted to $37,158,707 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.





(r)
            Statutory
      reserves





As
stipulated by the PRC’s Company Law and as provided in the SK Ceramic Valves,
and Shengkai’s Articles of Association, SK Ceramic Valves, 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 and
$4,693,020 respectively as of December 31, 2009 and June 30, 2009.





(s)
            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.


12


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





2.    
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





(t) Recently implemented
standards





ASC 105,
Generally Accepted Accounting
Principles (“ASC 105”) (formerly Statement of Financial Accounting
Standards No. 168, The
FASB Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles a replacement of FASB Statement No. 162)
reorganized by topic existing accounting and reporting guidance issued by the
Financial Accounting Standards Board (“FASB”) into a single source of
authoritative generally accepted accounting principles (“GAAP”) to be applied by
nongovernmental entities. All guidance contained in the Accounting Standards
Codification (“ASC”) carries an equal level of authority. Rules and interpretive
releases of the Securities and Exchange Commission (“SEC”) under authority of
federal securities laws are also sources of authoritative GAAP for SEC
registrants. Accordingly, all other accounting literature will be deemed
“non-authoritative”. ASC 105 is effective on a prospective basis for financial
statements issued for interim and annual periods ending after September 15,
2009. The Company has implemented the guidance included in ASC 105 as of
July 1, 2009. The implementation of this guidance changed the Company’s
references to GAAP authoritative guidance but did not impact the Company’s
financial position or results of operations.




ASC 855,
Subsequent Events (“ASC
855”) (formerly Statement of Financial Accounting Standards No. 165, Subsequent Events) includes
guidance that was issued by the FASB in May 2009, and is consistent with current
auditing standards in defining a subsequent event. Additionally, the guidance
provides for disclosure regarding the existence and timing of a company’s
evaluation of its subsequent events. ASC 855 defines two types of subsequent
events, “recognized” and “non-recognized”. Recognized subsequent events provide
additional evidence about conditions that existed at the date of the balance
sheet and are required to be reflected in the financial statements.
Non-recognized subsequent events provide evidence about conditions that did not
exist at the date of the balance sheet but arose after that date and, therefore;
are not required to be reflected in the financial statements. However, certain
non-recognized subsequent events may require disclosure to prevent the financial
statements from being misleading. This guidance was effective prospectively for
interim or annual financial periods ending after June 15, 2009. The Company
implemented the guidance included in ASC 855 as of April 1, 2009. The
effect of implementing this guidance was not material to the Company’s financial
position or results of operations.


13


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





2.    
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





(t) Recently implemented standards
(Continued)





ASC 944,
Financial Services –
Insurance (“ASC 944”) contains guidance that was previously issued by the
FASB in May 2008 as Statement of Financial Accounting Standards No. 163,
Accounting for Financial
Guarantee Insurance Contracts – an interpretation of FASB Statement No. 60that provides for changes to both the recognition and measurement of
premium revenues and claim liabilities for financial guarantee insurance
contracts that do not qualify as a derivative instrument in accordance with ASC
815, Derivatives and
Hedging (formerly included under Statement of Financial Accounting
Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities). This financial guarantee insurance
contract guidance also expands the disclosure requirements related to these
contracts to include such items as a company’s method of tracking insured
financial obligations with credit deterioration, financial information about the
insured financial obligations, and management’s policies for placing and
monitoring the insured financial obligations. ASC 944, as it relates to
financial guarantee insurance contracts, was effective for fiscal years
beginning after December 15, 2008, except for certain disclosures related
to the insured financial obligations, which were effective for the third quarter
of 2008. The Company does not have financial guarantee insurance products, and,
accordingly, the implementation of this portion of ASC 944 did not have an
effect on the Company’s results of operations or financial
position.




ASC 805,
Business Combinations(“ASC 805”) (formerly included under Statement of Financial Accounting
Standards No. 141 (revised 2007), Business Combinations)
contains guidance that was issued by the FASB in December 2007. It requires the
acquiring entity in a business combination to recognize all assets acquired and
liabilities assumed in a transaction at the acquisition-date fair value, with
certain exceptions. Additionally, the guidance requires changes to the
accounting treatment of acquisition related items, including, among other items,
transaction costs, contingent consideration, restructuring costs,
indemnification assets and tax benefits. ASC 805 also provides for a substantial
number of new disclosure requirements. ASC 805 also contains guidance that was
formerly issued as FSP FAS 141(R)-1, Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies which was intended to provide additional guidance
clarifying application issues regarding initial recognition and measurement,
subsequent measurement and accounting, and disclosure of assets and liabilities
arising from contingencies in a business combination. ASC 805 was effective for
business combinations initiated on or after the first annual reporting period
beginning after December 15, 2008. The Company implemented this guidance
effective January 1, 2009. Implementing this guidance did not have an
effect on the Company’s financial position or results of operations; however it
will likely have an impact on the Company’s accounting for future business
combinations, but the effect is dependent upon acquisitions, if any, that are
made in the future.


14


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





2.    SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





(u)
            Recently issued
      standards




In August
2009, the FASB issued ASC Update No. 2009-05, Fair Value Measurements and
Disclosures (Topic 820): Measuring Liabilities at Fair Value (“ASC Update
No. 2009-05”). This update amends ASC 820, Fair Value Measurements and
Disclosures and provides further guidance on measuring the fair value of
a liability. The guidance establishes the types of valuation techniques to be
used to value a liability when a quoted market price in an active market for the
identical liability is not available, such as the use of an identical or similar
liability when traded as an asset. The guidance also further clarifies that a
quoted price in an active market for the identical liability at the measurement
date and the quoted price for the identical liability when traded as an asset in
an active market when no adjustments to the quoted price of the asset are
required are both Level 1 fair value measurements. If adjustments are required
to be applied to the quoted price, it results in a level 2 or 3 fair value
measurement. The guidance provided in the update is effective for the first
reporting period (including interim periods) beginning after issuance. The
Company does not expect that the implementation of ASC Update No. 2009-05
will have a material effect on its financial position or results of
operations.





In
September 2009, the FASB issued ASC Update No. 2009-12, Fair Value Measurements and
Disclosures (Topic 820): Investments in Certain Entities that Calculate Net
Asset Value per Share (or Its Equivalent) (“ASC Update
No. 2009-12”). This update sets forth guidance on using the net asset value
per share provided by an investee to estimate the fair value of an alternative
investment. Specifically, the update permits a reporting entity to measure the
fair value of this type of investment on the basis of the net asset value per
share of the investment (or its equivalent) if all or substantially all of the
underlying investments used in the calculation of the net asset value is
consistent with ASC 820. The update also requires additional disclosures by each
major category of investment, including, but not limited to, fair value of
underlying investments in the major category, significant investment strategies,
redemption restrictions, and unfunded commitments related to investments in the
major category. The amendments in this update are effective for interim and
annual periods ending after December 15, 2009 with early application
permitted. The Company does not expect that the implementation of ASC Update
No. 2009-12 will have a material effect on its financial position or
results of operations.


