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 March 31, 2010





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


For
the transition period from _______ to _______





Commission
file number: 001-34587





SHENGKAI
INNOVATIONS, INC.


(Exact
      name of 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 12, 13 or 15(d) of the Exchange Act after the distribution of securities
under a plan confirmed by a court. Yes  ̈  No  ̈





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 May 14, 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 May 14, 2010, the
filing date of the original report.


TABLE
OF CONTENTS





PagePART
      IItem
      1.
                  
                  Financial
      Statements
                  
                  3Item
      2.
                  
                  Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation
                  
                  34Item
      3.
                  
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  
                  42Item
      4.
                  
                  Controls
      and Procedures
                  
                  42PART
      IIItem
      1.
                  
                  Legal
      Proceedings
                  
                  43Item
      1A.
                  
                  Risk
      Factors
                  
                  43Item
      2.
                  
                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                  
                  43Item
      3.
                  
                  Defaults
      Upon Senior Securities
                  
                  43Item
      4.
                  
                  Removed
      and Reserved
                  
                  44Item
      5.
                  
                  Other
      Information
                  
                  44Item
      6.
                  
                  Exhibits
                  
                  44SIGNATURES
                  
                  45


2


PART
I – FINANCIAL INFORMATION





Item
      1.
            Financial
      Statements





SHENGKAI
INNOVATIONS, INC.


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


CONSOLIDATED
BALANCE SHEETS


AS
AT MARCH 31, 2010 (UNAUDITED) (RESTATED) AND JUNE 30, 2009
(AUDITED)


(Stated
in US Dollars)





Note
                                                      
                                                      March 31, 2010
                                                      
                                                      
                                                      June 30, 2009(Unaudited)
                                                      
                                                      
                                                      (Audited)(Restated)ASSETSCurrent
      assetsCash
      and cash equivalents
                                                      
                                                      
                                                      
                                                      $
                                                      22,942,461
                                                      
                                                      
                                                      $
                                                      38,988,958Pledged
      deposits
                                                      
                                                      5
                                                      
                                                      
                                                      3,062,264
                                                      
                                                      
                                                      
                                                      940,488Trade
      receivables
                                                      
                                                      
                                                      
                                                      
                                                      6,147,211
                                                      
                                                      
                                                      
                                                      4,061,706Notes
      receivable
                                                      
                                                      
                                                      
                                                      
                                                      277,205
                                                      
                                                      
                                                      
                                                      292,193Other
      receivables
                                                      
                                                      6
                                                      
                                                      
                                                      57,061
                                                      
                                                      
                                                      
                                                      22,979Prepaid
      VAT
                                                      
                                                      
                                                      
                                                      
                                                      0
                                                      
                                                      
                                                      
                                                      194,535Advances
      to suppliers
                                                      
                                                      
                                                      
                                                      
                                                      12,684,349
                                                      
                                                      
                                                      
                                                      328,785Inventories
                                                      
                                                      7
                                                      
                                                      
                                                      1,769,526
                                                      
                                                      
                                                      
                                                      907,799Total
      current assets
                                                      
                                                      
                                                      
                                                      $
                                                      46,940,077
                                                      
                                                      
                                                      $
                                                      45,737,443Plant
      and equipment, net
                                                      
                                                      8
                                                      
                                                      
                                                      22,354,785
                                                      
                                                      
                                                      
                                                      5,173,269Intangible
      assets, net
                                                      
                                                      9
                                                      
                                                      
                                                      8,668,998
                                                      
                                                      
                                                      
                                                      9,342,322TOTAL
      ASSETS
                                                      
                                                      
                                                      
                                                      $
                                                      77,963,860
                                                      
                                                      
                                                      $
                                                      60,253,034LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilitiesNotes
      payable
                                                      
                                                      
                                                      
                                                      $
                                                      3,265,078
                                                      
                                                      
                                                      $
                                                      984,561Accounts
      payable
                                                      
                                                      
                                                      
                                                      
                                                      2,675,276
                                                      
                                                      
                                                      
                                                      1,121,185Advances
      from customers
                                                      
                                                      
                                                      
                                                      
                                                      892,620
                                                      
                                                      
                                                      
                                                      242,986Other
      payables
                                                      
                                                      10
                                                      
                                                      
                                                      737,207
                                                      
                                                      
                                                      
                                                      794,754Accruals
                                                      
                                                      
                                                      
                                                      
                                                      91,186
                                                      
                                                      
                                                      
                                                      131,581Income
      tax payable
                                                      
                                                      
                                                      
                                                      
                                                      977,668
                                                      
                                                      
                                                      
                                                      1,471,380Total
      current liabilities
                                                      
                                                      
                                                      
                                                      $
                                                      8,639,035
                                                      
                                                      
                                                      $
                                                      4,746,447Warrant
      liabilities
                                                      
                                                      
                                                      
                                                      
                                                      38,325,263Preferred
      (conversion option) liabilities
                                                      
                                                      
                                                      
                                                      
                                                      39,623,624TOTAL
      LIABILITIES
                                                      
                                                      
                                                      
                                                      $
                                                      86,587,922
                                                      
                                                      
                                                      $
                                                      4,746,447Commitments
      and contingencies
                                                      
                                                      17
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      -STOCKHOLDERS’
      EQUITYPreferred
      Stock – $0.001 par value 15,000,000 shares authorized ; 6,987,368 and
      7,887,368 issued and outstanding as of March 31, 2010 and June 30, 2009
      respectively.
                                                      
                                                      11
                                                      
                                                      $
                                                      6,987
                                                      
                                                      
                                                      $
                                                      7,887Common
      stock - $0.001 par value 50,000,000 shares authorized; 23,012,500 and
      22,112,500 shares issued and outstanding as of March 31, 2010 and June 30,
      2009 respectively.
                                                      
                                                      12
                                                      
                                                      
                                                      23,013
                                                      
                                                      
                                                      
                                                      22,113Additional
      paid-in capital
                                                      
                                                      12
                                                      
                                                      
                                                      16,186,035
                                                      
                                                      
                                                      
                                                      30,666,631Statutory
      reserves
                                                      
                                                      
                                                      
                                                      
                                                      7,081,706
                                                      
                                                      
                                                      
                                                      4,693,020Retained
      earnings (deficits)
                                                      
                                                      
                                                      
                                                      
                                                      (34,655,272
                                                      )
                                                      
                                                      
                                                      17,456,857Accumulated
      other comprehensive income
                                                      
                                                      
                                                      
                                                      
                                                      2,733,469
                                                      
                                                      
                                                      
                                                      2,660,079$
                                                      (8,624,062
                                                      )
                                                      
                                                      $
                                                      55,506,587TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                                                      
                                                      
                                                      
                                                      $
                                                      77,963,860
                                                      
                                                      
                                                      $
                                                      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 NINE MONTHS ENDED MARCH 31, 2010 (RESTATED) AND 2009


(Stated
in US Dollars) (Unaudited)





Nine months ended March 31,
                                      
                                      
                                      Three months ended March 31,Notes
                                      
                                      2010
                                      
                                      
                                      2009
                                      
                                      
                                      2010
                                      
                                      
                                      2009(restated)
                                      
                                      
                                      
                                      
                                      
                                      (restated)Net
      revenues
                                      
                                      
                                      
                                      $
                                      38,193,092
                                      
                                      
                                      $
                                      17,340,054
                                      
                                      
                                      $
                                      14,541,072
                                      
                                      
                                      $
                                      8,142,807Cost
      of sales
                                      
                                      
                                      
                                      
                                      (15,397,096
                                      )
                                      
                                      
                                      (7,011,661
                                      )
                                      
                                      
                                      (5,915,079
                                      )
                                      
                                      
                                      (3,404,087
                                      )Gross
      profit
                                      
                                      
                                      
                                      $
                                      22,795,996
                                      
                                      
                                      $
                                      10,328,393
                                      
                                      
                                      $
                                      8,625,993
                                      
                                      
                                      $
                                      4,738,720Operating
      expenses:Selling
                                      
                                      
                                      
                                      
                                      (3,521,765
                                      )
                                      
                                      
                                      (1,756,476
                                      )
                                      
                                      
                                      (1,403,775
                                      )
                                      
