VALV Shengkai Innovations Inc (CE)

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

PART I—FINANCIAL INFORMATION

 

Item 1.       Financial Statements.

 

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED BALANCE SHEETS

AS AT MARCH 31, 2013 AND JUNE 30, 2012

(Stated in US Dollars)

		March 31, 2013				June 30, 2012
ASSETS
Current Assets
Cash and cash equivalents		$	66,271,537			$	64,819,870
Restricted cash			207,201				124,433
Accounts receivable, net			6,468,644				9,388,820
Notes receivable			-				167,873
Other receivables (Note 4)			2,945,488				2,879,422
Advances to suppliers			4,804,119				2,339,362
Inventories (Note 5)			2,343,192				2,750,907
Total Current Assets			83,040,181				82,470,687
Property, plant and equipment, net (Note 6)			51,697,441				54,068,143
Land use rights, net (Note 7)			2,504,288				2,533,684
Other intangible assets, net (Note 8)			3,839,375				4,524,058
TOTAL ASSETS		$	141,081,285			$	143,596,572
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Notes payable (Note 9)			207,201				124,433
Accounts payable			1,005,471				1,942,262
Advances from customers			604,452				316,020
Other payables and accrued expenses (Note 10)			623,715				899,491
Income tax payable			-				240,438
Total Current Liabilities			2,440,839				3,522,644
Warrant liabilities			89				1,761
Preferred (conversion option) liabilities			589,982				481,128
TOTAL LIABILITIES		$	3,030,910			$	4,005,533

 

See accompanying notes to consolidated financial statements

 

2

---

 

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED BALANCE SHEETS (Continued)

AS AT MARCH 31, 2013 AND JUNE 30, 2012

(Stated in US Dollars)

	March 31, 2013					June 30, 2012
STOCKHOLDERS’ EQUITY
Preferred stock – $0.001 par value 15,000,000 shares authorized; 1,971,842 and 1,971,842 issued and outstanding; aggregate liquidation preference being $5,000,000 and $5,000,000 as of March 31, 2013 and June 30, 2012, respectively. (Note 12)		$	1,971			$	1,971
Common stock - $0.001 par value 100,000,000 shares authorized; 17,196,071 and 17,196,071 shares issued and outstanding as of March 31, 2013 and June 30, 2012, respectively.			17,197				17,197
Additional paid-in capital			72,277,648				71,695,567
Statutory reserves			11,196,604				11,196,604
Retained earnings			41,942,066				45,091,511
Accumulated other comprehensive income			12,614,889				11,588,189
TOTAL STOCKHOLDER’S EQUITY			138,050,375				139,591,039
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	141,081,285			$	143,596,572

 

See accompanying notes to consolidated financial statements

 

3

---

 

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

	For the Three Months Ended March 31,									For the Nine Months Ended March 31,
		2013				2012				2013				2012
Revenues		$	2,962,309			$	5,680,510			$	11,557,537			$	26,985,465
Cost of sales			(2,158,649	)			(3,058,282	)			(7,574,267	)			(15,221,094	)
Gross profit			803,660				2,622,228				3,983,270				11,764,371
Operating expenses:
Selling expenses			(704,123	)			(727,696	)			(1,910,775	)			(2,803,429	)
General and administrative expenses			(1,566,375	)			(2,172,307	)			(5,358,769	)			(7,618,949	)
Total operating expenses			(2,270,498	)			(2,900,003	)			(7,269,544	)			(10,422,378	)
(Loss) Income from operations			(1,466,838	)			(277,775	)			(3,286,274	)			1,341,993
Other income, net			2,294				20,802				16,046				74,843
Interest income, net			122,093				371,290				379,527				717,972
Changes in fair value of instruments - (loss) gain			(91,358	)			79,808				(107,182	)			1,836,530
Income before income taxes			(1,433,809	)			194,125				(2,997,883	)			3,971,338
Income taxes (Note 14)			-				(297,362	)			(151,562	)			(1,348,153	)
Net (loss) income			(1,433,809	)			(103,237	)			(3,149,445	)			2,623,185
Foreign currency translation adjustment			597,370				881,061				1,026,699				3,092,543
Comprehensive (loss) income		$	(836,439	)		$	777,824			$	(2,122,746	)		$	5,715,728
Basic (loss) earnings per share * (Note 15)		$	(0.08	)		$	(0.01	)		$	(0.18	)		$	0.16
Diluted (loss) earnings per share * (Note 15)		$	(0.08	)		$	(0.01	)		$	(0.18	)		$	0.14
Basic weighted average shares outstanding * (Note 15)			17,196,229				16,638,307				17,196,226				16,550,398
Diluted weighted average shares outstanding * (Note 15)			17,196,229				16,638,307				17,196,226				18,138,809

See accompanying notes to consolidated financial statements

* The earnings per share data and the weighted average shares outstanding for all periods have been retroactively restated to reflect the 1-for-2 reverse stock split effected on March 9, 2012.

 

 

4

---

 

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

 

	Nine Months Ended March 31,
	2013					2012
Cash flows from operating activities
Net (loss) income		$	(3,149,445	)		$	2,623,185
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			2,710,561				2,819,280
Amortization			777,284				768,943
Provision for doubtful accounts			128,719				185,531
(Gain) on disposal of property, plant and equipment			-				(10,584	)
Changes in fair value of instruments – loss (gain)			107,182				(1,836,530	)
Stock based compensation			582,081				4,180,178
Changes in operating assets and liabilities:
(Increase) decrease in assets:
Accounts receivable			2,841,429				6,302,473
Notes receivable			167,620				183,875
Other receivables			(47,555	)			18,132
Advances to suppliers			(2,444,015	)			(213,519	)
Inventories			423,555				(332,232	)
Increase (decrease) in liabilities:
Notes payable			82,751				(1,394,120	)
Accounts payable			(662,935	)			(2,887,770	)
Advances from customers			286,420				430,011
Other payables			(217,483	)			(1,561,822	)
Accruals			(62,126	)			-
Income tax payable			(241,106	)			(1,540,673	)
Net cash provided by operating activities			1,282,937				7,734,358
Cash flows from investing activities
Proceeds from disposition of property, plant and equipment			-				(487	)
Purchase of property, plant and equipment			(288,092	)			(52,973	)
Payment of construction in progress			-				(494,230	)
Purchase of intangible assets			(20,983	)			-
Increase in advances to suppliers for purchase of equipment and construction			-				(132,035	)
Decrease/(increase) in restricted cash			(82,751	)			1,276,189
Net cash provided by (used in) investing activities			(391,826	)			596,464

See accompanying notes to consolidated financial statement

 

 

5

---

 

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

FOR THE NINE MONTHS ENDED MARCH 31, 2013 AND 2012

 (Stated in US Dollars)

	Nine Months Ended March 31,
	2013				2012
Net increase (decrease) in cash and cash equivalents		$	891,111			$	8,330,822
Effect of exchange rate changes on cash and cash equivalents			560,556				1,361,842
Cash and cash equivalents–beginning of year			64,819,870				59,870,108
Cash and cash equivalents–end of year		$	66,271,537			$	69,562,772
Supplementary cash flow information:
Interest received		$	379,551			$	717,972
Taxes paid		$	424,711			$	2,888,824
Non-cash transaction:
Preferred stock conversion to common stock		$	-			$	-
Common stock issuance		$	-			$	-

 

See accompanying notes to consolidated financial statements

 

6

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

1. ORGANIZATION AND PRINCIPAL ACTIVITIES

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

On June 9, 2008, SKII executed a reverse merger with Shen Kun International Limited (“Shen Kun”) by an exchange of shares whereby SKII issued 10,275,000 shares of common stock at $0.001 par value in exchange for all Shen Kun shares. Immediately after the closing of the reverse merger, SKII had a total of 11,056,250 shares of common stock outstanding, with the Shen Kun shareholders (and their assignees) owning approximately 92.9% of the outstanding common stock on a non-diluted basis. Shen Kun became a wholly-owned subsidiary of SKII. (All common stock based data in the financial statements and accompanying notes has been retroactively restated to reflect the Reverse Stock Split effected on March 9, 2012. Please refer to Note 17.)

The exchange transaction was accounted for as a reverse acquisition in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations” (formerly included under Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations). For financial reporting purposes, this transaction is classified as a recapitalization of SKII and Shen Kun. The accompanying consolidated financial statements were retroactively adjusted to reflect the effects of the recapitalization of the financial statements of SKII and the historical financial statements of Shen Kun. The 781,250 shares of Shengkai Innovations, Inc. outstanding prior to this stock exchange transaction were accounted for at the net book value at the time of the transaction, which was a deficit of $62,206. The consolidated statements of operations include the results of operations of Tianjin Shengkai Industrial Technology Development Co., Ltd. and Shengkai (Tianjin) Limited for the periods ended March 31, 2013 and 2012.

Shen Kun formed Sheng Kai (Tianjin) Ceramic Valves Co., Ltd., on April 9, 2008 in the People’s Republic of China  (“PRC”) which was renamed to Shengkai (Tianjin) Limited in April 2010 (“SK WFOE”). SK WFOE entered into a series of agreements with Tianjin Shengkai Industrial Technology Development Co., Ltd (“Tianjin Shengkai”) including but not limited to consigned management agreement, technology service agreement, loan agreement, exclusive purchase option agreement, equity pledge agreement, etc. The agreements were entered on May 30, 2008. As a result of entering the abovementioned agreements, SK WFOE is deemed to control Tianjin Shengkai as a variable interest entity as required by Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810-10 (formerly FASB Interpretation No. 46 (revised March 2003) Consolidation of Variable Interest Entities -- an Interpretation of ARB No. 51).

Tianjin Shengkai, our operating entity, was organized as a collective-owned enterprise under the laws of the PRC on June 7, 1994 under the name Tianjin Shengkai Industrial Technology Development Company. On May 6, 1999, Tianjin Shengkai’s business was reorganized as a limited liability company under its current name, Tianjin Shengkai Industrial Technology Development Co., Ltd.

Shengkai (Tianjin) Trading Ltd., which is wholly-owned by SK WFOE, was organized as a corporation under the laws of the PRC on June 25, 2010 with a total registered capital of RMB500,000. Shengkai (Tianjin) Trading Ltd. is primarily engaged in the international trading of non-valve products to better serve the Company’s international customers. It has not started operations as of March 31, 2013.