15


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(u)
            Recently issued standards
      (Continued)





In June
2009, FASB issued Statement of Financial Accounting Standards No. 167,
Amendments to FASB
Interpretation No. 46(R)(“Statement No. 167”). Statement
No. 167 amends FASB Interpretation No. 46R, Consolidation of Variable Interest
Entities an interpretation of ARB No. 51 (“FIN 46R”) to require an
analysis to determine whether a company has a controlling financial interest in
a variable interest entity. This analysis identifies the primary beneficiary of
a variable interest entity as the enterprise that has a) the power to direct the
activities of a variable interest entity that most significantly impact the
entity’s economic performance and b) the obligation to absorb losses of the
entity that could potentially be significant to the variable interest entity or
the right to receive benefits from the entity that could potentially be
significant to the variable interest entity. The statement requires an ongoing
assessment of whether a company is the primary beneficiary of a variable
interest entity when the holders of the entity, as a group, lose power, through
voting or similar rights, to direct the actions that most significantly affect
the entity’s economic performance. This statement also enhances disclosures
about a company’s involvement in variable interest entities. Statement
No. 167 is effective as of the beginning of the first annual reporting
period that begins after November 15, 2009. Although Statement No. 167
has not been incorporated into the Codification, in accordance with ASC 105, the
standard shall remain authoritative until it is integrated. The Company does not
expect the adoption of Statement No. 167 to have a material impact on its
financial position or results of operations.





In June
2009, the FASB issued Statement of Financial Accounting Standards No. 166,
Accounting for Transfers of
Financial Assets an amendment of FASB Statement No. 140 (“Statement
No. 166”). Statement No. 166 revises FASB Statement of Financial
Accounting Standards No. 140, Accounting for Transfers and
Extinguishment of Liabilities a replacement of FASB Statement 125
(“Statement No. 140”) and requires additional disclosures about transfers
of financial assets, including securitization transactions, and any continuing
exposure to the risks related to transferred financial assets. It also
eliminates the concept of a “qualifying special-purpose entity”, changes the
requirements for derecognizing financial assets, and enhances disclosure
requirements. Statement No. 166 is effective prospectively, for annual
periods beginning after November 15, 2009, and interim and annual periods
thereafter. Although Statement No. 166 has not been incorporated into the
Codification, in accordance with ASC 105, the standard shall remain
authoritative until it is integrated. The Company does not expect the adoption
of Statement No. 166 will have a material impact on its financial position
or results of operations.





3.
            RESTATEMENT — ACCOUNTING FOR
      SERIES A WARRANT AND THE EMBEDDED CONVERSION OPTION OF SERIES A PREFERRED
      STOCK





On June
9, 2008, the Company acquired control of Shengkai through a “reverse merger”
transaction. In connection with the reverse merger, on June 11, 2008 , the
Company closed a financing in which it sold to investors 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 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”). The Company received $13,181,791 as net proceeds
from this financing.


16


Additionally,
on July 18, 2008, the Company sold to Blue Ridge Investments, LLC Units 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 Preferred Share and one
Warrant. The Company received $4,613,790 as net proceeds from this financing.
The June 2008 Financing, together with the July 2008 Financing, are collectively
referred to herein as the “Private Placements.”





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 the Warrants shall not be considered
indexed to the entity’s own stock and hence adjustments in classification of the
Warrants are required.





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 for the first two years from the initial issuance date
of the Preferred Shares. The Company performed a complete assessment of the
Preferred Shares 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, ASC 815 should have
been adopted as of July 1, 2009 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.





The
Company’s consolidated balance sheet as of December 31, 2009, as previously
reported and as restated, is as follows:





December 31, 2009As
                                                                    Previously
                                                                    Reported
                                                                  
                                                                  
                                                                  Adjustment
                                                                  
                                                                  
                                                                  As RestatedASSETSCurrent
      assetsCash
      and cash equivalents
                                                                  
                                                                  $
                                                                  37,160,406
                                                                  
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  37,160,406Pledged
      deposits
                                                                  
                                                                  
                                                                  4,959,811
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  4,959,811Trade
      receivables
                                                                  
                                                                  
                                                                  6,558,667
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  6,558,667Notes
      receivable
                                                                  
                                                                  
                                                                  14,626
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  14,626Other
      receivables
                                                                  
                                                                  
                                                                  40,354
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  40,354Prepaid
      VAT
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  -Advances
      to suppliers
                                                                  
                                                                  
                                                                  880,196
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  880,196Inventories
                                                                  
                                                                  
                                                                  903,820
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  903,820Total
      current assets
                                                                  
                                                                  $
                                                                  50,517,880
                                                                  
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  50,517,880Plant
      and equipment, net
                                                                  
                                                                  
                                                                  12,425,112
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  12,425,112Intangible
      assets, net
                                                                  
                                                                  
                                                                  8,894,270
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  8,894,270TOTAL
      ASSETS
                                                                  
                                                                  $
                                                                  71,837,262
                                                                  
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  71,837,262LIABILITIES
      AND STOCKHOLDERS’ EQUITY
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  -Current
      liabilities
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  -Notes
      payable
                                                                  
                                                                  $
                                                                  2,278,965
                                                                  
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  2,278,965Accounts
      payable
                                                                  
                                                                  
                                                                  1,971,770
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  1,971,770Advances
      from customers
                                                                  
                                                                  
                                                                  1,285,956
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  1,285,956Other
      payables
                                                                  
                                                                  
                                                                  1,087,502
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  1,087,502Accruals
                                                                  
                                                                  
                                                                  75,746
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  75,746Income
      tax payable
                                                                  
                                                                  
                                                                  1,387,544
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  1,387,544Total
      current liabilities
                                                                  
                                                                  $
                                                                  8,087,483
                                                                  
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  8,087,483Warrant
      liabilities
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  19,812,799
                                                                  
                                                                  
                                                                  
                                                                  19,812,799Preferred
      (conversion option) liabilities
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  25,158,016
                                                                  
                                                                  
                                                                  
                                                                  25,158,016TOTAL
      LIABILITIES
                                                                  
                                                                  $
                                                                  8,087,483
                                                                  
                                                                  
                                                                  $
                                                                  44,970,815
                                                                  
                                                                  
                                                                  $
                                                                  53,058,298Commitments
      and contingencies
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  -STOCKHOLDERS’
      EQUITY
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  -Preferred
      Stock – $0.001 par value 15,000,000 shares authorized ; 7,187,368 and
      7,887,368 issued and outstanding as of December 31,2009 and June 30, 2009
      respectively.
                                                                  
                                                                  $
                                                                  7,187
                                                                  
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  7,187Common
      stock - $0.001 par value 50,000,000 shares authorized; 22,812,500 and
      22,112,500 shares issued and outstanding as of  December 31,2009
      and June 30, 2009 respectively.
                                                                  
                                                                  
                                                                  22,813
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  22,813Additional
      paid-in capital
                                                                  
                                                                  
                                                                  30,666,631
                                                                  
                                                                  
                                                                  
                                                                  (17,340,087
                                                                  )
                                                                  
                                                                  
                                                                  13,326,544Statutory
      reserves
                                                                  
                                                                  
                                                                  7,081,706
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  7,081,706Retained
      earnings (deficits)
                                                                  