                                      
                                      (885,639
                                      )General
      and administrative
                                      
                                      
                                      
                                      
                                      (4,618,265
                                      )
                                      
                                      
                                      (1,102,185
                                      )
                                      
                                      
                                      (3,103,415
                                      )
                                      
                                      
                                      (505,699
                                      )Operating
      income
                                      
                                      
                                      
                                      $
                                      14,655,966
                                      
                                      
                                      $
                                      7,469,732
                                      
                                      
                                      $
                                      4,118,803
                                      
                                      
                                      $
                                      3,347,382Other
      income
                                      
                                      
                                      
                                      
                                      224,357
                                      
                                      
                                      
                                      7,316
                                      
                                      
                                      
                                      208,762
                                      
                                      
                                      
                                      -Interest
      income
                                      
                                      
                                      
                                      
                                      350,602
                                      
                                      
                                      
                                      66,111
                                      
                                      
                                      
                                      42,091
                                      
                                      
                                      
                                      43,265Changes
      in fair value of instruments - (loss)/gain
                                      
                                      
                                      
                                      
                                      (55,939,985
                                      )
                                      
                                      
                                      
                                      
                                      
                                      
                                      (33,678,134
                                      )Income
      (loss) before income taxes
                                      
                                      
                                      
                                      $
                                      (40,709,060
                                      )
                                      
                                      $
                                      7,543,159
                                      
                                      
                                      $
                                      (29,308,478
                                      )
                                      
                                      $
                                      3,390,647Provision
      for Income taxes
                                      
                                      14
                                      
                                      
                                      (3,645,506
                                      )
                                      
                                      
                                      (1,884,281
                                      )
                                      
                                      
                                      (977,763
                                      )
                                      
                                      
                                      (858,086
                                      )Net
      income (loss)
                                      
                                      
                                      
                                      $
                                      (44,354,566
                                      )
                                      
                                      $
                                      5,658,878
                                      
                                      
                                      $
                                      (30,286,241
                                      )
                                      
                                      $
                                      2,532,561Foreign
      currency translation adjustment
                                      
                                      
                                      
                                      
                                      23,725
                                      
                                      
                                      
                                      74,279
                                      
                                      
                                      
                                      (25,941
                                      )
                                      
                                      
                                      59,785Comprehensive
      income (loss)
                                      
                                      
                                      
                                      $
                                      (44,330,841
                                      )
                                      
                                      $
                                      5,733,157
                                      
                                      
                                      
                                      (30,312,182
                                      )
                                      
                                      
                                      2,592,346Basic
      earnings (loss) per share
                                      
                                      15
                                      
                                      $
                                      (1.964
                                      )
                                      
                                      $
                                      0.140
                                      
                                      
                                      $
                                      (1.318
                                      )
                                      
                                      $
                                      0.115Diluted
      earnings (loss) per share
                                      
                                      15
                                      
                                      $
                                      (1.964
                                      )
                                      
                                      $
                                      0.103
                                      
                                      
                                      $
                                      (1.318
                                      )
                                      
                                      $
                                      0.084Basic
      weighted average share outstanding
                                      
                                      15
                                      
                                      
                                      22,582,391
                                      
                                      
                                      
                                      22,112,500
                                      
                                      
                                      
                                      22,985,833
                                      
                                      
                                      
                                      22,112,500Diluted
      weighted average share outstanding
                                      
                                      15
                                      
                                      
                                      22,582,391
                                      
                                      
                                      
                                      29,999,868
                                      
                                      
                                      
                                      22,985,833
                                      
                                      
                                      
                                      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 NINE MONTHS ENDED MARCH 31, 2010 (RESTATED) AND 2009


(Stated
in US Dollars) (Unaudited)





Nine months ended March 31,2010
                  
                  2009(Restated)Cash
      flows from operating activitiesNet
      income (loss)
                  
                  $
                  (44,354,566
                  )
                  
                  $
                  9,177,928Depreciation
                  
                  
                  315,430
                  
                  
                  
                  125,490Amortization
                  
                  
                  687,675
                  
                  
                  
                  573,995Changes
      in fair value of instruments - loss/(gain)
                  
                  
                  55,939,985Share-based
      compensation
                  
                  
                  2,159,429
                  
                  
                  
                  -Adjustments
      to reconcile net income to net cash provided by operating
      activities:Trade
      receivables
                  
                  
                  (2,079,840
                  )
                  
                  
                  (1,139,996
                  )Notes
      receivable
                  
                  
                  15,356
                  
                  
                  
                  8,758Other
      receivables
                  
                  
                  (34,045
                  )
                  
                  
                  1,122Prepaid
      VAT
                  
                  
                  194,736
                  
                  
                  
                  -Deposits
      and prepaid expenses
                  
                  
                  -
                  
                  
                  
                  2,551Advances
      to suppliers
                  
                  
                  (438,387
                  )
                  
                  
                  (812,803
                  )Inventories
                  
                  
                  (860,367
                  )
                  
                  
                  (605,105
                  )Notes
      payable
                  
                  
                  2,278,721
                  
                  
                  
                  1,470,853Accounts
      payable
                  
                  
                  1,552,294
                  
                  
                  
                  196,381Advances
      from customers
                  
                  
                  649,170
                  
                  
                  
                  560,207Other
      payables
                  
                  
                  (58,544
                  )
                  
                  
                  223,953Accruals
                  
                  
                  (40,552
                  )
                  
                  
                  (47,714
                  )Income
      tax payable
                  
                  
                  (495,466
                  )
                  
                  
                  211,692Net
      cash provided by operating activities
                  
                  $
                  15,431,029
                  
                  
                  $
                  9,947,312Cash
      flows from investing activitiesPurchase
      of property, plant and equipment
                  
                  $
                  (17,486,268
                  )
                  
                  $
                  (122,443
                  )Decrease/(increase)
      in advances to suppliers
                  
                  
                  (11,913,814
                  )
                  
                  
                  -Increase
      in restrictive cash
                  
                  
                  (2,120,563
                  )
                  
                  
                  (536,674
                  )Payment
      of intangible assets
                  
                  
                  
                  
                  
                  
                  (1,894,339
                  )Net
      cash used in investing activities
                  
                  $
                  (31,523,270
                  )
                  
                  $
                  (2,553,456
                  )Cash
      flows from financing activitiesProceeds
      from stock issued, net of transaction costs of $386,210
                  
                  $
                  -
                  
                  
                  $
                  4,613,790Net
      cash provided by financing activities
                  
                  $
                  -
                  
                  
                  $
                  4,613,790Net
      cash and cash equivalents (used) / sourced
                  
                  $
                  (16,092,241
                  )
                  
                  $
                  12,007,646Effect
      of foreign currency translation on cash and cash
    equivalents
                  
                  
                  45,744
                  
                  
                  
                  73,844Cash
      and cash equivalents–beginning of the period
                  
                  
                  38,988,958
                  
                  
                  
                  21,313,484Cash
      and cash equivalents–end of the period
                  
                  $
                  22,942,461
                  
                  
                  $
                  33,394,974Supplementary
      cash flow information:Interest
      received
                  
                  $
                  350,594
                  
                  
                  $
                  162,750Tax
      paid
                  
                  $
                  4,140,972
                  
                  
                  $
                  2,838,793





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 NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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 periods ended March 31, 2010 and
2009.





Shen Kun
formed Sheng Kai (Tianjin) Ceramic Valves Co., Ltd., which was renamed to
Shengkai (Tianjin) Limited in April 2010 (“SK” or “WFOE”), which entered into a
series of agreements with Tianjin Shengkai Industrial Technology Development
Co., Ltd (“Shengkai”) including but not limited to consigned management,
technology service, loan, exclusive purchase option, equity pledge, etc. The
agreements were entered on May 30, 2008. As a result of entering the
abovementioned agreements, WFOE deem to control Shengkai as a Variable Interest
Entity as required by FASB Interpretation No. 46 (revised MARCH 2003)
Consolidated of Variable Interest Entities, and Interpretation of ARB No. 51. In
connection with the reverse merger transaction, on June 11, 2008 the Company
sold 5,915,526 Units for aggregate gross proceeds of $15,000,000, at a price of
$2.5357 per Unit. Each Unit consists of one share of Southern Sauce Series A
Convertible Preferred Stock, par value $0.001 per share (the “Preferred
Shares”), convertible into one share of common stock, par value $0.001 per share
(the “Common Stock”), and one Series A Warrant to purchase Common Stock equal to
120% of the number of shares of Common Stock issuable upon conversion of the
Preferred Shares (“Warrant”). Additionally, on July 18, 2008, the Company sold
1,971,842 Units for aggregate gross proceeds of $5,000,000, at a price of
$2.5357 per Unit. Each Unit consists of one Preferred Share, convertible into
one share of Common Stock, par value $0.001 per share, 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 sale of
industrial ceramic valves and components.