 

 

7

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)

In connection with the reverse merger transaction, on June 11, 2008, SKII sold 5,915,526 Units for aggregate gross proceeds of $15,000,000, at a price of $2.5357 per Unit. Each Unit consists of one share of Series A Convertible Preferred Stock, par value $0.001 per share (the “Preferred Shares”), convertible into 0.5 share of common stock, par value $0.001 per share (the “Common Stock”), and one Series A Warrant to purchase Common Stock equal to 120% of the number of shares of Common Stock issuable upon conversion of the Preferred Shares (“Warrant”). Additionally, on July 18, 2008, SKII sold 1,971,842 Units for aggregate gross proceeds of $5,000,000, at a price of $2.5357 per Unit. Each Unit consists of one Preferred Share, convertible into 0.5 share of Common Stock, and one Warrant to purchase Common Stock equal to 120% of the number of shares of Common Stock issuable upon conversion of the Preferred Shares.

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a)   Basis of presentation and method of accounting

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

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

 

(b)   Principles of consolidation

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

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

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

 

* Deemed variable interest entity  (“VIE”) member

 

 

8

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(b) Principles of consolidation (continued)

Pursuant to a restructuring plan intended to ensure compliance with the PRC rules and regulations, on May 30, 2008, SK WOFE entered into a series of contractual arrangements (the “Contractual Arrangements”) with Tianjin Shengkai and/or all of the Shareholders of Tianjin Shengkai as described below:

Consigned Management Agreement

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

Technology Service Agreement

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

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

Loan Agreement     

The Loan Agreement, among SK WFOE and all of the shareholders of Tianjin Shengkai, provides that SK WFOE will make a loan in the aggregate principal amount of RMB49,000,000 (approximately $7,153,702) to the shareholders of Tianjin Shengkai, each shareholder receiving a share of the loan proceeds proportional to its shareholding in Tianjin Shengkai, and in exchange each shareholder agreed (i) to contribute all of its proceeds from the loan to the registered capital of Tianjin Shengkai in order to increase the registered capital of Tianjin Shengkai, (ii) to cause Tianjin Shengkai to complete the process of registering the increase in its registered capital with PRC regulatory authorities within 30 days after receiving the loan, and (iii) to pledge their equity to SK WFOE under the Equity Pledge Agreement described below.

The loan is repayable at the option of SK WFOE either in cash or by transfer of Tianjin Shengkai equity or all of its assets to SK WFOE. The loan does not bear interest, except that if (x) SK WFOE is able to purchase the equity or assets of Tianjin Shengkai, and (y) the lowest allowable purchase price for that equity or those assets under PRC law is greater than the principal amount of the loan, then, insofar as it is allowable under PRC law, interest will be deemed to have accrued on the loan in an amount equal to the difference between the lowest allowable purchase price for Tianjin Shengkai and the principal amount of the loan. The effect of this interest provision is that, if and when permitted under PRC law, SK WFOE may acquire all of the equity or assets of Tianjin Shengkai by forgiving the loan, without making any further payment.

 

 

9

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(b) Principles of consolidation (continued)

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

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

Exclusive Purchase Option Agreement    

The Exclusive Purchase Option Agreement, among SK WFOE, Tianjin Shengkai, and all of the shareholders of Tianjin Shengkai, provides that Tianjin Shengkai will grant SK WFOE an irrevocable and exclusive right to purchase all or part of Tianjin Shengkai’s assets, and the shareholders of Tianjin Shengkai will grant SK WFOE an irrevocable and exclusive right to purchase all or part of their equity interests in Tianjin Shengkai. Either right may be exercised by SK WFOE in its sole discretion at any time that the exercise would be permissible under PRC law, and the purchase price for SK WFOE’s acquisition of equity or assets will be the lowest price permissible under PRC law. Tianjin Shengkai and its shareholders are required to execute purchase agreements and related documentation within 30 days of receiving notice from SK WFOE that it intends to exercise its right to purchase.

The Exclusive Purchase Option Agreement contains agreements from Tianjin Shengkai and its shareholders that they will refrain from taking actions, such as voting to dissolve or declaring dividends, that could impair SK WFOE’s security interest in the equity of Tianjin Shengkai or reduce its value. These agreements are substantially the same as those contained in the Loan Agreement described above.

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

Equity Pledge Agreement

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

 

 

10

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(b) Principles of consolidation (continued)

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

In 2008, SK WOFE invested US$7,153,702 (RMB 49,000,000) in Tianjin Shengkai (“Variable Interest Entity” or “VIE”) based on the loan amount entered into the Loan Agreement between SK WOFE and VIE. This is an implicit arrangement that SK WOFE has provided financial support to the VIE. Besides, SK WOFE had exercised the Consigned Management Service Agreement and Technology Service Agreement, SK WOFE had the operation control and the obligation to absorb loss or right to receive residual gain from VIE. Moreover, the SK WOFE gained control of the Board of Directors of VIE through the exercise of Equity Pledge Agreement. Those are the explicit arrangement that the SK WOFE had exercised actual control of the operation of the VIE.  The SK WOFE also has an option to exercise the Exclusive Purchase Option Agreement in the future to actually control VIE and turned it into direct control subsidiary.

The above five agreements represent interlocking agreements making SK WOFE becomes Primary Beneficiary of the Tianjin Shengkai. This fact and circumstances do not have any change up to the current period. In short, these five agreements met the ASC 810-10-25-5A analysis and the Company concluded that the VIE should be consolidated into the Group financial statements in all aspects.

(c) Use of estimates

The preparation of the financial statements in conformity with U.S. GAAP 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.

(d) Economic and political risks

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

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

 

 

11

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(e) Restricted Cash

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

(f) Accounts receivable

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

The following table sets forth the aging analysis for accounts receivable as of March 31, 2013 and June 30, 2012, respectively:

 

		As of March 31, 2013				As of June 30, 2012
Due within 30 days		$	1,031,539			$	1,696,581
Due from 31 to 90 days			2,147,455				2,844,993
Due from 91 to 180 days			1,816,652				3,257,626
Due from 181 to 360 days			1,472,999				1,589,620
Due over 361 days			228,273				246,685
Total		$	6,696,917			$	9,635,505

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

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

 

 

12

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(f) Accounts receivable (continued)

The amount of the allowance for doubtful accounts was $228,273 and $246,685 as of March 31, 2013 and June 30, 2012, respectively. An analysis of the allowance for doubtful accounts for the three and nine months ended March 31, 2013 and 2012 is as follows:

 

		Three Months Ended March 31,								Nine Months Ended March 31,
		2013				2012				2013				2012
Balance at beginning of period		$	85,222			$	110,839			$	246,685			$	175,874
Addition (recovery) of doubtful debt expenses, net			143,051				75,858				(18,412	)			10,823
Balance at end of period		$	228,273			$	186,697			$	228,273			$	186,697

 

(g) Property, plant and equipment

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

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

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

(h) Construction in progress

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

(i) Land use rights

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

 

 

13

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(j) Other intangible assets

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

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

The Company periodically evaluates the carrying value of long-lived assets to be held and used, including intangible assets subject to amortization, when events and circumstances warrant such a review, pursuant to the guidelines established in Statement of Financial Accounting Standards (“SFAS”) No. 144 (now known as "ASC 360"). The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost to dispose.

During the reporting periods, there was no impairment loss.

(l) Inventories

Inventories are stated at lower of cost or net realizable value.  Cost is determined by the weighted average basis and includes all expenditures incurred in bringing the goods to the point of sale and putting them in a saleable condition.  In case of manufacturing inventories and work in progress, cost includes an appropriate share of production overheads based on normal operating capacity. Net realizable value is the estimated selling price in the ordinary course of business less any applicable selling expenses. The Company has no reserve for inventories for the three and nine months ended March 31, 2013 and 2012.

(m) Cash and cash equivalents

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

 

		March 31,				June 30,
		2013				2012
Cash on hand		$	1,009			$	3,338
Bank deposits:
China Construction Bank			307				436
Industrial and Commercial Bank of China			1,442				185,596
Bank of China			26,518				168,344
Industrial Bank Co. Ltd.			79,840				86,175
Shanghai Pudong Development Bank			66,094,891				64,248,930
Harbin Bank			18,504				57,149
The Hong Kong and Shanghai Banking Corporation Limited			20,464				20,639
Bank of America			28,562				49,263
		$	66,271,537			$	64,819,870

 

 

14

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(n) Fair value of financial instruments

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

These tiers include:

•

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

•

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

•

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

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

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

The summary of fair values of financial instruments as of March 31, 2013 and June 30, 2012  is as follows:

March 31, 2013
Instrument		Fair  Value				Carrying  Value				Level			Valuation Methodology
Derivative warrant liabilities		$	89			$	89				3		Black-Scholes
Embedded conversion liability		$	589,982			$	589,982				3

June 30, 2012
Instrument		Fair  Value				Carrying  Value				Level			Valuation Methodology
Derivative warrant liabilities		$	1,761			$	1,761				3		Black-Scholes
Embedded conversion liability		$	481,128			$	481,128				3

 

 

15

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

(n) Fair value of financial instruments (continued)

The following represents a reconciliation of the changes in fair value of financial instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended March 31, 2013 and 2012, respectively:

		For the Three Months Ended March 31,								For the Nine Months Ended March 31,
		2013				2012				2013				2012
Beginning balance:  Derivative liabilities		$	498,713			$	1,393,198			$	482,889			$	5,950,456
Issuance of derivative warrants			-				-				-				-
Conversion from  preferred to common			-				-				-				(2,800,536	)
Changes in fair value			91,358				(79,808	)			107,182				(1,836,530	)
Ending balance:  Derivative liabilities		$	590,071			$	1,313,390			$	590,071			$	1,313,390

(o) Revenue recognition

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

- Persuasive evidence of an arrangement exists;

- Delivery has occurred or services have been rendered;

- The seller’s price to the buyer is fixed or determinable, and

- Collection is reasonably assured.

There were no sales returns and allowances for the three and nine months ended March 31, 2013 and 2012. The Company does not provide unconditional right of return, price protection or any other concessions to its customers.

(p) Costs of sales

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

(q) Advertising

The Company expensed all advertising costs as incurred.  Advertising expenses included in the selling expenses for the three and nine months ended March 31, 2013 and 2012 were $0.

 

 

16

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(r) Warranty expense

The Company generally provides one year warranty to most customers, or in some cases up to one and a half years. Historically warranty expense has been maintained at a very low percentage of sales revenue; therefore the Company does not accrue, but expenses all warranty expenses as incurred under selling expenses. The Company is closely monitoring warranty expense and will start to accrue it as soon as we identify that warranty expense regularly reaches certain percentage of total revenue. Warranty expenses for the three months ended March 31, 2013 and 2012 were $75,110 and $60,707, and for the nine months ended March 31, 2013 and 2012 were $181,849 and $151,873, respectively.

(s) Research and development costs

The Company expensed all research and development costs as incurred.  Research and development expenses included in the general and administrative expenses for the three months ended March 31, 2013 and 2012 were $298,738 and $225,344, and for the nine months ended March 31, 2013 and 2012 were $1,952,980 and $621,097 respectively.