                                                                  
                                                                  23,261,697
                                                                  
                                                                  
                                                                  
                                                                  (27,630,728
                                                                  )
                                                                  
                                                                  
                                                                  (4,369,031
                                                                  )Accumulated
      other comprehensive income
                                                                  
                                                                  
                                                                  2,709,745
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  2,709,745$
                                                                  63,749,779
                                                                  
                                                                  
                                                                  $
                                                                  (44,970,815
                                                                  )
                                                                  
                                                                  $
                                                                  18,778,964TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                                                                  
                                                                  $
                                                                  71,837,262
                                                                  
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  71,837,262




17


The
Company’s consolidated statements of operations for the three months ended
December 31, 2009, as previously reported and as restated, are as
follows:


Three months ended December 31,
      2009As
                      Previously
                      Reported
                    
                    
                    Adjustment
                    
                    
                    As RestatedNet
      revenues
                    
                    $
                    12,541,851
                    
                    
                    $
                    -
                    
                    
                    $
                    12,541,851Cost
      of sales
                    
                    
                    (5,161,926
                    )
                    
                    
                    -
                    
                    
                    
                    (5,161,926
                    )Gross
      profit
                    
                    $
                    7,379,925
                    
                    
                    $
                    -
                    
                    
                    $
                    7,379,925Operating
      expenses:
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Selling
                    
                    
                    (1,116,378
                    )
                    
                    
                    -
                    
                    
                    
                    (1,116,378
                    )General
      and administrative
                    
                    
                    (767,122
                    )
                    
                    
                    -
                    
                    
                    
                    (767,122
                    )Operating
      income
                    
                    $
                    5,496,425
                    
                    
                    $
                    -
                    
                    
                    $
                    5,496,425Other
      income
                    
                    
                    15,595
                    
                    
                    
                    -
                    
                    
                    
                    15,595Interest
      income
                    
                    
                    20,799
                    
                    
                    
                    -
                    
                    
                    
                    20,799Changes
      in fair value of instruments - (loss)/gain
                    
                    
                    -
                    
                    
                    
                    (15,358,928
                    )
                    
                    
                    (15,358,928
                    )Income
      (loss) before income tax
                    
                    $
                    5,532,819
                    
                    
                    $
                    (15,358,928
                    )
                    
                    $
                    (9,826,109
                    )Income
      tax
                    
                    
                    (1,387,740
                    )
                    
                    
                    -
                    
                    
                    
                    (1,387,740
                    )Net
      income (loss)
                    
                    $
                    4,145,079
                    
                    
                    $
                    (15,358,928
                    )
                    
                    $
                    (11,213,849
                    )Foreign
      currency translation adjustment
                    
                    
                    (10,437
                    )
                    
                    
                    -
                    
                    
                    
                    (10,437
                    )Comprehensive
      income (loss)
                    
                    
                    4,134,642
                    
                    
                    
                    (15,358,928
                    )
                    
                    
                    (11,224,286
                    )Basic
      earnings (loss) per share
                    
                    $
                    0.184
                    
                    
                    $
                    (0.681
                    )
                    
                    $
                    (0.497
                    )Diluted
      earnings (loss) per share
                    
                    $
                    0.130
                    
                    
                    $
                    (0.627
                    )
                    
                    $
                    (0.497
                    )Basic
      weighted average share outstanding
                    
                    
                    22,570,742
                    
                    
                    
                    -
                    
                    
                    
                    22,570,742Diluted
      weighted average share outstanding
                    
                    
                    31,999,449
                    
                    
                    
                    (9,428,707
                    )
                    
                    
                    22,570,742




18


The
Company’s consolidated statements of operations for the six months ended
December 31, 2009, as previously reported and as restated, are as
follows:





Six months ended December
      31,2009As
                          Previously
                          Reported
                        
                        
                        Adjustment
                        
                        
                        As RestatedNet
      revenues
                        
                        $
                        23,652,020
                        
                        
                        $
                        -
                        
                        
                        $
                        23,652,020Cost
      of sales
                        
                        
                        (9,482,017
                        )
                        
                        
                        -
                        
                        
                        
                        (9,482,017
                        )Gross
      profit
                        
                        $
                        14,170,003
                        
                        
                        $
                        -
                        
                        
                        $
                        14,170,003Operating
      expenses:
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Selling
                        
                        
                        (2,117,990
                        )
                        
                        
                        -
                        
                        
                        
                        (2,117,990
                        )General
      and administrative
                        
                        
                        (1,514,850
                        )
                        
                        
                        -
                        
                        
                        
                        (1,514,850
                        )Operating
      income
                        
                        $
                        10,537,163
                        
                        
                        $
                        -
                        
                        
                        $
                        10,537,163Other
      income
                        
                        
                        15,595
                        
                        
                        
                        -
                        
                        
                        
                        15,595Interest
      income
                        
                        
                        308,511
                        
                        
                        
                        -
                        
                        
                        
                        308,511Changes
      in fair value of instruments - (loss)/gain
                        
                        
                        -
                        
                        
                        
                        (22,261,851
                        )
                        
                        
                        (22,261,851
                        )Income
      before income tax
                        
                        $
                        10,861,269
                        
                        
                        $
                        (22,261,851
                        )
                        
                        $
                        (11,400,582
                        )Income
      tax
                        
                        
                        (2,667,743
                        )
                        
                        
                        -
                        
                        
                        
                        (2,667,743
                        )Net
      income
                        
                        $
                        8,193,526
                        
                        
                        $
                        (22,261,851
                        )
                        
                        $
                        (14,068,325
                        )Foreign
      currency translation adjustment
                        
                        
                        49,666
                        
                        
                        
                        -
                        
                        
                        
                        49,666Comprehensive
      income
                        
                        
                        8,243,192
                        
                        
                        
                        (22,261,851
                        )
                        
                        
                        (14,018,659
                        )Basic
      earnings (loss) per share
                        
                        $
                        0.366
                        
                        
                        $
                        (0.995
                        )
                        
                        $
                        (0.629
                        )Diluted
      earnings (loss) per share
                        
                        $
                        0.265
                        
                        
                        $
                        (0.894
                        )
                        
                        $
                        (0.629
                        )Basic
      weighted average share outstanding
                        
                        
                        22,382,719
                        
                        
                        
                        -
                        
                        
                        
                        22,382,719Diluted
      weighted average share outstanding
                        
                        
                        30,923,656
                        
                        
                        
                        (8,540,937
                        )
                        
                        
                        22,382,719


19


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





4.
            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 December 31, 2009 and June 30,
2009. The Group performs ongoing evaluations of its cash position and credit
evaluations to ensure sound collections and minimize credit losses
exposure.





As of
December 31, 2009 and June 30, 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 bank in Hong Kong.





For the
six months ended December 31, 2009 and 2008, more than 99% of the Group’s sales
were generated from the PRC. In addition, nearly all accounts receivable as of
December 31, 2009 and June 30, 2008, 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
six months ended December 31, 2009 and 2008, 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:





December 31, 2009
                  
                  
                  June 30, 2009Customer
      A
                  
                  $
                  -
                  
                  
                  $
                  655,755Customer
      B
                  
                  
                  -
                  
                  
                  
                  438,067





As at
December 31, 2009, there was no customer who accounts for 10% or more of the
Group’s accounts receivable.