6


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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
                                        %Shengkai
      (Tianjin) Limited, formerly Sheng Kai (Tianjin) Ceramic Valves Co.,
      Ltd
                                        
                                        PRC
                                        
                                        
                                        100
                                        %*Tianjin
      Shengkai Industrial TechnologyDevelopment
      Co., Ltd.
                                        
                                        PRC
                                        
                                        
                                        100
                                        %*Deemed
      variable interest entity 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 NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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 March 31,
2010 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 NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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 nine months or less to be cash equivalents. The Company maintains
bank accounts in the U.S.A., mainland China and Hong Kong.





March 31, 2010
                    
                    
                    June 30,
                      2009Cash
      on hand
                    
                    $
                    8,809
                    
                    
                    $
                    6,236Bank
      of China
                    
                    
                    5,630
                    
                    
                    
                    21,081Industrial
      and Commercial Bank of China
                    
                    
                    984,124
                    
                    
                    
                    750,757Industrial
      Bank Co. Ltd.
                    
                    
                    3,018,271
                    
                    
                    
                    2,962,345Shanghai
      Pudong Development Bank
                    
                    
                    18,750,058
                    
                    
                    
                    35,232,842The
      Hongkong and Shanghai Banking Corporation Limited
                    
                    
                    15,561
                    
                    
                    
                    15,697JPMorgan
      Chase Bank
                    
                    
                    160,008
                    
                    
                    
                    -$
                    22,942,461
                    
                    
                    $
                    38,988,958


9


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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
nine months ended March 31, 2010 and 2009 were $659,134 and $491,884
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 the general and
administrative expenses for the nine months ended March 31, 2010 and 2009 were
$101,962 and $26,875 respectively.


10


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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 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:





March
      31, 2010Balance
      sheet
                  RMB
      6.83610 to US$1.00Statements
      of income and comprehensive income
                  RMB
      6.83773 to US$1.00June
      30, 2009Balance
      sheet
                  RMB
      6.84480 to US$1.00Statements
      of income and comprehensive income
                  RMB
      6.84819 to US$1.00March
      31, 2009Balance
      sheet
                  RMB
      6.84560 to US$1.00Statements
      of income and comprehensive income
                  RMB
      6.85094 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 NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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 in the
U.S.A., mainland China and Hong Kong. Total cash in the banks at March 31, 2010
and June 30, 2009 amounted to $ 22,933,653 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 SK and Shengkai’s
Articles of Association, SK and Shengkai’s net income after taxation can only be
distributed as dividends after appropriation has been made for the
following:





(i)
            Making up cumulative prior years’
      losses, if any;


(ii)
            Allocations to the “Statutory
      surplus reserve” of at least 10% of income after tax, as determined under
      PRC accounting rules and regulations, until the fund amounts to 50% of the
      Company's registered capital, which is restricted for set off against
      losses, expansion of production and operation or increase in registered
      capital;


(iii)
            Allocations of 5-10% of income
      after tax, as determined under PRC accounting rules and regulations, to
      the Company's “Statutory common welfare fund”, which is restricted for
      capital expenditure for the collective benefits of the Company's
      employees; and


(iv)
            Allocations to the discretionary
      surplus reserve, if approved in the shareholders’ general
      meeting.





On
December 31, 2003, Shengkai established a statutory surplus reserve as well as a
statutory common welfare fund and commenced to appropriate 10% and 5%,
respectively of the PRC net income after taxation to these reserves. The amounts
included in the statutory reserves were surplus reserve of $7,081,706 and
$4,693,020 respectively, as of March 31, 2010 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 NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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 NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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 2009 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, 2009, except for certain disclosures related to the
insured financial obligations, which were effective for the third quarter of
2009. 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 July 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 NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(u)
            Recently issued
      standards





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 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 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 thetypes 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.


15


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





2.
            SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES
(Continued)





(u)
            Recently
      issued standards (Continued)





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.





In
January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair
Value Measurements. ASU 2010-06 amends ASC Topic 820 to require the following
additional disclosures regarding fair value measurements: (i) the amounts of
transfers between Level 1 and Level 2 of the fair value hierarchy; (ii) reasons
for any transfers in or out of Level 3 of the fair value hierarchy and (iii) the
inclusion of information about purchases, sales, issuances and settlements in
the reconciliation of recurring Level 3 measurements. ASU 2010-06 also amends
ASC Topic 820 to clarify existing disclosure requirements, requiring fair value
disclosures by class of assets and liabilities rather than by major category and
the disclosure of valuation techniques and inputs used to determine the fair
value of Level 2 and Level 3 assets and liabilities. With the exception of
disclosures relating to purchases, sales, issuances and settlements of recurring
Level 3 measurements, ASU 2010-06 was effective for interim and annual reporting
periods beginning after December 15, 2009. The disclosure requirements related
to purchases, sales, issuances and settlements of recurring Level 3 measurements
will be effective for financial statements for annual reporting periods
beginning after December 15, 2010. The Company does not expect the adoption of
this ASU 2010-06 to 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 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, 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.




17




The
Company’s consolidated balance sheet as of March 31, 2010, as previously
reported and as restated, is as follows:





March 31, 2010As
                                                          Previously
                                                          Reported
                                                        
                                                        
                                                        Adjustment
                                                        
                                                        
                                                        As RestatedASSETSCurrent
      assetsCash
      and cash equivalents
                                                        
                                                        $
                                                        22,942,461
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        22,942,461Pledged
      deposits
                                                        
                                                        
                                                        3,062,264
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        3,062,264Trade
      receivables
                                                        
                                                        
                                                        6,147,211
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        6,147,211Notes
      receivable
                                                        
                                                        
                                                        277,205
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        277,205Other
      receivables
                                                        
                                                        
                                                        57,061
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        57,061Prepaid
      VAT
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Advances
      to suppliers
                                                        
                                                        
                                                        12,684,349
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        12,684,349Inventories
                                                        
                                                        
                                                        1,769,526
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        1,769,526Total
      current assets
                                                        
                                                        $
                                                        46,940,077
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        46,940,077Plant
      and equipment, net
                                                        
                                                        
                                                        22,354,785
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        22,354,785Intangible
      assets, net
                                                        
                                                        
                                                        8,668,998
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        8,668,998TOTAL
      ASSETS
                                                        
                                                        $
                                                        77,963,860
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        77,963,860LIABILITIES
      AND STOCKHOLDERS’ EQUITY
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Current
      liabilities
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Notes
      payable
                                                        
                                                        $
                                                        3,265,078
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        3,265,078Accounts
      payable
                                                        
                                                        
                                                        2,675,276
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        2,675,276Advances
      from customers
                                                        
                                                        
                                                        892,620
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        892,620Other
      payables
                                                        
                                                        
                                                        737,207
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        737,207Accruals
                                                        
                                                        
                                                        91,186
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        91,186Income
      tax payable
                                                        
                                                        
                                                        977,668
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        977,668Total
      current liabilities
                                                        
                                                        $
                                                        8,639,035
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        8,639,035Warrant
      liabilities
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        38,325,263
                                                        
                                                        
                                                        
                                                        38,325,263Preferred
      (conversion option) liabilities
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        39,623,624
                                                        
                                                        
                                                        
                                                        39,623,624TOTAL
      LIABILITIES
                                                        
                                                        $
                                                        8,639,035
                                                        
                                                        
                                                        $
                                                        77,948,887
                                                        
                                                        
                                                        $
                                                        86,587,922Commitments
      and contingencies
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        -STOCKHOLDERS’
      EQUITY
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        -Preferred
      Stock – $0.001 par value 15,000,000 shares authorized ; 6,987,368 and
      7,887,368 issued and outstanding as of March 31, 2010 and June 30, 2009
      respectively.
                                                        