(t) Retirement benefit plans

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

Retirement benefits in the form of contributions under defined contribution retirement plans to the relevant authorities are charged to the statements of operations as incurred. The retirement benefit expenses included in general and administrative expenses for the three months ended March 31, 2013 and 2012 were $64,743 and $62,715, and for the nine months ended March 31, 2013 and 2012 were $197,999 and $208,885, respectively.

(u) Share-based compensation

Share-based compensation includes stock options and common stock awards granted to employees and directors for services, and are accounted for under FASB ASC 718 "Compensation - Stock Compensation".

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

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

 

17

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(u) Share-based compensation (continued)

The fair value of stock options is estimated using the Black-Scholes model. The Company's expected volatility assumption is based on the historical volatility of the Company's stock as well as historical volatility of comparable public companies, due to its relatively short trading history. The expected life assumption is presumed to be the mid-point between the vesting date and the end of the contractual term, as is permitted for "plain vanilla" employee stock options. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

 
 

FASB ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in the subsequent period if actual forfeitures differ from initial estimates. Forfeiture rate is estimated based on historical and future expectation of employee turnover rate and are adjusted to reflect future change in circumstances and facts, if any. Share-based compensation expense is recorded net of estimated forfeitures such that expenses were recorded only for those stock options and common stock awards that are expected to vest.

(v) Income tax

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

The Company uses FASB ASC 740 (formerly FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”)) – An Interpretation of FASB Statement No. 109, Accounting for Income Taxes .  The Interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.  Under FASB ASC 740, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.  FASB ASC 740 also provides guidance on recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.  At March 31, 2013 and June 30, 2012, the Company did not have a liability for unrecognized tax benefits.

(w) Value-added tax (“VAT”)

 

Enterprises or individuals, who sell commodities, engage in repair and maintenance or import or export goods in the PRC are subject to a value-added tax in accordance with the PRC laws.  The standard value-added tax rate is 17% of the gross sales price and the Company records its revenue net of VAT.  A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company’s finished products can be used to offset the VAT due on the sales of the finished products. Therefore, the amounts of VAT recoverable included in other receivables on the balance sheets represent the excess of VAT paid on purchases over the VAT due on sales at March 31, 2013 and June 30, 2012, respectively, which can be used to offset future VAT that is due on sales.

 

 

18

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(x) Foreign currency translation

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

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

March 31, 2013
Balance sheet	RMB 6.2741 to US$1.00
Statement of operations and comprehensive income (3 months)	RMB 6.2814 to US$1.00
Statement of operations and comprehensive income (9 months)	RMB 6.3000 to US$1.00
June 30, 2012
Balance sheet	RMB 6.3143 to US$1.00
Statement of operations and comprehensive income	RMB 6.3519 to US$1.00
March 31, 2012
Balance sheet	RMB 6.3185 to US$1.00
Statement of operations and comprehensive income (3 months)	RMB 6.3088 to US$1.00
Statement of operations and comprehensive income (9 months)	RMB 6.3626 to US$1.00

 

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

(y) Cash and concentration of risk

Cash includes cash on hand and demand deposits in bank accounts.  Total cash in the banks at March 31, 2013 and June 30, 2012 amounted to $66,270,528 and $64,816,532, 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.

(z) Statutory reserves

As stipulated by the PRC’s Company Law and as provided in SK WFOE and Tianjin Shengkai’s Articles of Association, SK WFOE and Tianjin 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;

 

 

19

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(z) Statutory reserves (continued)

	(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, Tianjin Shengkai established a statutory surplus reserve as well as a statutory common welfare fund and commenced to appropriate 10% and 5%, respectively of the PRC net income after taxation to these reserves. The amounts included in the statutory reserves were surplus reserve of $11,196,604 and $11,196,604 as at March 31, 2013 and June 30, 2012, respectively.

(aa)  Comprehensive income

 

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

(ab) Recent accounting pronouncements

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

In December 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. ASU No. 2011-11 is intended to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this Update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented.

 

 

20

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(ab) Recent accounting pronouncements (continued)

In December 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU No. 2011-11 is intended to supersede certain pending paragraphs in Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to effectively defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. All other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter.

In July 2012, the FASB issued Accounting Standards Update (ASU) No. 2012-02, Intangibles--Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This ASU states that an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Codification Subtopic 350-30, Intangibles--Goodwill and Other, General Intangibles Other than Goodwill. Under the guidance in this ASU, an entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments in this ASU are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance.

In August 2012, the FASB released Accounting Standards Update (ASU) No. 2012-03, Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22. This ASU amends various SEC paragraphs: (a) pursuant to the issuance of Staff Accounting Bulletin No. 114; (b) pursuant to the issuance of the SEC’s Final Rule, Technical Amendments to Commission Rules and Forms Related to the FASB’s Accounting Standards Codification, Release Nos. 33-9250, 34-65052, and IC-29748 August 8, 2011; and (c) related to ASU No. 2010-22, Accounting for Various Topics.

 

21

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(ab) Recent accounting pronouncements (continued)

In October 2012, FASB issued Accounting Standards Update (ASU) No. 2012-04, Technical Corrections and Improvements. This ASU make technical corrections, clarifications, and limited-scope improvements to various Topics throughout the Codification. The amendments in this ASU that will not have transition guidance will be effective upon issuance for both public entities and nonpublic entities. For public entities, the amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2012. For nonpublic entities, the amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2013.

In October 2012, FASB has issued Accounting Standards Update (ASU) No. 2012-05, Statement of Cash Flows (Topic 230). This ASU addresses how cash receipts arising from the sale of certain donated financial assets, such as securities, should be classified in the statement of cash flows of not-for-profit entities (NFPs). Some NFPs classify those cash receipts as investing cash inflows, while other entities classify them as either operating cash inflows or financing cash inflows, consistent with their treatment of inflows arising from cash contributions. The objective of this Update is for an NFP to classify cash receipts from the sale of donated financial assets consistently with cash donations received in the statement of cash flows if those cash receipts were from the sale of donated financial assets that upon receipt were directed without the NFP imposing any limitations for sale and were converted nearly immediately into cash. The amendments in the ASU are effective prospectively for fiscal years, and interim fiscal periods within those years, beginning after June 15, 2013. Retrospective application to all periods presented upon the date of adoption is permitted. Early adoption from the beginning of the fiscal year of adoption is permitted.

In January 2013, FASB issued Accounting Standards Update (ASU) No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. This ASU clarifies that ordinary trade receivables and receivables are not in the scope of ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. Specifically, ASU 2011-11 applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in the FASB Accounting Standards Codification™ (Codification) or subject to a master netting arrangement or similar agreement. The FASB undertook this clarification project in response to concerns expressed by U.S. stakeholders about the standard’s broad definition of financial instruments. An entity is required to apply the amendments in ASU 2013-01 for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented. The effective date is the same as the effective date of ASU 2011-11.

 

22

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(ab) Recent accounting pronouncements (continued)

In February 2013, FASB issued Accounting Standards Update (ASU) No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This ASU improves the transparency of reporting these reclassifications. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in this ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP.

The new amendments will require an organization to:

·

Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income - but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period;

·

Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense.

The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual). A private company is required to meet the reporting requirements of the amended paragraphs about the roll forward of accumulated other comprehensive income for both interim and annual reporting periods. However, private companies are only required to provide the information about the effect of reclassifications on line items of net income for annual reporting periods, not for interim reporting periods. The amendments are effective for reporting periods beginning after December 15, 2012, for public companies and are effective for reporting periods beginning after December 15, 2013, for private companies. Early adoption is permitted.

In February 2013, FASB issued Accounting Standards Update (ASU) No. 2013-03, Financial Instruments (Topic 825). This ASU clarifies the scope and applicability of a disclosure exemption that resulted from the issuance of Accounting Standards Update No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendment clarifies that the requirement to disclose "the level of the fair value hierarchy within which the fair value measurements are categorized in their entirety (Level 1, 2, or 3)" does not apply to nonpublic entities for items that are not measured at fair value in the statement of financial position, but for which fair value is disclosed. This ASU is the final version of Proposed Accounting Standards Update 2013-200—Financial Instruments (Topic 825) which has been deleted. The amendments are effective upon issuance.

 

23

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(ab) Recent accounting pronouncements (continued)

In February 2013, FASB issued Accounting Standards Update (ASU) No. 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date. This ASU provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this ASU is fixed at the reporting date, except for obligations addressed within existing guidance in U.S. GAAP. The guidance requires an entity to measure those obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance in this ASU also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2014, and interim periods and annual periods thereafter. The amendments in this ASU should be applied retrospectively to all prior periods presented for those obligations resulting from joint and several liability arrangements within the ASU’s scope that exist at the beginning of an entity’s fiscal year of adoption. An entity may elect to use hindsight for the comparative periods (if it changed its accounting as a result of adopting the amendments in this ASU) and should disclose that fact. Early adoption is permitted.

In March 2013, FASB issued Accounting Standards Update (ASU) No. 2013-05, Foreign Currency Matters (Topic 830). This ASU resolve the diversity in practice about whether Subtopic 810-10, Consolidation—Overall, or Subtopic 830-30, Foreign Currency Matters—Translation of Financial Statements, applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights)within a foreign entity. In addition, the amendments in this Update resolve the diversity in practice for the treatment of business combinations achieved in stages (sometimes also referred to as step acquisitions) involving a foreign entity. This ASU is the final version of Proposed Accounting Standards Update EITF11Ar—Foreign Currency Matters (Topic 830), which has been deleted. The amendments in this Update are effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. For nonpublic entities the amendments in this Update are effective prospectively for the first annual period beginning after December 15, 2014, and interim and annual periods thereafter. The amendments should be applied prospectively to derecognition events occurring after the effective date. Prior periods should not be adjusted. Early adoption is permitted. If an entity elects to early adopt the amendments, it should apply them as of the beginning of the entity’s fiscal year of adoption.

 

 

24

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

3. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS

Financial instruments which potentially expose the Company to concentrations of credit risk, consists of cash and accounts receivable as of March 31, 2013 and June 30, 2012. The Company performs ongoing evaluations of its cash position and credit evaluations to ensure sound collections and minimize credit losses exposure.

As of March 31, 2013 and June 30, 2012, almost all the Company’s bank deposits were placed with banks in the PRC where there is currently no rule or regulation mandated on obligatory insurance of bank accounts. Relatively small bank deposits were maintained with the banks in the U.S.A. and Hong Kong.

For the three and nine months ended March 31, 2013 and 2012, more than 90% of the Company’s sales were generated from the PRC. In addition, nearly all accounts receivable as of March 31, 2013 and June 30, 2012 also arose in the PRC.