5.
            PLEDGED
      DEPOSITS





Pledged
deposits as of December 31, 2009 and June 30, 2008 were restricted cash kept in
purpose of investor relation or public relation affairs and to secure notes
payable respectively.


20


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





6.
            OTHER
      RECEIVABLES





December 31, 2009
                    
                    
                    June 30, 2009Disbursement
      and advances to employee
                    
                    $
                    19,144
                    
                    
                    $
                    12,268Tender
      deposits
                    
                    
                    17,551
                    
                    
                    $
                    10,227Sundry
                    
                    
                    3,659
                    
                    
                    $
                    484$
                    40,354
                    
                    
                    $
                    22,979





7.
            INVENTORIES





Inventories
comprise the followings:





December 31, 2009
                    
                    
                    June 30, 2009Finished
      goods
                    
                    $
                    306,754
                    
                    
                    $
                    236,574Work
      in process
                    
                    
                    56,321
                    
                    
                    
                    49,607Raw
      materials
                    
                    
                    540,745
                    
                    
                    
                    621,618$
                    903,820
                    
                    
                    $
                    907,799


21


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





8.
            PLANT
      AND EQUIPMENT, NET




December 31, 2009
                    
                    
                    June 30, 2009At
      costBuildings
                    
                    $
                    2,053,260
                    
                    
                    $
                    2,050,980Machinery
      and equipment
                    
                    
                    3,078,651
                    
                    
                    
                    3,056,646Office
      equipment
                    
                    
                    171,974
                    
                    
                    
                    166,748Motor
      vehicles
                    
                    
                    484,861
                    
                    
                    
                    416,163$
                    5,788,746
                    
                    
                    $
                    5,690,537Less:
      accumulated depreciation
                    
                    
                    (1,042,228
                    )
                    
                    
                    (832,085
                    )$
                    4,746,518
                    
                    
                    $
                    4,858,452Construction
      in progress
                    
                    
                    7,678,594
                    
                    
                    
                    314,81712,425,112
                    
                    
                    
                    5,173,269





Depreciation
expenses included in the cost of sales for the six months ended December 31,
2009 and 2008 were $175,531 and $54,547 respectively; and in the general and
administrative expenses for the six months ended December 31, 2009 and 2008 were
$33,645 and $28,782 respectively.





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.  Capital commitments in respect
of these projects are $19,032,056 at December 31, 2009.


22


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





9.
            INTANGIBLE ASSETS,
      NET





December 31, 2009
                    
                    
                    June 30, 2009Land
      use rights, at cost
                    
                    $
                    2,791,468
                    
                    
                    $
                    2,788,369Less:
      accumulated amortization
                    
                    
                    (311,983
                    )
                    
                    
                    (302,714
                    )2,479,485
                    
                    
                    
                    2,485,655Patent
      rights, at costs
                    
                    
                    7,459,194
                    
                    
                    
                    7,450,912Less:
      accumulated amortization
                    
                    
                    (2,460,803
                    )
                    
                    
                    (2,085,525
                    )4,998,391
                    
                    
                    
                    5,365,387Others,
      at costs
                    
                    
                    1,520,024
                    
                    
                    
                    1,518,336Less:
      accumulated amortization
                    
                    
                    (103,630
                    )
                    
                    
                    (27,056
                    )1,416,394
                    
                    
                    
                    1,491,280$
                    8,894,270
                    
                    
                    $
                    9,342,322





Amortization
expenses included in the general and administrative expenses for the six months
ended December 31, 2009 and 2008 were $458,345 and $382,544
respectively.





10.
            OTHER
    PAYABLES





December 31, 2009
                    
                    
                    June 30, 2009Commission
      payables
                    
                    $
                    401,782
                    
                    
                    $
                    312,365Expense
      payables
                    
                    
                    17,829
                    
                    
                    
                    12,389Deposit
      for project
                    
                    
                    121,597
                    
                    
                    
                    467,508Sundry
      PRC taxes payables
                    
                    
                    526,484
                    
                    
                    
                    -Sundry
                    
                    
                    19,810
                    
                    
                    
                    2,492




23


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





11.
            PREFERRED
      STOCK AND WARRANTS





On June
11, 2008, the Company sold 5,915,526 shares of 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 Preferred Shares.  In the event of a
liquidation of the Company, holders of Preferred Shares are entitled to receive
a distribution equal to $2.5357 per Preferred Share 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
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 cashlessly exercised. Also, the Warrants have
Buy-in Rights similar to those of the Preferred Stock.





The gross
proceeds of the transaction were $15 million. The proceeds from the transaction
were allocated to the Preferred Shares, Warrants and beneficial conversion
feature based on the relative fair value of the securities. The Company
evaluated whether a relative fair value approach or residual fair value approach
was more appropriate given the terms and accounting treatment related to the
financial instruments involved. Given that the Warrants were not 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%.


24


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





11.
            PREFERRED
      STOCK AND WARRANTS (Continued)





The
Company 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 $15 million of proceeds received from the
sale. The Company recognized the $7.8 million beneficial conversion feature in
the equity as a transfer from retained earnings to additional paid in capital as
dividends in the accompanying consolidated financial statements on the date of
issuance of the Preferred Shares since the Preferred Shares were convertible at
the issuance date.





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 Preferred Shares.  In the event of a
liquidation of the Company, holders of Preferred Shares are entitled to receive
a distribution equal to $2.5357 per share of Preferred Shares prior to any
distribution to the holders of common stock or any other stock that ranks junior
to the Preferred Shares. The Preferred Shareholders are not entitled to
dividends unless paid to Common Shareholders. Any dividend paid will have the
same record and payment date and terms as the dividend payable to the Common
Stock. The Preferred Shares will participate based on their respective as-if
conversion rates if the Company declares any dividends.  Holders of
Preferred Shares also have voting rights required by applicable law and the
relevant number of votes shall be equal to the number of shares of Common Stock
issuable upon conversion of Preferred Shares. At any time, each Preferred Share
is convertible into 1 share of Common Stock adjusted from time to time to the
Conversion Rate. The Conversion Rate is computed as the Liquidation Preference
Amount ($2.5357 per share) divided by the Conversion Price. The Conversion Price
is initially $2.5357 per share but can adjust for anti-dilution.





The
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 Stock.


25


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





11.
            PREFERRED
      STOCK AND WARRANTS (Continued)





The gross
proceeds of the transaction were $5 million. The proceeds from the transaction
were allocated to the Preferred Shares, Warrants and beneficial conversion
feature based on the relative fair value of the securities. The Company
evaluated whether a relative fair value approach or residual fair value approach
was more appropriate given the terms and accounting treatment related to the
financial instruments involved. Given that the Warrants were not 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 recognized a beneficial conversion feature discount on the Series A
preferred stock at its intrinsic value, which was the fair value of the common
stock at the commitment date for the Series A preferred stock investment, less
the effective conversion price but limited to the $5 million of proceeds
received from the sale. The Company recognized the $2.6 million beneficial
conversion feature in the equity as a transfer from retained earnings to
additional paid in capital as dividends in the accompanying consolidated
financial statements on the date of issuance of the Series A preferred shares
since the Series A preferred shares were convertible at the issuance
date.