                                                        $
                                                        6,987
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        6,987Common
      stock - $0.001 par value 50,000,000 shares authorized; 23,012,500 and
      22,112,500 shares issued and outstanding as of March 31, 2010 and June 30,
      2009 respectively.
                                                        
                                                        
                                                        23,013
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        23,013Additional
      paid-in capital
                                                        
                                                        
                                                        32,826,060
                                                        
                                                        
                                                        
                                                        (16,640,025
                                                        )
                                                        
                                                        
                                                        16,186,035Statutory
      reserves
                                                        
                                                        
                                                        7,081,706
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        7,081,706Retained
      earnings (deficits)
                                                        
                                                        
                                                        26,653,590
                                                        
                                                        
                                                        
                                                        (61,308,862
                                                        )
                                                        
                                                        
                                                        (34,655,272
                                                        )Accumulated
      other comprehensive income
                                                        
                                                        
                                                        2,733,469
                                                        
                                                        
                                                        
                                                        -
                                                        
                                                        
                                                        
                                                        2,733,469$
                                                        69,324,825
                                                        
                                                        
                                                        $
                                                        (77,948,887
                                                        )
                                                        
                                                        $
                                                        (8,624,062
                                                        )TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                                                        
                                                        $
                                                        77,963,860
                                                        
                                                        
                                                        $
                                                        -
                                                        
                                                        
                                                        $
                                                        77,963,860


18





The
Company’s consolidated statements of operations for the three months ended March
31, 2010, as previously reported and as restated, are as follows:





Three months ended March 31, 2010As
                                Previously
                                Reported
                              
                              
                              Adjustment
                              
                              
                              As RestatedNet
      revenues
                              
                              $
                              14,541,072
                              
                              
                              $
                              -
                              
                              
                              $
                              14,541,072Cost
      of sales
                              
                              
                              (5,915,079
                              )
                              
                              
                              -
                              
                              
                              
                              (5,915,079
                              )Gross
      profit
                              
                              $
                              8,625,993
                              
                              
                              $
                              -
                              
                              
                              $
                              8,625,993Operating
      expenses:
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Selling
                              
                              
                              (1,403,775
                              )
                              
                              
                              -
                              
                              
                              
                              (1,403,775
                              )General
      and administrative
                              
                              
                              (3,103,415
                              )
                              
                              
                              -
                              
                              
                              
                              (3,103,415
                              )Operating
      income
                              
                              $
                              4,118,803
                              
                              
                              $
                              -
                              
                              
                              $
                              4,118,803Other
      income
                              
                              
                              208,762
                              
                              
                              
                              -
                              
                              
                              
                              208,762Interest
      income
                              
                              
                              42,091
                              
                              
                              
                              -
                              
                              
                              
                              42,091Changes
      in fair value of instruments - (loss)/gain
                              
                              
                              -
                              
                              
                              
                              (33,678,134
                              )
                              
                              
                              (33,678,134
                              )Income
      (loss) before income taxes
                              
                              $
                              4,369,656
                              
                              
                              $
                              (33,678,134
                              )
                              
                              $
                              (29,308,478
                              )Provision
      for Income taxes
                              
                              
                              (977,763
                              )
                              
                              
                              -
                              
                              
                              
                              (977,763
                              )Net
      income (loss)
                              
                              $
                              3,391,893
                              
                              
                              $
                              (33,678,134
                              )
                              
                              $
                              (30,286,241
                              )Foreign
      currency translation adjustment
                              
                              
                              (25,941
                              )
                              
                              
                              -
                              
                              
                              
                              (25,941
                              )Comprehensive
      income (loss)
                              
                              $
                              3,365,952
                              
                              
                              $
                              (33,678,134
                              )
                              
                              $
                              (30,312,182
                              )Basic
      earnings (loss) per share
                              
                              $
                              0.148
                              
                              
                              $
                              (1.466
                              )
                              
                              $
                              (1.318
                              )Diluted
      earnings (loss) per share
                              
                              $
                              0.095
                              
                              
                              $
                              (1.413
                              )
                              
                              $
                              (1.318
                              )Basic
      weighted average share outstanding
                              
                              
                              22,985,833
                              
                              
                              
                              -
                              
                              
                              
                              22,985,833Diluted
      weighted average share outstanding
                              
                              
                              35,627,204
                              
                              
                              
                              (12,641,371
                              )
                              
                              
                              22,985,833


19





The
Company’s consolidated statements of operations for the nine months ended March
31, 2010, as previously reported and as restated, are as follows:





Nine months ended March 31, 2010As
                                Previously
                                Reported
                              
                              
                              Adjustment
                              
                              
                              As RestatedNet
      revenues
                              
                              $
                              38,193,092
                              
                              
                              $
                              -
                              
                              
                              $
                              38,193,092Cost
      of sales
                              
                              
                              (15,397,096
                              )
                              
                              
                              -
                              
                              
                              
                              (15,397,096
                              )Gross
      profit
                              
                              $
                              22,795,996
                              
                              
                              $
                              -
                              
                              
                              $
                              22,795,996Operating
      expenses:
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Selling
                              
                              
                              (3,521,765
                              )
                              
                              
                              -
                              
                              
                              
                              (3,521,765
                              )General
      and administrative
                              
                              
                              (4,618,265
                              )
                              
                              
                              -
                              
                              
                              
                              (4,618,265
                              )Operating
      income
                              
                              $
                              14,655,966
                              
                              
                              $
                              -
                              
                              
                              $
                              14,655,966Other
      income
                              
                              
                              224,357
                              
                              
                              
                              -
                              
                              
                              
                              224,357Interest
      income
                              
                              
                              350,602
                              
                              
                              
                              -
                              
                              
                              
                              350,602Changes
      in fair value of instruments - (loss)/gain
                              
                              
                              -
                              
                              
                              
                              (55,939,985
                              )
                              
                              
                              (55,939,985
                              )Income
      (loss) before income taxes
                              
                              $
                              15,230,925
                              
                              
                              $
                              (55,939,985
                              )
                              
                              $
                              (40,709,060
                              )Provision
      for Income taxes
                              
                              
                              (3,645,506
                              )
                              
                              
                              -
                              
                              
                              
                              (3,645,506
                              )Net
      income (loss)
                              
                              $
                              11,585,419
                              
                              
                              $
                              (55,939,985
                              )
                              
                              $
                              (44,354,566
                              )Foreign
      currency translation adjustment
                              
                              
                              23,725
                              
                              
                              
                              -
                              
                              
                              
                              23,725Comprehensive
      income (loss)
                              
                              $
                              11,609,144
                              
                              
                              $
                              (55,939,985
                              )
                              
                              $
                              (44,330,841
                              )Basic
      earnings (loss) per share
                              
                              $
                              0.513
                              
                              
                              $
                              (2.477
                              )
                              
                              $
                              (1.964
                              )Diluted
      earnings (loss) per share
                              
                              $
                              0.347
                              
                              
                              $
                              (2.311
                              )
                              
                              $
                              (1.964
                              )Basic
      weighted average share outstanding
                              
                              
                              22,582,391
                              
                              
                              
                              -
                              
                              
                              
                              22,582,391Diluted
      weighted average share outstanding
                              
                              
                              33,404,014
                              
                              
                              
                              (10,821,623
                              )
                              
                              
                              22,582,391


20


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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 March 31, 2010 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
March 31, 2010 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. Relatively small bank
deposits were maintained with the banks in the U.S.A and Hong Kong.





For the
nine months ended March 31, 2010 and 2009, more than 99% of the Group’s sales
were generated from the PRC. In addition, nearly all accounts receivable as of
March 31, 2010 and June 30, 2009, also arose in the PRC.





The
maximum amount of loss exposure due to credit risk that the Group would bear if
the counter parties of the financial instruments fail 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
nine months ended March 31, 2010 and 2009, there was no single customer who
accounts for 10% or more of the Group’s revenue.





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





March 31, 2010
                  
                  
                  June 30, 2009Customer
      A
                  
                  $
                  -
                  
                  
                  $
                  655,755Customer
      B
                  
                  
                  -
                  
                  
                  
                  438,067





As at
March 31, 2010, there was no customer who accounts for 10% or more of the
Group’s accounts receivable.