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

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

For the three and nine months ended March 31, 2013 and 2012, there was no single customer who accounted for 10% or more of the Company’s revenue. As at March 31, 2013 and June 30, 2012, there was no customer who accounted for 10% or more of the Company’s accounts receivable.

For the three and nine months ended March 31, 2013 and 2012, there was no single supplier who accounted for 10% or more of the Company’s purchase. As at March 31, 2013 and June 30, 2012, there was no supplier who accounted for 10% or more of the Company’s accounts payable.

 

 

25

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

4. OTHER RECEIVABLES

Other receivables consist of the followings:

		March 31, 2013				June 30, 2012
Advance to employees		$	39,456			$	61,500
Tender deposits			112,313				141,320
Sundry			85				1,620
VAT recoverable			2,761,520				2,674,982
Deferred tax assets			32,114				-
		$	2,945,488			$	2,879,422

5. INVENTORIES

Inventories consist of the followings:

		March 31, 2013				June 30, 2012
Finished goods		$	835,724			$	1,099,922
Work in process			17,412				88,447
Raw materials			1,490,056				1,562,538
		$	2,343,192			$	2,750,907

6. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of the followings:

		March 31, 2013				June 30, 2012
At cost
Buildings		$	43,113,013			$	42,838,533
Machinery and equipment			17,750,231				17,637,224
Office equipment			188,782				183,700
Motor vehicles			464,032				461,078
			61,516,058				61,120,535
Less: accumulated depreciation
Buildings			(4,793,543	)			(3,361,896	)
Machinery and equipment			(4,626,013	)			(3,356,337	)
Office equipment			(160,071	)			(141,395	)
Motor vehicles			(238,990	)			(192,764	)
			(9,818,617	)			(7,052,392	)
Property, plant and equipment, net		$	51,697,441			$	54,068,143

Depreciation expenses included in the cost of sales for the three months ended March 31, 2013 and 2012 were $782,427 and $806,818, and for the nine months ended March 31, 2013 and 2012 were $2,345,393 and $2,450,146, respectively. Depreciation expenses included in the general and administrative expenses for the three months ended March 31, 2013 and 2012 were $122,103 and $146,420, and for the nine months ended March 31, 2013 and 2012 were $365,167 and $369,134, respectively.

 

26

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

7. LAND USE RIGHTS

		March 31, 2013				June 30, 2012
Cost of land use rights		$	3,042,002			$	3,022,635
Less: Accumulated amortization			(537,714	)			(488,951	)
Land use rights, net		$	2,504,288			$	2,533,684

Amortization expenses for land use rights for the three months ended March 31, 2013 and 2012 were $15,192 and $15,126, and for the nine months ended March 31, 2013 and 2012 were $45,455 and $44,962, respectively.

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

2013 (for 1 remaining quarter)		$	15,210
2014			60,840
2015			60,840
2016			60,840
2017			60,840
Thereafter			2,245,718
		$	2,504,288

8. OTHER INTANGIBLE ASSETS

		March 31, 2013				June 30, 2012
At cost:
Patent rights		$	8,128,656			$	8,076,905
Software			1,691,251				1,659,634
			9,819,907				9,736,539
Less: Accumulated amortization
Patent rights			(5,323,473	)			(4,683,813	)
Software			(657,059	)			(528,668	)
			(5,980,532	)			(5,212,481	)
Other intangible assets, net		$	3,839,375			$	4,524,058

Amortization expenses for other intangible assets for the three months ended March 31, 2013 and 2012 were $244,547 and $243,564, and for the nine months ended March 31, 2013 and 2012 were $731,829 and $723,981, respectively.

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

2013 (for 1 remaining quarter)		$	244,672
2014			978,689
2015			978,529
2016			880,707
2017			422,474
Thereafter			313,321
		$	3,818,392
Trademark not subject to amortization			20,983
		$	3,839,375

 

 

27

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

 

9. NOTES PAYABLE

 

		March 31,  2013			June 30, 2012
Due July 30, 2013			79,693				-
Due July 30, 2013			47,816				-
Due July 5, 2013			79,692				-
Due July 18, 2012, subsequently repaid on due date			-				6,605
Due August 9, 2012, subsequently repaid on due date			-				117,828
Total		$	207,201			$	124,433

 

All the notes payable are subject to bank charges of 0.05% of the face value on each transaction.  Bank charges for notes payable for the three months ended March 31, 2013 and 2012 were $104 and $62, and for the nine months ended March 31, 2013 and 2012 were $104 and $190, respectively.

The interest-free notes payable were secured by restricted cash of $207,201 and $124,433 as of March 31, 2013 and June 30, 2012, respectively.

 

10. OTHER PAYABLES AND ACCRUED EXPENSES

		March 31, 2013				June 30, 2012
Commission payable		$	73,970			$	167,325
Expense payable			89,502				105,122
Sundry PRC taxes payable			96,726				260,999
Sundry			267,308				208,212
Accrual			96,209				157,833
		$	623,715			$	899,491

11. PUBLIC OFFERINGS AND WARRANTS ISSUED IN 2010

On November 24, 2010, the Company closed a public offering of 1,228,400 shares of common stock at $11.00 per share, resulting in approximately $13.5 million in gross proceeds. On December 22, 2010, the Company closed a public offering of 529,323 shares of common stock at $11.00 per share, resulting in approximately $5.8 million in gross proceeds. Global Hunter Securities, LLC and Maxim Group LLC (collectively the “Underwriters”) acted as the joint book runners for both offerings.

In connection with the public offerings, the Company issued to the Underwriters warrants (the “Underwriters’ Warrants”) to purchase 61,420 and 20,473 shares, respectively, of Common Stock of the Company according to the Underwriting Agreement dated November 19, 2010 and December 17, 2010, respectively. The Underwriters’ Warrants are exercisable in whole or in part at any time and from time to time. The exercise price, expiration date and total number of shares eligible to be purchased with the Underwriters’ Warrants are summarized in the following table:

Number of shares	Exercise price	Contractual term
81,893	$       13.75	3.0 years

 

 

28

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

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

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

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

12. PREFERRED STOCK AND WARRANTS ISSUED IN 2008 FINANCING

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

Series of warrant	Number of shares underlying Warrants	Exercise price	Contractual term
Series A	3,549,316	$    7.04	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 0.5 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 currently $5.0714 per share but can adjust for anti-dilution. The holder can also void the conversion or exercise its Buy-in Rights. The Buy-in-Rights entitle the holder to be protected in the case that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party. The Preferred Shares have registration rights that the Company is required to have a registration statement filed with the SEC within 45 days after the earlier of the date of the Second Closing or June 30, 2008, and declared effective by the SEC not later than November 27, 2008. We filed the initial registration statement on August 7, 2008, and it was declared effective by the SEC on August 21, 2008.

 

The Warrants were issued at an exercise price of $7.04 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.

 

29

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

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

The gross proceeds of the transaction were $15 million. The proceeds from the transaction were originally allocated to the Preferred Shares, Warrants and beneficial conversion feature based on the relative fair value of the securities. The Company evaluated whether a relative fair value approach or residual fair value approach was more appropriate given the terms and accounting treatment related to the financial instruments involved. Given that the Warrants were not originally classified as a liability, the relative fair value method was used. The Warrants were first valued using the Black-Scholes valuation model. The Company valued the Warrants at issuance at $1.84 per warrant with the following assumptions: Common Stock fair market value of $5.10, expected life of 5 year, volatility of 100% and an interest rate of 4.5%.

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

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

Series of warrant	Number of shares underlying the Warrants	Exercise price	Contractual term
Series A	1,183,106	$     7.04	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 0.5 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 currently $5.0714 per share but can adjust for anti-dilution. The holder can also void the conversion or exercise its Buy-in Rights. The Buy-in-Rights entitle the holder to be protected in the case that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party. The Preferred Shares have registration rights that the Company is required to have a registration statement filed with the SEC within 45 days after the date of the Closing Date, or September 1, 2008, and declared effective by the SEC not later than December 15, 2008. We filed the initial registration statement on August 7, 2008, and it was declared effective by the SEC on August 21, 2008.

 

30

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

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

The Warrants were issued at an exercise price of $7.04 per share. The exercise price can adjust for dilutive events.  The Warrants are immediately exercisable. However, if after exercise the holder would become a holder of greater than 9.9% of Common Stock they cannot exercise without filing a waiver with the company.  The waiver is required to be filed 61 days prior to exercise and by filing the waiver the restriction is removed. (Since the company is required to accept the waiver this restriction is not considered significant in valuing the warrant.) The Warrants expire 5 years from the date of issuance. The Warrants are freely transferable upon registration. The Warrants are subject to the same Registration Rights Agreement as that of the Preferred Shares. If a registration statement providing for the resale of the Common Stock issued upon exercise of the Warrant is not declared effective after 180 days after the issuance date, the Warrants can be cashless exercised. Also, the Warrants have Buy-in Rights similar to those of the Preferred Shares.

The gross proceeds of the transaction were $5 million. The proceeds from the transaction were originally allocated to the Preferred Shares, Warrants and beneficial conversion feature based on the relative fair value of the securities. The Company evaluated whether a relative fair value approach or residual fair value approach was more appropriate given the terms and accounting treatment related to the financial instruments involved. Given that the Warrants were not originally classified as a liability, the relative fair value method was used. The Warrants were first valued using the Black-Scholes valuation model. The Company valued the Warrants at issuance at $1.84 per warrant with the following assumptions:  Common Stock fair market value of $5.10, expected life of 5 year, volatility of 100% and an interest rate of 4.5%.

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

 

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

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.

 

 

31

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

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

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

During the course of internal evaluation, the Company re-evaluated its accounting treatment as of July 1, 2009 for the Preferred Shares issued in the June 2008 Financing and July 2008 Financing.  The Certificate of Designations of the Preferred Shares includes a down-round provision pursuant to which, if the Company issues any additional shares of Common Stock at a per share price of less than $5.0714, the conversion ratio will be adjusted downward to reflect such lesser issued price. The down-round provision changed for the period commencing on the two (2) year anniversary of the Original Issue Date as set forth in Section 5 (e)(i) and 5(e)(ii) thereof. Although the adjustment under the Section 5(e)(ii) is different from the Section 5(e)(i), the nature of the down-round provision is not changed under both sections. The Company performed a complete assessment of the preferred stock and concluded that the Preferred Shares issued in the June and July 2008 Private Placements is within the scope of ASC 815-40-55-33 due to the down-round provisions included in the terms of the agreements.  Pursuant to ASC 815-40-55-33, the down-round provision precludes the embedded conversion option of the Preferred Shares from being considered indexed to the entity’s own stock. Accordingly, the Company adjusted its accounting effective from the beginning of fiscal year 2010, i.e. July 1, 2009, on which date ASC 815 should have been adopted, by bifurcating the embedded conversion option of the Preferred Shares which should be recorded as a liability measured at fair value with changes in fair value recognized in earnings for each reporting period and recording a cumulative-effect adjustment to the opening balance of retained earnings. See Note 2(n).