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.





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 the 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.


26


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 include 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 for the first two years from the initial issuance date
of the Preferred Shares. The Company performed a complete assessment of the
preferred stock and concluded that the Preferred Shares issued in the June and
July 2008 Private Placements is within the scope of ASC 815-40-55-33 due to the
down-round provisions included in the terms of the
agreements.  Pursuant to ASC 815-40-55-33, the down-round provision
precludes the embedded conversion option of the Preferred Shares from being
considered indexed to the entity’s own stock. Accordingly, the Company adjusted
its accounting effective from the beginning of fiscal year 2010, i.e. July 1,
2009, on which date ASC 815 should have been adopted, by bifurcating the
embedded conversion option of the Preferred Shares which should be recorded as a
liability measured at fair value with changes in fair value recognized in
earnings for each reporting period and recording a cumulative-effect adjustment
to the opening balance of retained earnings.





12.
            CAPITALIZATION





As a
result of the Group’s reverse-merger on June 9, 2008, the Group’s capital
structure has been changed. The number of common stock was 22,112,500 after
reverse-merger. During the six months ended December 31, 2009, 700,000 shares of
common stocks were converted from preferred stock. The common stocks are $22,813
and $22,113 with paid-in capital $30,666,631 as of December 31, 2009 and June
30, 2008 respectively.


27


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





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 Ceramic Valves and VIE,
      Shengkai (see note 1).





SK
Ceramic Valves, 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.





A
reconciliation between the income tax computed at the U.S. statutory rate and
the Group’s provision for income tax is as follows:





For the six months ended December 31,2009
                      
                      
                      2008U.S.
      statutory rate
                      
                      
                      34
                      %
                      
                      
                      34
                      %Foreign
      income not recognized in the U.S.
                      
                      
                      (34
                      )%
                      
                      
                      (34
                      )%PRC
      Enterprise Income Tax
                      
                      
                      25
                      %
                      
                      
                      25
                      %Provision
      for income tax
                      
                      
                      25
                      %
                      
                      
                      25
                      %





(b)
            The effective tax rate for the
      six months ended December 31, 2009 and 2008 both were
      25%.





Income
before income tax expenses of $10,861,269 and $7,543,159 for the six months
ended December 31, 2009 and 2008 respectively, was attributed to subsidiaries
with operations in China. Income tax expense related to China income for the six
months ended December 31, 2009, and 2008 are $2,667,743 and $1,884,281,
respectively.


28


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





14.
            EARNINGS (LOSS) PER
      SHARE





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





For
      the six months ended
                              December
      31,
                            
                            
                            For
      the three months ended
                              December
      31,2009
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2008Earnings
      (loss):Net
      income (loss) for the year
                            
                            $
                            (14,068,325
                            )
                            
                            $
                            5,658,878
                            
                            
                            $
                            (11,213,849
                            )
                            
                            
                            2,532,561Non-Cash
      Dividends on convertible preferred stock
                            
                            
                            -
                            
                            
                            
                            (2,560,186
                            )
                            
                            
                            -
                            
                            
                            
                            -Earnings
      (loss) for the purpose of basic earnings per share
                            
                            $
                            (14,068,325
                            )
                            
                            $
                            3,098,692
                            
                            
                            $
                            (11,213,849
                            )
                            
                            $
                            2,532,561Effect
      of dilutive potential common stock
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Earnings
      (loss) for the purpose of dilutive earnings (loss) per
    share
                            
                            $
                            (14,068,325
                            )
                            
                            $
                            3,098,692
                            
                            
                            $
                            (11,213,849
                            )
                            
                            $
                            2,532,561Number
      of shares:Weighted
      average number of common stock for the purpose of basic earnings (loss)
      per share
                            
                            
                            22,382,719
                            
                            
                            
                            22,112,500
                            
                            
                            
                            22,570,742
                            
                            
                            
                            22,112,500Effect
      of dilutive potential common stock-Conversion
      of Series A convertible preferred stock
                            
                            
                            -
                            
                            
                            
                            7,887,368
                            
                            
                            
                            -
                            
                            
                            
                            7,887,368-Conversion
      of A Warrant
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Weighted
      average number of common stock for the purpose of dilutive earnings (loss)
      per share
                            
                            
                            22,382,719
                            
                            
                            
                            29,999,868
                            
                            
                            
                            22,570,742
                            
                            
                            
                            29,999,868Earnings
      (loss) per share:Basic
      earnings (loss) per share
                            
                            $
                            (0.629
                            )
                            
                            $
                            0.140
                            
                            
                            $
                            (0.497
                            )
                            
                            $
                            0.115Dilutive
      earnings (loss) per share
                            
                            $
                            (0.629
                            )
                            
                            $
                            0.103
                            
                            
                            $
                            (0.497
                            )
                            
                            $
                            0.084




29


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008


(Stated
in US Dollars)(Unaudited)





15.
            FAIR
      VALUE OF FINANCIAL INSTRUMENTS





The fair
value of a financial instrument is the amount at which the instrument could be
exchanged in a current transaction between willing parties.  The
carrying amounts of financial assets and liabilities, such as cash and cash
equivalents, accounts receivable, other receivables, accounts payable, and other
payables, approximate their fair values because of the short maturity of these
instruments and market rates of interest available to the Group.





16.
            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 $26,710,649 (RMB182,626,051) of which
$7,678,593 (RMB52,500,079) was paid as at December 31, 2009. The balance of
$19,032,056 (RMB130,125,972) will be settled within one year.





17.
            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.


30


Item 2.
            Management’s Discussion and
      Analysis or Plan of
Operation




Cautionary
Notice Regarding Forward-Looking Statements




In this
quarterly report, references to “Shengkai,” “SKII,” “the Company,” “we,” “us,”
and “our” refer to Shengkai Innovations, Inc.





We make
certain forward-looking statements in this report. Statements concerning our
future operations, prospects, strategies, financial condition, future economic
performance (including growth and earnings), demand for our services, and other
statements of our plans, beliefs, or expectations, including the statements
contained under the captions “Management’s Discussion and Analysis of Financial
Condition and Results of Operations,” “Business,” as well as captions elsewhere
in this document, are forward-looking statements. In some cases these statements
are identifiable through the use of words such as “anticipate,” “believe,”
“estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can”, “could,”
“may,” “should,” “will,” “would,” and similar expressions. We intend such
forward-looking statements to be covered by the safe harbor provisions contained
in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”)
and in Section 21E of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”). The forward-looking statements we make are not guarantees of
future performance and are subject to various assumptions, risks, and other
factors that could cause actual results to differ materially from those
suggested by these forward-looking statements. Because such statements are
subject to risks and uncertainties, actual results may differ materially from
those expressed or implied by the forward-looking statements. Indeed, it is
likely that some of our assumptions will prove to be incorrect. Our actual
results and financial position will vary from those projected or implied in the
forward-looking statements and the variances may be material. You are cautioned
not to place undue reliance on such forward-looking statements. These risks and
uncertainties, together with the other risks described from time to time in
reports and documents that we file with the SEC should be considered in
evaluating forward-looking statements.