5.
            PLEDGED
      DEPOSITS





Pledged
deposits as of March 31, 2010 and June 30, 2009 were restricted cash kept for
purpose of investor relation or public relation affairs, and to secure notes
payable.


21


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





6.
            OTHER
      RECEIVABLES





March 31, 2010
                  
                  
                  June 30, 2009Disbursement
      and advances to employee
                  
                  $
                  53,726
                  
                  
                  $
                  12,268Tender
      deposits
                  
                  
                  3,335
                  
                  
                  $
                  10,227Sundry
                  
                  
                  -
                  
                  
                  $
                  484$
                  57,061
                  
                  
                  $
                  22,979





7.
            INVENTORIES





Inventories
comprise the followings:





March 31, 2010
                  
                  
                  June 30, 2009Finished
      goods
                  
                  $
                  918,771
                  
                  
                  $
                  236,574Work
      in process
                  
                  
                  53,529
                  
                  
                  
                  49,607Raw
      materials
                  
                  
                  797,226
                  
                  
                  
                  621,618$
                  1,769,526
                  
                  
                  $
                  907,799


22


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





8.
            PLANT
      AND EQUIPMENT, NET





March 31, 2010
                    
                    
                    June 30, 2009At
      costBuildings
                    
                    $
                    2,110,923
                    
                    
                    $
                    2,050,980Machinery
      and equipment
                    
                    
                    3,266,951
                    
                    
                    
                    3,056,646Office
      equipment
                    
                    
                    172,749
                    
                    
                    
                    166,748Motor
      vehicles
                    
                    
                    484,939
                    
                    
                    
                    416,163$
                    6,035,562
                    
                    
                    $
                    5,690,537Less:
      accumulated depreciation
                    
                    
                    (1,148,649
                    )
                    
                    
                    (832,085
                    )$
                    4,886,913
                    
                    
                    $
                    4,858,452Construction
      in progress
                    
                    
                    17,467,872
                    
                    
                    
                    314,81722,354,785
                    
                    
                    
                    5,173,269





Depreciation
expenses included in the cost of sales for the nine months ended March 31, 2010
and 2009 were $265,118 and $81,993 respectively; and in the general and
administrative expenses for the nine months ended March 31, 2010 and 2009 were
$50,312 and $43,497 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 were $15,242,157 at March 31, 2010.


23


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





9.
            INTANGIBLE ASSETS,
      NET





March 31, 2010
                    
                    
                    June 30, 2009Land
      use rights, at cost
                    
                    $
                    2,791,917
                    
                    
                    $
                    2,788,369Less:
      accumulated amortization
                    
                    
                    (316,501
                    )
                    
                    
                    (302,714
                    )2,475,416
                    
                    
                    
                    2,485,655Patent
      rights, at costs
                    
                    
                    7,460,394
                    
                    
                    
                    7,450,912Less:
      accumulated amortization
                    
                    
                    (2,647,708
                    )
                    
                    
                    (2,085,525
                    )4,812,686
                    
                    
                    
                    5,365,387Others,
      at costs
                    
                    
                    1,522,894
                    
                    
                    
                    1,518,336Less:
      accumulated amortization
                    
                    
                    (141,998
                    )
                    
                    
                    (27,056
                    )1,380,896
                    
                    
                    
                    1,491,280$
                    8,668,998
                    
                    
                    $
                    9,342,322





Amortization
expenses included in the general and administrative expenses for the nine months
ended March 31, 2010 and 2009 were $687,675 and $573,995
respectively.





10.
            OTHER
    PAYABLES





March 31, 2010
                    
                    
                    June 30, 2009Commission
      payables
                    
                    $
                    319,324
                    
                    
                    $
                    312,365Expense
      payables
                    
                    
                    3,448
                    
                    
                    
                    12,389Deposit
      for project
                    
                    
                    120,471
                    
                    
                    
                    467,508Sundry
      PRC taxes payables
                    
                    
                    244,975
                    
                    
                    
                    -Sundry
                    
                    
                    48,989
                    
                    
                    
                    2,492$
                    737,207
                    
                    
                    $
                    794,754


24


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





11.
            PREFERRED
      STOCK AND WARRANTS





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





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





The
Preferred Shares have liquidation rights senior to common stock and to any other
class or series of stock issued by the Company not designated as ranking senior
to or pari passu with the 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 Shares.





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%.


25


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





11.
            PREFERRED
      STOCK AND WARRANTS (Continued)





The
Company recognized a beneficial conversion feature discount on the Preferred
Shares at their intrinsic value, which was the fair value of the common stock at
the commitment date for the Preferred Shares investment, less the effective
conversion price but limited to the $15 million of proceeds received from the
sale. The Company 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 Shares.


26


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(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 was 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 Preferred
Shares at its intrinsic value, which was the fair value of the common stock at
the commitment date for the Preferred Shares investment, less the effective
conversion price but limited to the $5 million of proceeds received from the
sale. The Company recognized the $2.6 million beneficial conversion feature in
the equity as a transfer from retained earnings to additional paid in capital as
dividends in the accompanying consolidated financial statements on the date of
issuance of the Series A preferred shares since the Preferred Shares were
convertible at the issuance date.





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





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





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


27




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 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 nine months ended March 31, 2010, 700,000 shares of
common stocks were converted from preferred stocks. The common stocks are
$22,813 and $22,113 with additional paid-in capital of $32,826,060 and
$30,666,631 as of March 31, 2010 and June 30, 2009,
respectively.


28


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





13.  SHARE-BASED
COMPENSATION





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





On March
31, 2010, the Company issued 1,651,125 shares of non-statutory stock options to
key employees and 310,000 shares to independent directors as compensation, these
options have a 5 year contractual term. The options issued to key employees vest
in three equal annual installments of 33.3%, with exercise price of $7.97 per
share.  Options issued to independent directors vest in three equal
annual installments of 33.3% or in four equal annual installments of 25%, with
exercise price of $3 per share.





The
Company accounts for share-based payments in accordance with ASC 718.
Accordingly, the Company expenses the fair value of awards made under its
share-based plan. That cost is recognized in the consolidated financial
statements over the requisite service period of the grants. Total compensation
expense related to the stock options for the three and nine months ended March
31, 2010 was $2,159,429 and was recorded as general and administrative
expense.  As of March 31, 2010, there was $8,759,510 of unrecognized
compensation costs related to nonvested share-based compensation arrangements
granted under the Plan.  That cost is expected to be recognized over a
weighted average period of 2.5 years.  There were no options vested
during three and nine months ended March 31, 2010; therefore the total fair
value of options vested this period was $0.





The fair
value of the stock option grant for the nine months ended March 31, 2010 was
estimated at the date of grant using the Black-Scholes option pricing model with
the following assumptions: volatility of 100%, the risk-free interest rate of
1.6%, expected dividend yield of 0% and expected life of 3.5 to 4
years.





Expected
volatilities utilized in the model are based on the historic volatility of the
Company’s stock price as well as volatility of comparable
companies.  The risk free interest rate is derived from the U.S.
Treasury yield with a remaining term equal to the expected life of the option in
effect at the time of the grant.  Since the Company has limited option
exercise history, it has elected to estimate the expected life of an award based
upon the SEC-approved “simplified method” noted under the provisions of Staff
Accounting Bulletin No. 107 with the continued use of this method extended under
the provisions of Staff Accounting Bulletin No. 110. With the vesting period
forms the lower bound of the estimate of expected term.





The above
assumptions were used to determine the weighted average grant date fair value of
stock options of $5.57 per share for the options granted on March 31,
2010.