As of March 31, 2013, one holder of Preferred Shares had converted all of the 5,915,526 Preferred Shares it acquired in the “June 2008 Financing” into 2,957,763 shares of the Company’s Common Stock. No Warrants have been exercised, forfeited or expired since issuance.

13. SHARE-BASED COMPENSATION

The Company’s 2010 Incentive Stock Plan (the “2010 Plan”) adopted by our Board of Directors and approved by our shareholders, permits the grant of incentive stock options, non-statutory stock options, stock awards or restricted stock purchase offer, to our officers, employees, consultants and non-employee directors. The 2010 Plan provides for the issuance of up to 1,105,626 shares of Common Stock. Option awards generally vest in three to four equal installments and have 5 year contractual terms. The Company’s general policy is to issue new shares of Common Stock to satisfy stock option exercises or grants of unvested shares.

 

32

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

13. SHARE-BASED COMPENSATION (CONTINUED)

On March 31, 2010, the Company granted non-statutory stock options to purchase 825,563 shares of Common Stock to key employees and options to purchase 155,000 shares of Common Stock to independent directors as compensation, which options have a 5 year contractual term. The options granted to key employees vest in three equal annual installments of 33.3%, with an exercise price of $15.94 per share.  Options granted to independent directors vest in three equal annual installments of 33.3% or in four equal annual installments of 25%, with an exercise price of $6 per share. On June 22, 2010, the Company issued non-statutory stock options to purchase 75,000 shares of Common Stock to Mr. Chen Wang, Chief Executive Officer of the Company, and options to purchase 50,063 shares of Common Stock to Ms. Wei Guo, director of the Company and VP International Sales of Tianjin Shengkai. These options have a 5 year contractual term, vest in three equal annual installments of 33.3%, with an exercise price of $16.26 per share.

 

On March 20, 2012, Mr. David Ming He resigned as the Company’s Chief Financial Officer, effective on April 19, 2012. Pursuant to the option agreement between the Company and Mr. He, the part of option to purchase 36,854 shares of Common Stock which had not yet vested as of the date of termination of his employment terminated on the date of termination of his employment, and the part of option to purchase 73,709 shares of Common Stock which had already vested during his employment would be forfeited if Mr. He did not exercise any within three months following such termination of employment. On July 19, 2012, this part of vested option was forfeited as Mr. He did not exercise any. On May 18, 2012, Mr. Michael Marks resigned as director and chairman of the Audit Committee of the board of directors of the Company, effective immediately. Pursuant to the option agreement between the Company and Mr. Marks, he still has the right to exercise the part of his option to acquire 50,000 shares of Common Stock that had vested, at any time during the remaining term of the option, but the part of his option to acquire 25,000 shares of Common Stock not yet vested terminated on the date he ceased to serve as a director of the Company.

The Company accounts for share-based payments in accordance with ASC 718. Accordingly, the Company expenses the fair value of awards made under its share-based plan. That cost is recognized in the consolidated statement of operations over the requisite service period of the grants. Total compensation expense related to the stock options for the three months ended March 31, 2013 and 2012 were $192,561 and $1,011,742, and for the nine months ended March 31, 2013 and 2012 were $580,614 and $3,054,677, respectively, and were recorded as general and administrative expense. As of March 31, 2013, there was $272,927 of unrecognized compensation costs related to nonvested share-based compensation arrangements granted under the 2010 Plan. That cost is expected to be recognized over a weighted average period of 0.37 years. Options to acquire 908,375 shares of Common Stock have vested up to March 31, 2013, out of which none and 20,000 options vested during the three and nine months then ended, respectively.

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

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

 

33

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

13. SHARE-BASED COMPENSATION (CONTINUED)

The above assumptions were used to determine the weighted average grant date fair value of stock options of $11.26 per share for the options granted on March 31, 2010 and June 22, 2010.

A summary of the Company’s stock option activity as of March 31, 2013, and changes during the three months then ended are presented in the following table:

 

		Number of Shares of Common Stock Underlying Options				Weighted-Average  Exercise Price
Outstanding at January 1, 2013			970,063			$	14.65
Granted			-				-
Exercised			-				-
Forfeited or Expired			-				-
Outstanding at March 31, 2013			970,063			$	14.65
Vested at March 31, 2013			908,375			$	14.77

The following table summarizes information about stock options outstanding at March 31, 2013:

			Options Outstanding												Options Exercisable
	Exercise Price		Number of Shares of Common Stock Underlying Outstanding Options				Weighted Average Remaining  Contractual Life (years)				Weighted Average Exercise Price				Number of Shares of Common Stock Underlying Exercisable Options				Weighted Average Exercise Price
$	16.26			125,063				2.22			$	16.26				83,375			$	16.26
$	6.00			130,000				2.00			$	6.00				110,000			$	6.00
$	15.94			715,000				2.00			$	15.94				715,000			$	15.94
				970,063				2.03			$	14.65				908,375			$	14.77

 

A summary of the status of the Company’s nonvested options as of March 31, 2013, and changes during the three months then ended, are presented below:

		Number of Shares of Common Stock Underlying Options				Weighted Average  Grant Date  Fair Value
Nonvested at January 1, 2013			61,688			$	12.55
Granted			-				-
Vested			-				-
Forfeited			-				-
Nonvested at March 31, 2013			61,688			$	12.55

 

34

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

13. SHARE-BASED COMPENSATION (CONTINUED)

The Company’s 2011 Incentive Stock Plan (the “2011 Plan”) adopted by our Board of Directors and ratified and approved by our shareholders on March 4, 2011, permits the grant of incentive stock options, non-statutory stock options, stock awards or restricted stock purchase offers, to our officers, employees, consultants and non-employee directors. The 2011 Plan provides for the issuance of up to 1,335,331 shares of Common Stock. The Company’s general policy is to issue new shares of Common Stock to satisfy stock option exercises or grants of unvested shares.

On March 18, 2011 and June 22, 2011, our Board of Directors approved to grant an aggregate of 600,000 and 735,000 shares, respectively, of the Company’s Common Stock as stock awards under the 2011 Plan to certain key employees in order to incentivize them and retain their valued services with the Company. 1,035,000 of the approved stock awards were issued during the fiscal year ended June 30, 2011 and the remaining 300,000 shares were issued during the fiscal year ended June 30, 2012.

The Company accounts for share-based payments in accordance with ASC 718. Accordingly, the Company expenses the fair value of awards made under its share-based plan. The Company estimates fair value of Common Stock awards based on the number of shares issued and the quoted price of the Company's Common Stock on the date of issuance. That cost is fully recognized in the consolidated statement of operations. Total compensation expense related to the Common Stock awards for the three months ended March 31, 2013 and 2012 was $0 and $0, and for the nine months ended March 31, 2013 and 2012 was $0 and $1,125,500, respectively, and were recorded as general and administrative expense.

14. INCOME TAXES

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

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

In accordance with the New CIT Law, enterprises established under the laws of foreign countries or regions and whose “place of effective management” is located within the PRC territory are considered PRC resident enterprises and subject to the PRC income tax at the rate of 25% on worldwide income.  The definition of “place of effective management" refers to an establishment that exercises, in substance, overall management and control over the production and business process, personnel, accounting and properties of an enterprise.  As of March 31, 2013, no detailed interpretation or guidance has been issued to define “place of effective management”.  Furthermore, as of March 31, 2013, the administrative practice associated with interpreting and applying the concept of “place of effective management” is unclear.  If the Company’s non-PRC incorporated entities are deemed PRC tax residents, such entities would be subject to PRC tax under the New CIT Law.  The Company has analyzed the applicability of this law, and has not accrued for PRC tax on such basis as of March 31, 2013.  The Company will continue to monitor changes in the interpretation or guidance of this law. 

 

35

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

14. INCOME TAXES (CONTINUED)

The New CIT Law also imposes a 10% withholding income tax, subject to reduction based on tax treaty where applicable, for dividends distributed by a foreign invested enterprise to its immediate holding company outside China.  Such dividends were exempted from PRC tax under the previous income tax law and regulations.  A foreign invested enterprise is subject to the withholding tax starting from January 1, 2008.  There were no such dividends distributed in the three or nine months ended March 31, 2013 and 2012.

In April 2010, Tianjin Shengkai was awarded the status of “high technology” enterprise for the calendar years 2009 through 2011, of which Tianjin Shengkai enjoys a preferential enterprise income tax rate of 15%.  However, for the periods through December 31, 2009, we already used income tax rate of 25% to provide and pay for income taxes. We did not record any tax refund receivable as of June 30, 2012 as we are not sure whether the refund of the overpaid income tax expenses during the calendar year 2009 would be approved by relevant tax authority. After January 1, 2010 we used the preferential income tax rate of 15% to provide and pay for income tax expenses. In April 2013, Tianjin Shengkai officially received the approval to renew the “high technology” enterprise status and extend the 15% preferential enterprise income tax treatment for another three years. Income taxes payable was $0 and $240,438 at March 31, 2013 and June 30, 2012, respectively.