The
nature of our business makes predicting the future trends of our revenue,
expenses, and net income difficult. Thus, our ability to predict results or the
actual effect of our future plans or strategies is inherently uncertain. The
risks and uncertainties involved in our business could affect the matters
referred to in any forward-looking statements and it is possible that our actual
results may differ materially from the anticipated results indicated in these
forward-looking statements. Important factors that could cause actual results to
differ from those in the forward-looking statements include, without limitation,
the following:





·
            the effect of political,
      economic, and market conditions and geopolitical
      events;


·
            legislative and regulatory
      changes that affect our
business;


·
            the availability of funds and
      working capital;


·
            the actions and initiatives of
      current and potential
competitors;


·
            investor sentiment;
      and


·
            our
      reputation.




We do not
undertake any responsibility to publicly release any revisions to these
forward-looking statements to take into account events or circumstances that
occur after the date of this report. Additionally, we do not undertake any
responsibility to update you on the occurrence of any unanticipated events which
may cause actual results to differ from those expressed or implied by any
forward-looking statements.




The
following discussion and analysis should be read in conjunction with our
consolidated financial statements and the related notes thereto as filed with
the SEC and other financial information contained elsewhere in this
Report.




31


Overview




We were
incorporated in Florida on December 8, 2004 and have since undergone a change in
business. In October 2008, our shareholders approved our name change from
“Southern Sauce Company, Inc.” to “Shengkai Innovations, Inc.”





As
a result of the reverse merger, financing and related
transactions described in our current report on Form 8-K/A filed with the
SEC on June 23, 2008, the Company ceased to be a shell company and became a
holding company for entities that, through contractual relationships, control
the business of Shengkai Industrial Technology Development Co., Ltd, a company
organized under the laws of the PRC that designs, manufactures and sells ceramic
valves. Because Shengkai Industrial Technology Development Co., Ltd.’s
operations are the only significant operations of the Company and its
affiliates, this discussion and analysis focuses on the business results of
Shengkai Industrial Technology Development Co., Ltd., comparing its results in
the three months and six months ended December 31, 2009 to the three months
ended December 31, 2008.




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 three months and six months ended December 31, 2009 and 2008
should be read in conjunction with 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, 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 North America, and
other countries in the Asia-Pacific region. Having over 300 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.




Results
of Operations




Comparison
of the Three Months Ended December 31, 2009 and 2008





Revenue





Revenue
for the three months ended December 31, 2009 was $12,541,851, an increase of
$4,399,044 or 54.0% from $8,142,807 for the comparable period in 2008. The
product output has increased due to improved ceramic production technology to
shorten the production cycle of some kinds of the ceramic pieces. Approximately
93.6% of our source of revenue came from customers in the electric power,
petrochemical and chemical for the past three months. The electric power
industry was still the significant market to our revenue, contributing
approximately 68.8% of total revenue for the three months ended December 31,
2009. Revenue from the electric power industry was approximately $8.6 million
for the three months ended December 31, 2009, an increase of approximately $2.1
million or 32.3% from approximately $6.5 million  for the comparable
period in 2008. 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 biggest potential market, was
approximately $3.1 million for the three months ended December 31, 2009, an
increase of approximately $1.6 million or 106.7% from approximately $1.5 million
for the comparable period in 2008.  The increase was primarily due to
our hightened effort to develop the market ofthe petrochemical industry. Revenue
from other industries, including the aluminum and  metallurgy
industries, was approximately $0.8 million for the three months ended December
31, 2009, an increase of approximately $0.7 million or 700.0% from approximately
$0.1 million for the comparable period in 2008.


32





At
present we are still experiencing a deficiency of production capacity. A new
manufacturing facility is under construction  and the manufacturing
plant is expected to be completed during the second quarter of calendar year
2010.





Gross
Profit





Gross
profit for the three months ended December 31, 2009 was $7,379,925, an increase
of $2,641,205 or 55.7% compared to $4,738,720 for the comparable period in 2008.
The gross profit margin for the three months ended December 31, 2009 slightly
increased from 58.2% to 58.8% for the comparable period in 2008. The gross
profit margin over these two comparable periods were relatively
stable.





Selling
Expenses





Selling
expenses for the three months ended December 31, 2009 was $1,116,378, an
increase of $230,739 or 26.1%, from $885,639 for the comparable period in 2008.
The major selling expense was attributable to commission paid to the agents for
introducing new sales, which was approximately $1.0 million for the three months
ended December 31, 2009, an increase of approximately $0.3 million or 42.9% from
approximately $0.7 million for the comparable period in 2008.





General and Administrative
Expenses





General
and administrative expenses for the three months ended December 31, 2009 were
$767,122, an increase of $261,423 or 51.7% compared to $505,699 for the
comparable period in 2008. The increase was primarily attributable to research
and development, from $112,276 to $188,963 over the comparable periods of 2008
and 2009, an increase of $76,687 or 68.3%. The increase was also attributable to
the increase in the expenses related to the financing activities. The cost of
financing activities increased by $89,602 for the comparable period of 2009 and
2008. The salaries of the management staff for the three months ended December
31, 2009 were $94,100, an increase of $51,517 or 121% compared to $42,583 for
the comparable period in 2008.  The amortization of intangible assets
for the three months ended December 31, 2009 were $229,248, an increase of
$37,980 or 19.9% compared to $191,267 for the comparable period in
2008.





Interest
expense




There was
no interest expense for the three months ended December 31, 2009 or the
comparable period in 2008. No short or long term loans were outstanding for the
three months ended December 31, 2009 or the comparable period in
2008.





Changes in fair value of
instruments




For the
three months ended December 31, 2009, the Company incurred non-cash expense for
aggregate amount of approximately $15.4 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”). The accounting treatment of the
warrants resulted from the difference between the Company's functional currency
in Renminbi and the denominated currency of the strike price of the warrants in
USD; The 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 the three months ended December
31, 2009.


33





Income Tax
Expenses





Income
tax for the three months ended December 31, 2009 was $1,387,740, an increase of
$529,654 or 61.7%  from $858,086 for the comparable period in 2008.
The effective tax rates were 25% for both of the three months ended September
30, 2009 and 2008.





Comparison of the
Six Months Ended December 31, 2009 and 2008





Revenue





Revenue
for the six months ended December 31, 2009 was $23,652,020, an increase of
$6,311,966 or 36.4% from $17,340,054 for the comparable period in
2008.  The product output has increased due to improved ceramic
production technology to shorten the production cycle of some kinds of the
ceramic pieces. Approximately 94.1% of our source of revenue came from customers
in the electric power, petrochemical and chemical for the past six months. The
electric power industry was still the significant market to our revenue,
contributing approximately 69.6% of total revenue for the six months ended
December 31, 2009. Revenue from the electric power industry was approximately
$16.5 million  for the six months ended December 31, 2009, an increase
of approximately $3.0 million or 22.2% from approximately $13.5 million for the
comparable period in 2008. 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 biggest potential
market, was approximately $5.8 million for the six months ended December 31,
2009, an increase of approximately $2.9 million or 100.0% from approximately
$2.9 million for the comparable period in 2008.  Revenue from other
industries, including the aluminum and  metallurgy industries, was
approximately $1.4 million for the six months ended December 31, 2009, an
increase of approximately $0.5 million or 55.6% from approximately $0.9 million
for the comparable period in 2008.