29


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





13.  SHARE-BASED
COMPENSATION (CONTINUED)





A summary
of the Company’s stock option activity as of March 31, 2010, and changes during
the nine months ended March 31, 2010 is presented in the following
table:





Options
                      
                      
                      Weighted-Average Exercise
                        Price
                      
                      
                      Aggregate Intrinsic ValueOutstanding
      at July 1, 2009
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      -Granted
                      
                      
                      1,961,125
                      
                      
                      
                      7.18
                      
                      
                      
                      -Exercised
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Forfeited
      or Expired
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Outstanding
      at March 31, 2010
                      
                      
                      1,961,125
                      
                      
                      $
                      7.18
                      
                      
                      $
                      1,795,646Vested
      and expected to vest at March 31, 2010
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      -Exercisable
      at March 31, 2010
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      -





The
following table summarizes information about stock options outstanding at March
31, 2010:


Options Outstanding
                      
                      
                      Options ExercisableExercise Price
                      
                      
                      Number
                        Outstanding
                      
                      
                      Weighted Average
                        Remaining Contractual Life
                        (years)
                      
                      
                      Weighted Average
                        Exercise Price
                      
                      
                      Number
                        Exercisable
                      
                      
                      Weighted
                        Average
                        Exercise
                        Price$
                      3.00
                      
                      
                      
                      310,000
                      
                      
                      
                      5.00
                      
                      
                      $
                      3.00
                      
                      
                      
                      -
                      
                      
                      $
                      -$
                      7.97
                      
                      
                      
                      1,651,125
                      
                      
                      
                      5.00
                      
                      
                      $
                      7.97
                      
                      
                      
                      -
                      
                      
                      $
                      -1,961,125
                      
                      
                      
                      5.00
                      
                      
                      $
                      7.18
                      
                      
                      
                      -
                      
                      
                      $
                      -





A summary
of the status of the Company’s nonvested shares as of March 31, 2010, and
changes during the nine months ended March 31, 2010, is presented
below:





Nonvested Shares
                      
                      Shares
                      
                      
                      Weighted Average Grant Date Fair ValueNonvested
      at July 1, 2010
                      
                      
                      -
                      
                      
                      $
                      -Granted
                      
                      
                      1,961,125
                      
                      
                      
                      5.57Vested
                      
                      
                      -
                      
                      
                      
                      -Forfeited
                      
                      
                      -
                      
                      
                      
                      -Nonvested
      at March 31, 2010
                      
                      
                      1,961,125
                      
                      
                      $
                      5.57


30


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





14.  INCOME
TAXES





(a)
            The
      Company is registered in the State of Florida whereas its subsidiary, Shen
      Kun being incorporated in the British Virgin Islands is not subject to any
      income tax and conducts all of its business through its PRC subsidiary, SK
      and VIE, Shengkai (see note 1).





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





In April
2010, Shengkai was awarded the status of “high technology” enterprise for the
calendar years 2009 through 2011. Hence Shengkai enjoys a preferential
enterprise income tax rate of 15% starting from January 1, 2010 through December
31, 2011, and will receive a 10% refund for the income taxes paid at the
standard 25% tax rate for calendar year 2009.





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 nine months ended March 31,2010
                    
                    
                    2009U.S.
      statutory rate
                    
                    
                    34
                    %
                    
                    
                    34
                    %Foreign
      income not recognized in the U.S.
                    
                    
                    (34
                    )%
                    
                    
                    (34
                    )%PRC
      Enterprise Income Tax
                    
                    
                    20.8
                    %
                    
                    
                    25
                    %Provision
      for income tax
                    
                    
                    20.8
                    %
                    
                    
                    25
                    %





(b)
            The
      effective tax rate for the nine months ended March 31, 2010 and 2009 were
      20.8% and 25% respectively.





Income
before income tax expenses of $17,488,987 and $12,316,497 for the nine months
ended March 31, 2010 and 2009, respectively, was attributed to subsidiaries with
operations in China. Provision for Income taxes related to China income for the
nine months ended March 31, 2010, and 2009 were $3,645,506 and $3,050,485
respectively.


31


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





15.  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 nine months ended
                      March 31,
                    
                    
                    For the three months ended
                      March 31,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Earnings:Net
      income for the year
                    
                    $
                    (44,354,566
                    )
                    
                    
                    9,177,928
                    
                    
                    $
                    (30,286,241
                    )
                    
                    
                    3,519,050Non-Cash
      Dividends on convertible preferred stock
                    
                    
                    -
                    
                    
                    
                    (2,560,186
                    )
                    
                    
                    -
                    
                    
                    
                    -Earnings
      for the purpose of basic earnings per share
                    
                    $
                    (44,354,566
                    )
                    
                    $
                    6,617,742
                    
                    
                    $
                    (30,286,241
                    )
                    
                    $
                    3,519,050Effect
      of dilutive potential common stock
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Earnings
      for the purpose of dilutive earnings per share
                    
                    $
                    (44,354,566
                    )
                    
                    $
                    6,617,742
                    
                    
                    $
                    (30,286,241
                    )
                    
                    $
                    3,519,050Number
      of shares:Weighted
      average number of common stock for the purpose of basic earnings per
      share
                    
                    
                    22,582,391
                    
                    
                    
                    22,112,500
                    
                    
                    
                    22,985,833
                    
                    
                    
                    22,112,500Effect
      of dilutive potential common stock-Conversion
      of Series A convertiblepreferred stock
                    
                    
                    -
                    
                    
                    
                    7,887,368
                    
                    
                    
                    -
                    
                    
                    
                    7,887,368-Exercise
      of A Warrants
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    --Exercise
      of options
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Weighted
      average number of common stock for the purpose of dilutive earnings per
      share
                    
                    
                    22,582,391
                    
                    
                    
                    29,999,868
                    
                    
                    
                    22,985,833
                    
                    
                    
                    29,999,868Earnings
      per share:Basic
      earnings per share
                    
                    $
                    (1.964
                    )
                    
                    $
                    0.299
                    
                    
                    $
                    (1.318
                    )
                    
                    $
                    0.159Dilutive
      earnings per share
                    
                    $
                    (1.964
                    )
                    
                    $
                    0.221
                    
                    
                    $
                    (1.318
                    )
                    
                    $
                    0.117


32


SHENGKAI
INNOVATIONS, INC.


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


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED MARCH 31, 2010 AND 2009


(Stated
in US Dollars)(Unaudited)





16.  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.





17.  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 $29,760,761 (RMB203,496,051), of which
$17,463,708 (RMB119,412,120) had been paid as of March 31, 2010. The balance of
$12,297,053 (RMB84,083,931) will be settled by the end of calendar year
2010.





Certain
equipment and machinery contracts were executed. The total amount of executed
contracts was $16,339,750 (RMB111,726,800), of which $11,884,067 (RMB81,260,040)
had been paid as of March 31, 2010. The balance of $4,455,683 (RMB30,466,760)
will be settled by the end of calendar year 2010.





18.  SEGMENT
INFORMATION





The Group
is principally engaged in one segment of the manufacturing and sale of ceramic
valves and components. Majority of the 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.





19.  SUBSEQUENT
EVENTS





The
Company evaluated subsequent events through the time of filing this Quarterly
Report on Form 10-Q, and no significant events occurred subsequent to
the balance sheet date but prior to the filing of this report that would have a
material impact on our Consolidated Financial Statements.


33


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





Cautionary
Notice Regarding Forward-Looking Statements





In this
quarterly report, references to “Shengkai Innovations,” “SHE,” “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.


34




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 equity and contractual relationships,
controls the business of Shengkai (Tianjin) Limited (“SK”) and Tianjin Shengkai
Industrial Technology Development Co., Ltd. (“Shengkai”), both companies
organized under the laws of the PRC that design, manufacture and sell ceramic
valves. Because SK and Shengkai’s operations are the only significant operations
of the Company and its affiliates, this discussion and analysis focuses on the
business results of SK and Shengkai, comparing its results in the three and nine
months ended March 31, 2010 to the three and nine months ended March 31,
2009.




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 and nine months ended March 31, 2010 and 2009 should be
read in conjunction with the financial statements and the notes to those
statements that are included elsewhere in this Form 10-Q. 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 14 years of experience and possess a unique
method for creating ceramic valves.





We
believe that Shengkai is the one of the few ceramic valve manufacturers in the
world with research and development, engineering, and production capacity for
structural ceramics. Shengkai’s product categories include a broad range of
valves in nearly all industries that are sold throughout China, to Europe, North
America, and other countries in the Asia-Pacific region. Totaling over 400
customers, Shengkai became a supplier of China Petroleum & Chemical
Corporation (“CPCC” or “Sinopec”) in 2005 and a member of the PetroChina Co.
Ltd. (“PetroChina”) supply network in 2006. Shengkai is currently the only
domestic ceramic valve manufacturer entering the CPCC and PetroChina supply
system, after a six-year application process.