Income tax expenses consist of the following:

	For the Three Months Ended March 31,								For the Nine Months Ended March 31,
	2013				2012				2013				2012
Current		$	-			$	297,362			$	151,562			$	1,348,153
Deferred			-				-				-				-
Total		$	-			$	297,362			$	151,562			$	1,348,153

Reconciliation from the expected income tax expenses calculated with reference to the statutory tax rate in the PRC of 25% for the three and nine months ended March 31, 2013 and 2012 is as follows:

		For the Three Months Ended March 31,
		2013				2012
Income (loss) before income taxes		$	(1,433,809)			$	194,125
Income (loss) before income taxes from non-Chinese headquarters and subsidiaries			(1,298,808)				(1,713,013)
Income (loss) before income taxes from Chinese subsidiaries			(135,001)				1,907,138
Income tax expenses (benefits) for Chinese subsidiaries computed at the PRC statutory rate of 25%			-				476,785
Preferential tax rate effect of 10% on Shengkai for the period			-				(190,714)
Permanent difference			-				11,291
		$	-			$	297,362

 

36

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

 

14. INCOME TAXES (CONTINUED)

 

		For the Nine Months Ended March 31,
		2013				2012
Income (loss) before income taxes		$	(2,997,883)			$	3,971,338
Income (loss) before income taxes from non-Chinese headquarters and subsidiaries			(4,069,848)				(5,108,952)
Income before income taxes from Chinese subsidiaries			1,071,965				9,080,290
Income tax expenses for Chinese subsidiaries computed at the PRC statutory rate of 25%			301,741				2,270,072
Preferential tax rate effect of 10% on Shengkai for the period			(120,697)				(908,029)
Permanent difference			(29,482)				(13,890)
		$	151,562			$	1,348,153

15. EARNINGS (LOSS) PER SHARE

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

The calculation of the basic and diluted earnings (loss) per share attributable to the shareholders of Common Stock is based on the following data:

 

 

37

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

15.	EARNINGS (LOSS) PER SHARE (CONTINUED)

	For the Three Months
	Ended March 31,
	2013				2012
(Loss):
Net (loss)		$	(1,433,809	)		$	(103,237	)
(Loss) for the purpose of basic (loss) per share		$	(1,433,809	)		$	(103,237	)
Effect of dilutive potential common stock			-				-
(Loss) for the purpose of dilutive loss per share		$	(1,433,809	)		$	(103,237	)
Number of shares:
Weighted average number of common stock for the purpose of basic (loss) per share			17,196,229				16,638,307
Effect of dilutive potential common stock
-Conversion of Series A convertible preferred stock			-				-
-Exercise of A Warrants			-				-
-Exercise of options			-				-
Weighted average number of common stock for the purpose of dilutive (loss) per share			17,196,229				16,638,307
(Loss) per share:
Basic (loss) per share		$	(0.08	)		$	(0.01	)
Dilutive (loss) per share		$	(0.08	)		$	(0.01	)

	For the Nine Months
	Ended March 31,
	2013				2012
Earnings (loss):
Net (loss) income		$	(3,149,445	)		$	2,623,185
Earnings (loss) for the purpose of basic earnings per share		$	(3,149,445	)		$	2,623,185
Effect of dilutive potential common stock			-				-
Earnings (loss) for the purpose of dilutive earnings per share		$	(3,149,445	)		$	2,623,185
Number of shares:
Weighted average number of common stock for the purpose of basic earnings per share			17,196,226				16,550,398
Effect of dilutive potential common stock
-Conversion of Series A convertible preferred stock			-				1,588,411
-Exercise of A Warrants			-				-
-Exercise of options			-				-
Weighted average number of common stock for the purpose of dilutive earnings per share			17,196,226				18,138,809
Earnings (loss) per share:
Basic earnings (loss) per share		$	(0.18	)		$	0.16
Dilutive earnings (loss) per share		$	(0.18	)		$	0.14

 

 

38

---

 

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2013 AND 2012

(Stated in US Dollars)

15. EARNINGS (LOSS) PER SHARE (CONTINUED)

Diluted shares used in the calculation of the diluted loss per share for the three and nine months ended March 31, 2013 and the three months ended March 31, 2012 represented basic shares. Due to the net loss experienced by the Company in the three and nine months ended March 31, 2013, and in the three months ended March 31, 2012, the inclusion of the potentially dilutive effect of the 985,921,  985,921 and 1,543,684 shares, respectively, of convertible preferred stock in the calculation of actual diluted shares would have resulted in anti-dilution.

16.  SEGMENT INFORMATION

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

A breakdown of the Company's revenues for the three and nine months ended March 31, 2013 and 2012 in terms of customers' industry classification is as follows:

		For the Three Months  Ended March 31,								For the Nine Months  Ended March 31,
Customer industry		2013				2012				2013				2012
Electric power		$	518,464			$	1,310,214			$	1,627,080			$	7,459,934
Petrochemical and chemical			2,360,209				3,986,856				8,942,435				17,768,568
Aluminum, metallurgy and others			83,636				383,440				988,022				1,756,963
Total Sales		$	2,962,309			$	5,680,510			$	11,557,537			$	26,985,465

17. AMENDMENT TO ARTICLES OF INCORPORATION

On March 6, 2012, the Company filed an Articles of Amendment to its Articles of Incorporation to effect a reverse stock split of all issued and outstanding shares of Common Stock at a ratio of 1 for 2 (the “Reverse Stock Split”). Fractional shares outstanding after the Reverse Stock Split are rounded up to the next highest number of full shares. The effective date of the Reverse Stock Split was March 9, 2012.

All Common Stock based data in our Consolidated Financial Statements and the accompanying notes has been retroactively restated to reflect this Reverse Stock Split.

18. 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.

 

 

39

---

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

Cautionary Notice Regarding Forward-Looking Statements

In this quarterly report, references to “Shengkai Innovations,” “VALV,” “the Company,” “we,” “us,” and “our” are 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.

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.”

 

40

---

 

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 of Shen Kun International Limited (“Shen Kun”), a company incorporated under the laws of British Virgin Islands on November 7, 2007.  Shen Kun holds 100% of the equity interests in Shengkai (Tianjin) Limited (“SK WFOE”), a wholly foreign owned enterprise organized under the laws of the People’s Republic of China (“PRC”), which, in turn, through contractual relationships, controls the business of Tianjin Shengkai Industrial Technology Development Co., Ltd. (“Tianjin Shengkai”), a PRC company that designs, manufactures and sells ceramic valves.

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

Because SK WFOE and Tianjin 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 WFOE and Tianjin Shengkai, comparing their business results for the three and nine months ended March 31, 2013 to the three and nine months ended March 31, 2012.

On March 9, 2012, the Company effected a one-for-two reverse stock split of its issued and outstanding common stock. All common stock based data in this quarterly report on Form 10-Q, in the consolidated financial statements and accompanying notes has been retroactively restated to reflect this reverse stock split.

General

SK WFOE and Tianjin Shengkai, the entities through which we run our operations, are prominent ceramic valve manufacturers. We have nearly 19 years of experience and possess a unique method for creating ceramic valves.

We believe that we are one of the few ceramic valve manufacturers in the world with research and development, engineering, and production capacity for structural ceramics, and are able to produce large-sized ceramic valves with calibers of 150mm or more. Our product categories include a broad range of valves in nearly all industries and are sold throughout the PRC, to Europe, North America, Middle East and other countries in the Asia-Pacific region. Totaling over 200 customers, we became a supplier of China Petroleum & Chemical Corporation (“CPCC” or “Sinopec”) in 2005; we joined the supply network of China National Petroleum Corporation (“CNPC”) in 2006 and subsequently received a CNPC Certificate of Material Supplier for valve products in 2011. We are currently the only domestic ceramic valve manufacturer entering into the Sinopec and CNPC supply system.

Since September 2011, we started phasing out our less profitable domestic market segments including the electric power market and focusing on expanding our presence in the more profitable domestic and foreign oil and chemical industries where ceramic valve products typically command higher prices than the domestic Chinese market.

Results of Operations

Comparison of the Three Months Ended March 31, 2013 and 2012

Revenue

In the past two years, because of the heightened suspicions on the integrity of Chinese companies, enquiries into the Company’s business and domestic customers mounted by certain shareholders and interested parties without the Company’s approval or endorsement have resulted in severely damaged relations with some of the Company’s important domestic customers. These customers had complained that numerous anonymous calls or visits had seriously disturbed their normal business operations. They also suspected the Company had encountered fatal product quality and safety liability issues, deteriorating financial conditions or legal issues. They further questioned our business integrity and stopped ordering from us. We estimate that such damaged business relations has resulted in loss of business of an aggregate of over $60 million since June 2011, and a higher turnover in the Company’s sales agents and representatives, which in turn undermined our marketing force and customer service. Some of the Company’s other customers have seized this opportunity to demand price cuts from the Company. Meanwhile, some of the Company’s competitors also have seized this opportunity to take away our customers.

 

41

---

 

In addition, in the past one year or so, due to the general economy slowdown in China and particularly the poor operating performance and financial pressure experienced by most of our major customers in the electric power market, business with those customers have become increasingly difficult. Some of our agents/distributors, through whom we sold our products to those end customers in the electric power industry, have even been forced out of business because they could not timely collect accumulated trade receivables from their customers. We estimate that in the three months ended March 31, 2013, total revenue loss of approximately $9.0 million and $35.5 million, respectively, were attributable to above-mentioned damaged business relations and the economy slowdown in China.

As a result, revenue for the three months ended March 31, 2013 decreased by $2,718,201 or 47.9% to $2,962,309 from $5,680,510 for the three months ended March 31, 2012. Total ceramic valves sold in the three months ended March 31, 2013 was 600 sets, compared with 905 sets in the three months ended March 31, 2012. We estimate decrease in sales volume and average selling price accounted for approximately 61% and 39%, respectively, of the total decrease in revenue for the three months ended March 31, 2013.

Unlike previously, the electric power industry contributed significantly less to our revenue, generating approximately 17.5% of total revenue for the three months ended March 31, 2013, compared with 23.1% for the three months ended March 31, 2012. Revenue from the electric power industry was $518,464 for the three months ended March 31, 2013, a decrease of $791,750 or 60.4% from $1,310,214 for the comparable period in fiscal 2012.

Revenue from the petrochemical and chemical industry accounted for approximately 79.7% of total revenue for the three months ended March 31, 2013, compared with 70.2% for the three months ended March 31, 2012. The revenue from the petrochemical and chemical industry was $2,360,209 for the three months ended March 31, 2013, a decrease of $1,626,647 or 40.8% from $3,986,856 for the comparable period in fiscal 2012.

Revenue from other industries, including the aluminum and metallurgy industries, accounted for approximately 2.8% of total revenue for the three months ended March 31, 2013, compared with 6.8% for the three months ended March 31, 2012. The revenue for other industries was $83,636 for the three months ended March 31, 2013, a decrease of $299,804 or 78.2% from $383,440 for the comparable period in fiscal 2012. Such other industries have not been the Company’s marketing focus because of less educated and lower quality customer base and less promising future prospects in terms of potential market size, selling price and profit margin. Revenue from these industries has remained low.

Cost of Sales and Gross Profit

Cost of sales for the three months ended March 31, 2013 was $2,158,649, a decrease of $899,633 or 29.4% as compared to $3,058,282 for the three months ended March 31, 2012, primarily due to decline in revenue. Gross profit for the three months ended March 31, 2013 was $803,660, a decrease of $1,818,568 or 69.4% as compared to $2,622,228 for the three months ended March 31, 2012. The decrease was primarily attributable to decrease in sales volume and decrease in average selling price of the product mix as we sold more lower-end products in this quarter. The gross margin for the three months ended March 31, 2013 was 27.1%, as compared to 46.2% for the comparable period in fiscal 2012. The decrease in gross margin was primarily attributed to the fixed depreciation costs spread over a smaller revenue base, and increase in sales of valves with lower profit margin in the product mix for this quarter.