Gross
Profit





Gross
profit for the six months ended December 31, 2009 was $14,170,003, an increase
of $3,841,610 or 37.2% compared to $10,328,393 for the comparable period in
2008. The gross profit margin for the six months ended December 31, 2009 also
increased slightly from 59.6% to 59.9% for the comparable period in 2008. The
gross profit margin over these two comparable periods were relatively
stable.





Selling
Expenses





Selling
expenses for the six months ended December 31, 2009 was $2,117,990, an increase
of $361,514 or 20.6%, from $1,756,476 for the comparable period in 2008. The
major selling expense was attributable to commission paid to the agents for
introducing new sales, which was approximately $1.9 million for the six months
ended December 31, 2009, an increase of approximately $0.5 million or 35.7% from
approximately $1.4 million for the six months ended December 31,
2008.





General and Administrative
Expenses





General
and administrative expenses for the six months ended December 31, 2009 were
$1,514,850, an increase of $412,665 or 37.4% compared to $1,102,185 for the
comparable period in 2008. The increase was primarily attributable to research
and development, from $222,167 to $347,107 over the comparable periods of 2008
and 2009, an increase of $124,940 or 56.2%. The salaries of the management staff
for the six months ended December 31, 2009 were $160,380, an increase of $78,724
or 96.4% compared to $81,656 for the comparable period in 2008. The amortization
of intangible assets for the six months ended December 31, 2009 were $458,345,
an increase of $75,801 or 19.8% compared to $382,544 for the comparable period
in 2008. The cost of office expenses and financing activities for the six months
ended December 31, 2009 were $243,939, an increase of $47,462 or 24.16% compared
to $196,477 for the comparable period in 2008.


34


Interest
expense




There was
no interest expense for the six months ended December 31, 2009 or the comparable
period in 2008. No short or long term loans were outstanding for the six months
ended December 31, 2009 or the comparable period in 2008.





Changes in fair value of
instruments




For the
six months ended December 31, 2009, the Company incurred non-cash expense for
aggregate amount of approximately $22.3 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”). The accounting treatment of the
warrants resulted from the difference between the Company's functional currency
in Renminbi and the denominated currency of the strike price of the warrants in
USD. The 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 the six months ended December 31,
2009.





Income Tax
Expenses





Income
tax for the six months ended December 31, 2009 was $2,667,743, an increase of
$783,462 or 41.6%  from $1,884,281 for the comparable period in 2008.
The effective tax rates were 25% for both of the six months ended December 31,
2009 and 2008.




Liquidity
and Capital Resources





Cash and Cash
Equivalents




Our cash
and cash equivalents as at the beginning of the six months ended December 31,
2009 was $38,988,958 and decreased to $37,160,406 by the end of the period, a
decrease of $1,828,552 or 4.7%. The net change in cash and cash equivalents
represented a decrease of $11,116,893 or 119.7% from $9,288,340 for the
comparable period in 2008.




Net cash provided by
operating activities





Net cash
provided by operating activities was $9,613,448 for the six months ended
December 31, 2009, an increase of $4,362,063 or 83.1% from $5,251,385 for the
comparable period in 2008. Net income was  $8,193,526 for six months
ended December 31, 2009, an increase of $2,534,648 or 44.8% from $5,658,878 for
the comparable period in 2008. Notes payable, accounts payable and advances from
customers increased $1,164,189, $885,790 and $842,033 respectively in cash
provision over the six months ended December 31, 2008 and 2009. The increase in
trade receivables contributed $2,229,387 to the increase of net cash outflow
between the two comparable periods in 2008 and 2009.


35


Net cash used in investing
activities





Net cash
used in investing activities was $11,471,748 for the six months ended December
31, 2009, compared to $611,817 for the six months ended December 31, 2008, an
increase of $10,859,931 or 1775.0%.The change was primarily attributable to the
payment of $7.3 million for the new manufacturing facilities that was still
under construction. The increase was also due to deposits pledged for notes
payables for coming construction payments in the amount of approximately $3.9
million.




Net cash used in financing
activities





There was
no net cash provided by financing activities for the six months ended December
31, 2009. For the comparable six months ended December 31, 2008, there was
$4,613,790 cash provided by private placement.





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 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, pursuant to
which the Company shall 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 made under related construction contracts
totaled $26,710,649 (RMB182,626,051), of which $7,678,593 (RMB52,500,079) was
paid as of December 31, 2009. The balance of $19,032,056 (RMB130,125,972) will
be settled within one year. In order to complete such expansion of
production capacity, we would need to substantially increase our capital
expenditures.





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.




The
following table summarizes our contractual obligations as of December 31, 2009,
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)
                    
                    $
                    19,032,056
                    
                    
                    $
                    19,032,056
                    
                    
                    $
                    -




(1)
Capital expenditure is commitment for the construction of a new manufacturing
facility. See Note 15 - 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 $26,710,649,
of which $7,678,593 was paid as at of December 31, 2009. The construction
of both the manufacturing facility and the headquarters’ building is estimated
to be completed during this fiscal year.


36


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





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




Intangible
assets





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




Foreign
currency translation





The
accompanying financial statements are presented in United States dollars. The
functional currency of Shengkai is the Renminbi (RMB). The 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.




New
Financial Accounting Pronouncements




In June
2009, FASB issued Statement of Financial Accounting Standards No. 167,
Amendments to FASB
Interpretation No. 46(R)(“Statement No. 167”). Statement
No. 167 amends FASB Interpretation No. 46R, Consolidation of Variable Interest
Entities an interpretation of ARB No. 51 (“FIN 46R”) to require an
analysis to determine whether a company has a controlling financial interest in
a variable interest entity. This analysis identifies the primary beneficiary of
a variable interest entity as the enterprise that has a) the power to direct the
activities of a variable interest entity that most significantly impact the
entity’s economic performance and b) the obligation to absorb losses of the
entity that could potentially be significant to the variable interest entity or
the right to receive benefits from the entity that could potentially be
significant to the variable interest entity. The statement requires an ongoing
assessment of whether a company is the primary beneficiary of a variable
interest entity when the holders of the entity, as a group, lose power, through
voting or similar rights, to direct the actions that most significantly affect
the entity’s economic performance. This statement also enhances disclosures
about a company’s involvement in variable interest entities. Statement
No. 167 is effective as of the beginning of the first annual reporting
period that begins after November 15, 2009. Although Statement No. 167
has not been incorporated into the Codification, in accordance with ASC 105, the
standard shall remain authoritative until it is integrated. The Company does not
expect the adoption of Statement No. 167 to have a material impact on its
financial position or results of operations.