35




Results
of Operations




Comparison of the
Three Months Ended March 31, 2010 and 2009





Revenue





Revenue
for the three months ended March 31, 2010 was $14,541,072, an increase of
$4,565,767 or 45.8% from $9,975,305 for the comparable period in fiscal 2009.
The product output has increased due to increased equipment and shifts of
operation, as well as improved ceramic production technology to shorten the
production cycle of some kinds of the ceramic pieces. Approximately 95.7% of our
source of revenue came from customers in the electric power, petrochemical and
chemical industries for the past three months. The electric power industry
was still the significant market to our revenue, contributing approximately
60.6% of total revenue for the three months ended March 31, 2010. Revenue from
the electric power industry was approximately $8.8 million for the three months
ended March 31, 2010, an increase of approximately $1.3 million or 17.3% from
approximately $7.5 million for the comparable period in fiscal 2009. The
increase was primarily attributable to the broadening of our customer base and
increased orders from existing customers. Revenue from the petrochemical and
chemical industry, our biggest potential market, was approximately $5.1 million
for the three months ended March 31, 2010, an increase of approximately $2.9
million or 133.0% from approximately $2.2 million for the comparable period in
fiscal 2009. The increase was primarily due to our hightened efforts to develop
the market of the petrochemical industry. Revenue from other industries,
including the aluminum and  metallurgy industries, was approximately
$0.6 million for the three months ended March 31, 2010, an increase of
approximately $0.3 million or 119.2% from approximately $0.3 million for the
comparable period in fiscal 2009.





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





Gross
Profit





Gross
profit for the three months ended March 31, 2010 was $8,625,993, an increase of
$2,403,265 or 38.6% compared to $6,222,728 for the comparable period in fiscal
2009. The increase was primarily attributable to the revenue increase. The gross
margin for the three months ended March 31, 2010 was 59.3%, compared to 62.4%
for the comparable period in fiscal 2009. The decrease was primarily
attributable to several new large projects started in March 2009, which were set
at a higher price for the initial stage and temporarily raised our overall
gross margin in the third quarter of fiscal year 2009.





Selling
Expenses





Selling
expenses for the three months ended March 31, 2010 was $1,403,775, an increase
of $428,278 or 43.9%, from $975,497 for the comparable period in fiscal 2009.
The major component of selling expenses was commission paid to agents for
introducing new sales, which was approximately $1.2 million for the three months
ended March 31, 2010, an increase of approximately $0.4 million or 45.7% from
approximately $0.8 million for the three months ended March 31, 2009. Selling
expenses as a percentage of total sales revenue slightly decreased to 9.7% for
the three months ended March 31, 2010 from 9.8% for the comparable period in
fiscal 2009, primarily attributable to the revenue increase, as well as to the
decrease in media advertisements incurred in the current period.





General and Administrative
Expenses





General
and administrative expenses for the three months ended March 31, 2010 were
$3,103,415, an increase of 2,375,337 or 326.2% compared to $728,078 for the
comparable period in fiscal 2009. The increase was primarily attributable to the
recognition of $2,159,429 share-based compensation cost on the options to
independent directors and management issued on March 31, 2010 under the
Company’s 2010 Incentive Stock Plan. The increase in G&A was also attributed
to the increase over the comparable periods of fiscal 2009 and 2010, in research
and development expenses; in cash compensation to independent directors and
management staff due to new appointments and hirings; as well as in the expenses
for the U.S. capital market related activities such as NYSE AMEX application and
listing fees, costs for participation of investment conferences and professional
consulting fees for corporate internal control system and U.S. securities
regulations compliance. The amortization of intangible assets for the three
months ended March 31, 2010 were $229,274, an increase of $37,793 or 19.7%
compared to $191,481 for the comparable period in fiscal 2009.





Interest
expense




There was
no interest expense for the three months ended March 31, 2010 or the comparable
period in fiscal 2009. No short or long term loans were outstanding for the
three months ended March 31, 2010 or the comparable period in fiscal
2009.


36




Changes in fair value of
instruments




For the
three months ended March 31, 2010, the Company incurred non-cash expense for
aggregate amount of approximately $ 33.7 million related to its issuance of
Series A warrants and Series A convertible preferred stock in the Private
Placements in June and July, 2008 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 March 31,
2010.





Provision for Income
Taxes





Provision
for income taxes for the three months ended March 31, 2010 was $977,763 , a
decrease of $188,441 or 16.2%  from $1,166,204 for the comparable
period in fiscal 2009. Excluding the $2.16 million share-based compensation
cost, income before taxes was approximately $6.5 million for the three months
ended March 31, 2010 compared with approximately $4.7 million for the comparable
period in fiscal 2009. The decrease in provision for income taxes was
attributable to the new preferential income tax rate in calendar 2010. In April
2010, Shengkai, the Company’s operating subsidiary in Tianjin, China, was
newly awarded the status of “high technology” enterprise for the calendar
years 2009 through 2011. Hence Shengkai enjoys a preferential enterprise
income tax rate of 15% starting from January 1, 2010 through December 31, 2011,
and will receive a 10% refund for the income taxes paid at the standard 25% tax
rate for calendar year 2009. The applicable income tax rate was 25% for the
comparable period in fiscal 2009.





Comparison of the
Nine Months Ended March 31, 2010 and
2009





Revenue





Revenue
for the nine months ended March 31, 2010 was $38,193,092, an increase of
$10,877,733 or 39.8% from $27,315,359 for the comparable period in fiscal 2009.
The product output has increased due to increased equipment and shifts of
operation, as well as improved ceramic production technology to shorten the
production cycle of some kinds of the ceramic pieces. Approximately 95.4% of our
source of revenue came from customers in the electric power, petrochemical and
chemical industries for the past nine months. The electric power industry was
still the significant market to our revenue, contributing approximately 66.1% of
total revenue for the nine months ended March 31, 2010. Revenue from the
electric power industry was approximately $25.3 million for the nine months
ended March 31, 2010, an increase of approximately $4.2 million or 19.7% from
approximately $21.1 million for the comparable period in fiscal 2009. The
increase was primarily attributable to the broadening of our customer base and
increased orders from existing customers. Revenue from the petrochemical and
chemical industry, our biggest potential market, was approximately $10.9 million
for the nine months ended March 31, 2010, an increase of approximately $5.9
million or 117.1% from approximately $5.0 million for the comparable period in
fiscal 2009. The increase was primarily due to our hightened efforts to develop
the market of the petrochemical industry. Revenue from other industries,
including the aluminum and  metallurgy industries, was approximately
$2.0 million for the nine months ended March 31, 2010, an increase of
approximately $0.8 million or 62.1% from approximately $1.2 million for the
comparable period in fiscal 2009.




Gross
Profit





Gross
profit for the nine months ended March 31, 2010 was $22,795,996, an increase of
$6,244,875 or 37.7% compared to $16,551,121 for the comparable period in fiscal
2009. The increase was primarily attributable to the revenue increase. The gross
margin for the nine months ended March 31, 2010 was 59.7%, compared to 60.6% for
the comparable period in fiscal 2009. The decrease was attributable to several
new large projects started in March 2009, which were set at a higher price for
the initial stage and temporarily raised our overall gross margin
in the third quarter of fiscal year 2009.


37




Selling
Expenses





Selling
expenses for the nine months ended March 31, 2010 was $3,521,765, an increase of
$789,792 or 28.9%, from $2,731,973 for the comparable period in fiscal 2009. The
major component of selling expense was commission paid to the agents for
introducing new sales, which was approximately $3.1 million for the nine months
ended March 31, 2010, an increase of approximately $0.9 million or 39.7% from
approximately $2.2 million for the nine months ended March 31, 2009. Selling
expenses as a percentage of total sales revenue decreased to 9.2% for the nine
months ended March 31, 2010 from 10.0% for the comparable period in fiscal 2009,
primarily attributable to the revenue increase, as well as to the decrease in
media advertisements incurred in the current period.