Selling Expenses

Selling expenses for the three months ended March 31, 2013 were $704,123, a decrease of $23,573 or 3.2%, from $727,696 for the comparable period in fiscal 2012.  Commissions paid to agents for introducing new sales was approximately $235,033 for the three months ended March 31, 2013, a decrease of approximately $219,408 or 48.3% from approximately $454,441 for the three months ended March 31, 2012. Selling expenses as a percentage of total sales revenue increased to 23.8% for the three months ended March 31, 2013 from 12.8% for the comparable period in fiscal 2012, primarily due to increase in overseas sales and marketing expenses  incurred as a result of the Company’s shifted strategy to explore overseas markets. In addition, certain minor components of selling expenses such as sales staff’s salaries, sales offices’ administrative expenses and after-sale service expenses are flat-rate and did not diminish proportionally to revenue decrease.

 

42

---

 

General and Administrative Expenses

General and administrative (“G&A”) expenses for the three months ended March 31, 2013 were $1,566,375, a decrease of $605,932 or 27.9% as compared to $2,172,307 for the comparable period in fiscal 2012. Included in G&A expenses for the three months ended March 31, 2013 was a non-cash charge of $194,027, which was the share-based compensation costs on the options to independent directors, management and key employees issued in March and June, 2010, under the Company’s 2010 Incentive Stock Plan. The non-cash share-based compensation costs included in the G&A expenses for the comparable period in fiscal 2012 was $1,011,742. G&A expenses (excluding the non-cash items) for the three months ended March 31, 2013 were $1,372,348, an increase of $211,783 or 18.2% compared to $1,160,565 for the comparable period in fiscal 2012. The increase in G&A (excluding the non-cash items) expenses was primarily attributable to the consulting and training fee of approximately $199,000 during the quarter ended March 31, 2013 incurred as a result of ongoing compliance with ISO14000 environment management standards.

Other Income and Interest Income

Other income primarily consists of net income from services or non-valve accessories and government grants. Other income for the three months ended March 31, 2013 was $2,294, a decrease of $18,508 or 89.0% as compared to $20,802 for the comparable period in fiscal 2012. The decrease was primarily attributable to less service income and government grants received in this fiscal quarter.

Interest income primarily refers to the interest earned on cash deposits. Interest income for the three months ended March 31, 2013 was $122,093, a decrease of $249,197 or 67.1% as compared to $371,290 for the comparable period in fiscal 2012. The decrease was primarily attributable to decrease in interest rates on cash deposits in the three months ended March 31, 2013 and decrease in interest on term deposits.

Changes in Fair Value of Instruments

For the three months ended March 31, 2013, the Company incurred non-cash loss in an aggregate amount of $91,358 related to its issuance of Series A warrants and Series A convertible preferred stock in the private placements in June and July, 2008, as well as issuance of warrants to underwriters in the public offerings in November and December 2010, pursuant to provision of FASB ASC Topic 815, “Derivative and Hedging” (“ASC 815”). The accounting treatment of the warrants resulted from the difference between the Company's functional currency in Renminbi and the denominated currency of the strike price of the warrants in U.S. dollars. The accounting treatment of the preferred stock resulted from a down-round provision providing anti-dilution protection to the preferred stockholders. Both warrants and the embedded conversion option of Series A convertible preferred stock are recorded as liabilities measured at fair value with changes in their fair value recognized in earnings for the three months ended March 31, 2013. Fair value of the instruments was primarily a function of the price of our common stock. An increase in our stock price over the three months resulted in an increase in fair value of the instruments, which are liabilities; hence a loss was recognized for the reporting period. For the comparable period in fiscal 2012, the Company recognized a non-cash gain of $79,808 due to the decrease in our stock price over that period. A decrease in our stock price over that period resulted in a decrease in fair value of the instruments, which are liabilities; hence a gain was recognized for that reporting period.

Provision for Income Taxes

The income tax expense for the three months ended March 31, 2013 was $0, compared with $297,362 for the comparable period in fiscal 2012. Excluding the share-based compensation cost of $194,027 and the loss of $91,358 from changes in fair value of instruments, adjusted loss before taxes was $1,148,424 for the three months ended March 31, 2013 compared with adjusted income before taxes of $1,126,059 for the comparable period in fiscal 2012, after adjusting for the share-based compensation cost of $1,011,742 and gain of $79,808 from changes in fair value of instruments. The income tax expense is calculated based on the actual loss or income before taxes and applicable income tax rate for our PRC subsidiary and affiliate, according to the generally accepted accounting principles of PRC. The income tax benefit recognized for the three months ended March 31, 2013 would offset the income tax expenses recognized for previous quarters. In April 2010, Tianjin Shengkai, the Company’s operating entity in Tianjin, PRC, was awarded the status of “high technology” enterprise for the calendar years 2009 through 2011. Hence Tianjin Shengkai enjoys a preferential enterprise income tax rate of 15% starting from January 1, 2010 through December 31, 2011, rather than the standard tax rate of 25%. In April 2013, Tianjin Shengkai officially received the approval to renew such “high technology” enterprise status and extend the 15% preferential enterprise income tax treatment for another three years.

 

43

---

 

Net Income (loss)

Net loss (per U.S. GAAP) for the three months ended March 31, 2013 was $1,433,809, compared with $103,237 for the comparable period in fiscal 2012. Diluted loss per share was $0.08 compared to $0.01 in the comparable period in fiscal 2012. During the quarter ended March 31, 2013, the number of diluted shares was 17,196,229 compared with 16,638,307 diluted shares for the comparable period in fiscal 2012.

Excluding the $194,027 share-based compensation cost and the $91,358 loss from changes in fair value of instruments, adjusted net loss (non-GAAP) was $1,148,424 for the three months ended March 31, 2013 compared with adjusted net income (non-GAAP) of $828,697 for the comparable period in fiscal 2012, after adjusting for the $1,011,742 share-based compensation cost and $79,808 gain from changes in fair value of instruments. The decrease was attributable to the factors described above. Non-GAAP loss was $0.07 per diluted share for the quarter ended March 31, 2013 compared with Non-GAAP earnings of $0.05 per diluted share in the comparable period in fiscal 2012.

Comparison of the Nine Months Ended March 31, 2013 and 2012

Revenue

In the past two years, because of the heightened suspicions on the integrity of Chinese companies, enquiries into the Company’s business and domestic customers mounted by certain shareholders and interested parties without the Company’s approval or endorsement have resulted in severely damaged relations with some of the Company’s important domestic customers. These customers had complained that numerous anonymous calls or visits had seriously disturbed their normal business operations. They also suspected the Company had encountered fatal product quality and safety liability issues, deteriorating financial conditions or legal issues. They further questioned our business integrity and stopped ordering from us. We estimate that such damaged business relations has resulted in loss of business of an aggregate of over $60 million since June 2011, and a higher turnover in the Company’s sales agents and representatives, which in turn undermined our marketing force and customer service. Some of the Company’s other customers have seized this opportunity to demand price cuts from the Company. Meanwhile, some of the Company’s competitors also have seized this opportunity to take away our customers.

In addition, in the past one year or so, due to the general economy slowdown in China and particularly the poor operating performance and financial pressure experienced by most of our major customers in the electric power market, business with those customers have become increasingly difficult. Some of our agents/distributors, through whom we sold our products to those end customers in the electric power industry, have even been forced out of business because they could not timely collect accumulated trade receivables from their customers. We estimate that in the nine months ended March 31, 2013 total revenue loss of approximately $30.0 million and $44.6 million, respectively, were attributable to above-mentioned damaged business relations and the economy slowdown in China.

As a result, revenue for the nine months ended March 31, 2013 decreased by $15,427,928 or 57.2% to $11,557,537 from $26,985,465 for the nine months ended March 31, 2012. Total ceramic valves sold in the nine months ended March 31, 2013 was 2,282 sets, compared with 4,667 sets in the nine months ended March 31, 2012. We estimate that decrease in volume sold and average selling price accounted for approximately 80% and 20%, respectively, of the total decrease in revenue for the nine months ended March 31, 2013 .

 

44

---

 

Unlike previously, the electric power industry contributed significantly less to our revenue, generating approximately 14.1% of total revenue for the nine months ended March 31, 2013, compared with 27.6% for the nine months ended March 31, 2012. Revenue from the electric power industry was $1,627,080 for the nine months ended March 31, 2013, a decrease of $5,832,854 or 78.2% from $7,459,934 for the comparable period in fiscal 2012.

Revenue from the petrochemical and chemical industry accounted for approximately 77.4% of total revenue for the nine months ended March 31, 2013, compared with 65.8% for the nine months ended March 31, 2012 . The revenue from the petrochemical and chemical industry was $8,942,435 for the nine months ended March 31, 2013, a decrease of $8,826,133 or 49.7% from $17,768,568 for the comparable period in fiscal 2012.

Revenue from other industries, including the aluminum and metallurgy industries, accounted for approximately 8.5% of total revenue for the nine months ended March 31, 2013, compared with 6.5% for the nine months ended March 31, 2012. The revenue for other industries was $988,022 for the nine months ended March 31, 2013, a decrease of $768,941 or 43.8% from $1,756,963 for the comparable period in fiscal 2012. Such other industries have not been the Company’s marketing focus because of less educated and lower quality customer base and less promising future prospects in terms of potential market size, selling price and profit margin. Revenue from these industries has remained low.

Cost of Sales and Gross Profit

Cost of sales for the nine months ended March 31, 2013 was $7,574,267, a decrease of $7,646,827 or 50.2% as compared to $15,221,094 for the nine months ended March 31, 2012, primarily due to decline in revenue. Gross profit for the nine months ended March 31, 2013 was $3,983,270, a decrease of $7,781,101 or 66.1% as compared to $11,764,371 for the nine months ended March 31, 2012. The decrease was primarily attributable to decrease in sales volume and decrease in average selling price of the product mix as we sold more lower-end products in this period. The gross margin for the nine months ended March 31, 2013 was 34.5%, as compared to 43.6% for the comparable period in fiscal 2012. The decrease in gross margin between the two comparable periods was primarily attributed to the fixed depreciation costs spread over a smaller revenue base, and increase in sales of valves with lower profit margin in the product mix for the nine months ended March 31, 2013.

Selling Expenses

Selling expenses for the nine months ended March 31, 2013 were $1,910,775, a decrease of $892,654 or 31.8%, from $2,803,429 for the comparable period in fiscal 2012. Commissions paid to agents for introducing new sales was approximately $917,339 for the nine months ended March 31, 2013, a decrease of approximately $1,241,498 or 57.5% from approximately $2,158,837 for the nine months ended March 31, 2012. Selling expenses as a percentage of total sales revenue increased to 16.5% for the nine months ended March 31, 2013 from 10.4% for the comparable period in fiscal 2012, primarily due to increase in overseas sales and marketing expenses incurred as a result of the Company’s shifted strategy to explore overseas markets. Additionally, certain minor components of selling expenses such as sales staff’s salaries, sales offices’ administrative expenses and after-sale service expenses are flat-rate and did not diminish proportionally to revenue decrease.