37




In June
2009, the FASB issued Statement of Financial Accounting Standards No. 166,
Accounting for Transfers of
Financial Assets an amendment of FASB Statement No. 140 (“Statement
No. 166”). Statement No. 166 revises FASB Statement of Financial
Accounting Standards No. 140, Accounting for Transfers and
Extinguishment of Liabilities a replacement of FASB Statement 125
(“Statement No. 140”) and requires additional disclosures about transfers
of financial assets, including securitization transactions, and any continuing
exposure to the risks related to transferred financial assets. It also
eliminates the concept of a “qualifying special-purpose entity”, changes the
requirements for derecognizing financial assets, and enhances disclosure
requirements. Statement No. 166 is effective prospectively, for annual
periods beginning after November 15, 2009, and interim and annual periods
thereafter. Although Statement No. 166 has not been incorporated into the
Codification, in accordance with ASC 105, the standard shall remain
authoritative until it is integrated. The Company does not expect the adoption
of Statement No. 166 will have a material impact on its financial position
or results of operations.





In August
2009, the FASB issued ASC Update No. 2009-05, Fair Value Measurements and
Disclosures (Topic 820): Measuring Liabilities at Fair Value (“ASC Update
No. 2009-05”). This update amends ASC 820, Fair Value Measurements and
Disclosures and provides further guidance on measuring the fair value of
a liability. The guidance establishes the types of valuation techniques to be
used to value a liability when a quoted market price in an active market for the
identical liability is not available, such as the use of an identical or similar
liability when traded as an asset. The guidance also further clarifies that a
quoted price in an active market for the identical liability at the measurement
date and the quoted price for the identical liability when traded as an asset in
an active market when no adjustments to the quoted price of the asset are
required are both Level 1 fair value measurements. If adjustments are required
to be applied to the quoted price, it results in a level 2 or 3 fair value
measurement. The guidance provided in the update is effective for the first
reporting period (including interim periods) beginning after issuance. The
Company does not expect that the implementation of ASC Update No. 2009-05
will have a material effect on its financial position or results of
operations.




In
September 2009, the FASB issued ASC Update No. 2009-12, Fair Value Measurements and
Disclosures (Topic 820): Investments in Certain Entities that Calculate Net
Asset Value per Share (or Its Equivalent) (“ASC Update
No. 2009-12”). This update sets forth guidance on using the net asset value
per share provided by an investee to estimate the fair value of an alternative
investment. Specifically, the update permits a reporting entity to measure the
fair value of this type of investment on the basis of the net asset value per
share of the investment (or its equivalent) if all or substantially all of the
underlying investments used in the calculation of the net asset value is
consistent with ASC 820. The update also requires additional disclosures by each
major category of investment, including, but not limited to, fair value of
underlying investments in the major category, significant investment strategies,
redemption restrictions, and unfunded commitments related to investments in the
major category. The amendments in this update are effective for interim and
annual periods ending after December 15, 2009 with early application
permitted. The Company does not expect that the implementation of ASC Update
No. 2009-12 will have a material effect on its financial position or
results of operations.





The
management of the Company does not anticipate that the adoption of these three
standards will have a material impact on these financial
statements.





Item 3.
            Quantitative and Qualitative
      Disclosures about Market
Risk.




N/A.




38





Item 4.
            Controls and
      Procedures.





Our
management is responsible for establishing and maintaining a system of
disclosure controls and procedures (as defined in Rule 13a-15(e)) under the
Exchange Act) that is designed to ensure that information required to be
disclosed by the Company in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported, within the time
specified in the Commission's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by an issuer in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the issuer's management, including its principal executive officer or
officers and principal financial officer or officers, or persons performing
similar functions, as appropriate to allow timely decisions regarding required
disclosure.





Pursuant
to Rule 13a-15(b) under the Exchange Act, the Company carried out an evaluation
with the participation of the Company’s management, including Wang Chen, the
Company’s Chief Executive Officer (“CEO”), of the effectiveness of the Company’s
disclosure controls and procedures (as defined under Rule 13a-15(e) under the
Exchange Act) as of the three months ended December 31, 2009. Based upon that
evaluation, the Company’s CEO concluded that, as of the date of evaluation, the
Company did not have a sufficient number of personnel with an
appropriate level of knowledge of and experience in generally
accepted accounting principles in the United States of America
(U.S. GAAP) that are appropriate to the
Company's financial reporting requirements.  In particular, it
identified a material weakness in the Company’s internal control over financial
reporting with respect to, among other things, the proper classification of all
its costs directly associated with the generation in its cost of services. 
As a result of such evaluation, the Company's CEO concluded that, as of the date
of evaluation, the Company’s disclosure controls and procedures were not
effective to ensure that information required to be disclosed by the Company in
the reports that the Company files or submits under the Exchange Act, is
recorded, processed, summarized and reported, within the time periods specified
in the SEC’s rules and forms, or that such information is accumulated and
communicated to the Company’s management, including the Company’s CEO, as
appropriate, to allow timely decisions regarding required
disclosure.





As a
result of comments raised by the SEC, we determined that accounting errors were
made in connection with:





·
            Classification
      of certain warrants in accordance with ASC 815-40-15-7I as adopted on July
      1, 2009;


·
            Classification
      of the embedded conversion option of the Series A preferred stock in
      accordance with ASC 815-40-55-33 as adopted on July 1,
    2009.





Based on
the impact of the aforementioned accounting errors, we determined to restate our
consolidated financial statements as of September 30, 2009, December 31,
2009 and March 31, 2010.




Changes
in internal controls





Other
than as disclosed above, there were no changes in our internal controls over
financial reporting during the quarter ended December 31, 2009 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting. Since this time, the Company has 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. Management believes this will help strengthen the
general internal control process.





PART
II – OTHER INFORMATION





Item 1.
            Legal
      Proceedings.





To our
knowledge, there is no material litigation pending or threatened against
us.





Item 1A.
            Risk
    Factors.





N/A.


39





Item 2.
            Unregistered Sale of Equity
      Securities and Use of
Proceeds.





None.





Item 3.
            Defaults Upon Senior
      Securities.





To our
knowledge, there are no material defaults upon senior
securities.





Item 4.
            (Removed and
      Reserved).





Item 5.
            Other
      Information.





None.




Item 6.
            Exhibits.




(a)
Exhibits




31.1
                
                Certification
      Required Under Section 302 of Sarbanes-Oxley Act of
  2002.31.2
                
                Certification
      Required Under Section 302 of Sarbanes-Oxley Act of
  2002.32.1
                
                Certification
      Required Under Section 906 of Sarbanes-Oxley Act of
  2002.32.2
                
                Certification
      Required Under Section 906 of Sarbanes-Oxley Act of
  2002.


40


SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.





SHENGKAI
      INNOVATIONS, INC.Date:
      August 19, 2010
              By:
              /s/ Wang ChenName: Wang ChenTitle: Chief Executive Officer(principal
      executive officer )Date:
      August 19, 2010
              By:
              /s/ David Ming HeName: David Ming HeTitle: Chief Financial Officer(principal
      financial and accounting officer
)




41