General and Administrative
Expenses





General
and administrative expenses for the nine months ended March 31, 2010 were
$4,618,265, an increase of $2,788,002 or 152.3% compared to $1,830,263 for the
comparable period in fiscal 2009. The increase was primarily attributable to the
recognition of $2,159,429 share-based compensation cost on the options to
independent directors and management issued on March 31, 2010 under the
Company’s 2010 Incentive Stock Plan. The increase in G&A was also attributed
to the increase over the comparable periods of fiscal 2009 and 2010, in research
and development expenses; in cash compensation to independent directors and
management staff due to new appointments and hirings; as well as in the expenses
for the U.S. capital market related activities such as NYSE Amex application and
listing fees, costs for participation of investment conferences and professional
consulting fees for corporate internal control system and U.S. securities
regulations compliance. The amortization of intangible assets for the nine
months ended March 31, 2010 were $687,675, an increase of $113,680 or 19.8%
compared to $573,995 for the comparable period in fiscal 2009.





Interest
expense




There was
no interest expense for the nine months ended March 31, 2010 or the comparable
period in fiscal 2009. No short or long term loans were outstanding for the nine
months ended March 31, 2010 or the comparable period in fiscal
2009.





Changes in fair value of
instruments




For the
nine months ended March 31, 2010, the Company incurred non-cash expense for
aggregate amount of approximately $ 55.9 million related to its issuance of
Series A warrants and Series A convertible preferred stock in the private
placements in June and July 2008 pursuant to provision of FASB ASC Topic
815,”Derivative and Hedging”(“ASC 815”). 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 nine months ended March 31,
2010.





Provision for Income
Taxes





Provision
for income taxes for the nine months ended March 31, 2010 was $3,645,506, an
increase of $595,021 or 19.5% from $3,050,485 for the comparable period in
fiscal 2009. Excluding the $2.16 million share-based compensation cost, income
before taxes was approximately $17.4 million for the nine months ended March 31,
2010 compared with approximately $12.2 million for the comparable period in
fiscal 2009. The less increase in provision for income taxes was attributable to
the new preferential income tax rate in calendar 2010. In April 2010, Shengkai,
the Company’s operating subsidiary in Tianjin, China, was newly awarded the
status of “high technology” enterprise for the calendar years 2009 through 2011.
Hence Shengkai enjoys a preferential enterprise income tax rate of 15% starting
from January 1, 2010 through December 31, 2011, and will receive a 10% refund
for the income taxes paid at the standard 25% tax rate for calendar year 2009.
The applicable income tax rate was 25% for the periods from July 1, 2009 through
December 31, 2009, and the comparable period in fiscal 2009.


38





Liquidity
and Capital Resources





Cash and Cash
Equivalents




Our cash
and cash equivalents as at the beginning of the nine months ended March 31, 2010
was $38,988,958 and decreased to $22,942,461 by the end of the period, an
decrease of $16,046,497 or 41.2%. The net change in cash and cash
equivalents represented a decrease of $28,127,987 or 233% from $12,081,490 for
the comparable period in fiscal 2009. The decrease was primarily attributable to
the investment in the new manufacturing facility.




Net cash provided by
operating activities





Net cash
provided by operating activities was $15,431,029 for the nine months ended March
31, 2010, an increase of $5,483,717 or 55.1% from $9,947,312 for the comparable
period in 2009. Net income plus the non-cash share-based compensation cost
charge was $13,744,848 for the nine months ended March 31, 2010, an increase of
$4,566,920 or 49.8% from $9,177,928 for the comparable period in fiscal 2009.
The increase in trade receivables contributed $939,844 to the increase of net
cash outflow between the two comparable periods in fiscal in 2009 and 2010,
while notes payable, accounts payable and advances from customers increased
$807,868, $1,355,913 and 88,963 respectively in cash provision over the nine
months ended March 31, 2009 and 2010.





Net cash used in investing
activities




Net cash
used in investing activities was $31,523,270 for the nine months ended March 31,
2010, compared to $2,553,456 for the nine months ended March 31, 2009, an
increase of $28,969,814 or 1,134.5%.The change was primarily attributable to the
total payment of $29.4 million for equipment purchase and the new manufacturing
facilities that were still under construction. The increase was also due to a
deposit pledged for notes payables in the amount of approximately $2.1 million
during the nine months ended March 31, 2010.




Net cash used in financing
activities





There was
no net cash provided by financing activities for the nine months ended March 31,
2010. For the comparable nine months ended March 31, 2009, there was $4,613,790
cash provided by a private placement in July 2008.





Capital
Expenditures




In
October 2008, we successfully won a bid on a land use right over a plot of land
approximately 43,566.3 square meters in size. The land is located in Tianjin,
China and the bid price was approximately $1.8 million (RMB12.6 million). The
formal contract was signed with the government on January 23, 2009, with the
Company due to pay the bid price in full by March 25, 2009. The land was
purchased with plans to construct corporate headquarters and to build a new
manufacturing facility to expand our production capacity. Expenditures
committed under related construction contracts totaled 29,760,761
(RMB203,496,051), of which $17,463,708 (RMB119,412,120) had been paid as of
March 31, 2010. The balance of $12,297,053 (RMB84,083,931) will be settled by
the end of calendar year 2010. Certain equipment and machinery contracts
have also been executed, total amount of which was approximately $16,339,750
(RMB111,726,800), of which $11,884,067 (RMB81,260,040) had been paid as of March
31, 2010. The balance of $4,455,683 (RMB30,466,760) will be settled by the end
of calendar year 2010.


39




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 March 31, 2010, and
the effect these obligations are expected to have on our liquidity and cash
flows in future periods.




Totals
                      
                      
                      Less Than
                        1 Year
                      
                      
                      1 to 3
                        Years
                      
                      ThereafterCapital
      expenditures (1)
                      
                      $
                      16,752,736
                      
                      
                      $
                      16,752,736
                      
                      
                      $
                      -




(1)
Capital expenditures are commitments for the construction of a new
manufacturing facility and for the purchase of new equipment and machinery. See
Note 16 - Commitment and Contingency in the notes to the financial statements,
included elsewhere in this report. The Company entered into certain construction
contracts for building a new manufacturing facility and a headquarters’
building. The total amount of executed contracts was 29,760,761, of which
$17,463,708 had been paid as of March 31, 2010. The construction of both the
manufacturing facility and the headquarters’ building is estimated to be
substantially completed during this fiscal year. The Company has also executed
certain equipment and machinery contracts. The total amount of executed
contracts was $16,339,750, of which $11,884,067 had been paid as of March 31,
2010.





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.


40




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.




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.


41


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 March 31, 2010 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.




In
January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair
Value Measurements. ASU 2010-06 amends ASC Topic 820 to require the following
additional disclosures regarding fair value measurements: (i) the amounts of
transfers between Level 1 and Level 2 of the fair value hierarchy; (ii) reasons
for any transfers in or out of Level 3 of the fair value hierarchy and (iii) the
inclusion of information about purchases, sales, issuances and settlements in
the reconciliation of recurring Level 3 measurements. ASU 2010-06 also amends
ASC Topic 820 to clarify existing disclosure requirements, requiring fair value
disclosures by class of assets and liabilities rather than by major category and
the disclosure of valuation techniques and inputs used to determine the fair
value of Level 2 and Level 3 assets and liabilities. With the exception of
disclosures relating to purchases, sales, issuances and settlements of recurring
Level 3 measurements, ASU 2010-06 was effective for interim and annual reporting
periods beginning after December 15, 2009. The disclosure requirements related
to purchases, sales, issuances and settlements of recurring Level 3 measurements
will be effective for financial statements for annual reporting periods
beginning after December 15, 2010. The Company does not expect the adoption of
this ASU 2010-06 to have a material impact on its financial position or results
of operations.




Item
3.   Quantitative and Qualitative Disclosures about Market
Risk.




N/A.





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.


42




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”), and David Ming He, the Company’s
Chief Financial Officer (“CFO”), 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 March 31, 2010. Based upon that
evaluation, the Company’s CEO and CFO also 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 and CFO, 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 March 31, 2010 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.





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.


43




Item
4.  (Removed and Reserved).





Item
5.  Other Information.





None.





Item 6.  Exhibits.




(a)
Exhibits





21.1
              List
      of Subsidiaries.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.


44


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
)


45