General and Administrative Expenses

General and administrative (“G&A”) expenses for the nine months ended March 31, 2013 were $5,358,769, a decrease of $2,260,180 or 29.7% as compared to $7,618,949 for the comparable period in fiscal 2012. Included in G&A expenses for the nine months ended March 31, 2013 was a non-cash charge of $582,081, which was the share-based compensation costs on the options to independent directors, management and key employees issued in March and June, 2010, under the Company’s 2010 Incentive Stock Plan. The non-cash share-based compensation costs included in the G&A expenses for the comparable period in fiscal 2012 was $4,180,178. G&A expenses (excluding the non-cash items) for the nine months ended March 31, 2013 were $4,776,688, an increase of $1,337,917 or 38.9% compared to $3,438,771 for the comparable period in fiscal 2012. The increase in G&A (excluding the non-cash items) expenses was primarily attributable to an increase in R&D expense of $1,331,883 resulting from development of new products targeting new markets, and the consulting and training fee of approximately $199,000 during the quarter ended March 31, 2013 incurred as a result of ongoing compliance with ISO14000 environment management standards, offset by decrease of $210,514 in expenses and professional fees incurred for our U.S. capital market-related activities.

 

45

---

 

Other Income and Interest Income

Other income primarily consists of net income from services or non-valve accessories and government grants. Other income for the nine months ended March 31, 2013 was $16,046, a decrease of $58,797 or 78.6% as compared to $74,843 for the comparable period in fiscal 2012. The decrease was primarily attributable to less service income and government grants received in the nine months in this fiscal year. In the comparable period in fiscal 2012, the Company received from local government grants of an aggregate of approximately $44,000 to support its energy conservation project and encourage its technology improvement, new product development and overseas market development.

Interest income primarily refers to the interest earned on cash deposits. Interest income, for the nine months ended March 31, 2013 was $379,527, a decrease of $338,445 or 47.1% as compared to $717,972 for the comparable period in fiscal 2012. The decrease was primarily attributable to decrease in interest rates on cash deposits in the three months ended March 31, 2013 and decrease in interest on term deposits.

Changes in Fair Value of Instruments

For the nine months ended March 31, 2013, the Company incurred non-cash loss in an aggregate amount of $107,182 related to its issuance of Series A warrants and Series A convertible preferred stock in the private placements in June and July, 2008, as well as issuance of warrants to underwriters in the public offerings in November and December 2010, pursuant to provision of FASB ASC Topic 815, “Derivative and Hedging” (“ASC 815”). The accounting treatment of the warrants resulted from the difference between the Company's functional currency in Renminbi and the denominated currency of the strike price of the warrants in U.S. dollars. The accounting treatment of the preferred stock resulted from a down-round provision providing anti-dilution protection to the preferred stockholders. Both warrants and the embedded conversion option of Series A convertible preferred stock are recorded as liabilities measured at fair value with changes in their fair value recognized in earnings for the nine months ended March 31, 2013. Fair value of the instruments was primarily a function of the price of our common stock as well as its volatility. An increase in our stock price over the nine months resulted in an increase in fair value of the instruments, which are liabilities. In addition, a lower volatility of the stock price during the nine-month period resulted in lower valuation of options and warrants based on the Black-Scholes valuation model, and a lower discount to equity component of the convertible preferred stock; the effect of such lower discount overweighed the effect brought from the Black-Scholes model, hence higher value of the embedded conversion option, which means higher liabilities. Both factors caused the loss recognized during the nine-month period. For the comparable period in fiscal 2012, the Company recognized a non-cash gain of $1,836,530 due to the decrease in our stock price over that period. A decrease in our stock price over that period resulted in a decrease in fair value of the instruments, which are liabilities; hence a gain was recognized for that reporting period.

Provision for Income Taxes

Provision for income taxes for the nine months ended March 31, 2013 was $151,562, a decrease of $1,196,591 or 88.8% from $1,348,153 for the comparable period in fiscal 2012. Excluding the $582,081 share-based compensation cost and the $107,182 loss from changes in fair value of instruments, adjusted loss before taxes was $2,308,620 for the nine months ended March 31, 2013 compared with income before taxes of $6,314,986 for the comparable period in fiscal 2012, after adjusting for the $4,180,178 share-based compensation cost and $1,836,530 gain from changes in fair value of instruments. The income tax provision is calculated based on the actual income before taxes and applicable income tax rate for our PRC subsidiary and affiliate, according to the generally accepted accounting principles of PRC. In April 2010, Tianjin Shengkai, the Company’s operating entity in Tianjin, PRC, was awarded the status of “high technology” enterprise for the calendar years 2009 through 2011. Hence Tianjin Shengkai enjoys a preferential enterprise income tax rate of 15% starting from January 1, 2010 through December 31, 2011, rather than the standard tax rate of 25%. In April 2013, Tianjin Shengkai officially received the approval to renew such “high technology” enterprise status and extend the 15% preferential enterprise income tax treatment for another three years.

 

46

---

 

Net Income (Loss)

Net loss (per U.S. GAAP) for the nine months ended March 31, 2013 was $3,149,445, compared with the net income of $2,623,185 for the comparable period in fiscal 2012. Diluted loss per share was $0.18 compared to earnings of $0.14 per diluted share in the comparable period in fiscal 2012. During the nine months ended March 31, 2013, the number of diluted shares was 17,196,226 compared with 18,138,809 diluted shares for the comparable period in fiscal 2012.

Excluding the $582,081 share-based compensation cost and the $107,182 loss from changes in fair value of instruments, adjusted net loss (non-GAAP) was $2,460,182 for the nine months ended March 31, 2013 compared with adjusted net income (non-GAAP) of $4,966,833 for the comparable period in fiscal 2012, after adjusting for the $4,180,178 share-based compensation cost and $1,836,530 gain from changes in fair value of instruments. The decrease was attributable to the factors described above. Non-GAAP loss was $0.14 per diluted share for the nine months ended March 31, 2013 compared with Non-GAAP earnings of $0.27 per diluted share in the comparable period in fiscal 2012.

Non-GAAP Financial Measures

To supplement our consolidated financial statements presented on a U.S. GAAP basis, in this report, we provided non-U.S. GAAP ("non-GAAP") financial information that excludes the impact of non-cash items of i) share-based compensation costs related to the stock options and stock awards granted to advisors, independent directors and management staff, and ii) changes in the fair value of instruments as a result of adoption on July 1, 2009 of FASB ASC Topic 815, "Derivative and Hedging" ("ASC 815"). We believe that these non-GAAP measures, namely adjusted income before taxes, adjusted net income/loss and non-GAAP diluted earnings/loss per share, provide investors with a better understanding of how the results relate to our current and historical performance. The additional non-GAAP information is not meant to be considered in isolation or as a substitute for the financials presented on a GAAP basis. The non-GAAP financial information that we provide also may differ from the non-GAAP information provided by other companies. We believe that these non-GAAP financial measures are useful to investors because they exclude non-cash expenses we exclude when we internally evaluate the performance of our business and make operating decisions, including internal budgeting and performance measurement, because these measures provide a consistent method of comparison to historical periods. Moreover, we believe that these non-GAAP measures reflect our essential operating activities. In addition, the provision of these non-GAAP measures allows investors to evaluate our performance using the same methodology and information as that used by our management. Non-GAAP measures are subject to inherent limitations because they do not include all of the expenses included under GAAP and because they involve the exercise of judgment of which charges are excluded from the non-GAAP financial measures. However, we compensate for these limitations by providing the relevant disclosure of the items excluded.

Liquidity and Capital Resources

Cash and Cash Equivalents

Our cash and cash equivalents at the beginning of the nine months ended March 31, 2013 were $64,819,870 and increased to $66,271,537 by the end of the period, an increase of $1,451,667 or 2.2%.  The increase was primarily attributable to the internal cash flows generated from operations, as well as effects of exchange rate change, offset by investment in fixed and intangible assets.

We believe that after taking into account of our current cash position and cash generated from operating activities, we have adequate operating funds to sustain working capital, capital expenditures and milestone payments for the next twelve months. From time to time, we may identify new expansion opportunities, research and development projects and significant marketing initiatives for which there will be a need to use cash.

We manage our cash based on thorough consideration of our corporate strategy, business environment as well as the macro economic situation. Factors we take into account when managing our cash include interest rates, foreign currency fluctuation as well as the flexibility in executing our corporate strategy.

 

47

---

 

We keep most of our cash in Renminbi in form of call deposits at banks in China. Call deposit has no definite term, but requires depositor to pre-notify the bank of the date and amount of withdrawal. 7-day call deposit had an interest rate ranging from 0.385% to 1.265% per annum in the three and nine months ended March 31, 2013.

Currently we are experiencing downturns in our business as well as in the transition period of seeking new business opportunities. We cannot forecast for sure the length of such transition period. We need to preserve cash to ensure the Company will survive in the event that the macro economy remains slow or deteriorates, and our business keeps running at a low level. On the other hand, once we find a promising opportunity that would turn our operations around and boom our business, we may expect to incur significant amount of investment in R&D, qualification, marketing, capital expenditures or other forms, within a short time to grasp the opportunity. As other sources of financing such as equity or debt financing is difficult in the current circumstances, it is necessary to maintain sufficient cash balances for potential business opportunities.

Net Cash Provided by Operating Activities

Net cash provided by operating activities was $1,282,937 for the nine months ended March 31, 2013, a decrease of $6,451,421 or 83.4% from $7,734,358 for the comparable period in fiscal 2012. The decrease in net cash inflow from operations was primarily attributable to the net loss for the nine months ended March 31, 2013 as compared to the net income for the nine months ended March 31, 2012.

Our operation required less working capital during the nine months ended March 31, 2013 as compared to the nine months ended March 31, 2012.

-	Decrease in inventory contributed approximately $0.4 million cash flow during the nine months ended March 31, 2013, primarily due to slowdown of our business, compared with approximately $0.3 million cash used in comparable period in fiscal 2012 due to increase of inventory.

-

Notes were usually used to pay construction contractors or equipment suppliers in fiscal 2011 and before when the Company had significant capital expenditures. There was no significant change in notes payable during the nine months ended March 31, 2013 given that the Company no longer had significant capital expenditures, compared with approximately $1.4 million cash outflow due to significant decrease in note payable for the comparable period in fiscal 2012.

-	Accounts payables decreased in both comparison periods primarily due to slowdown of business operation, generating cash outflow of approximately $0.7 million and $2.9 million, respectively, in the nine months ended March 31, 2013 and 2012.

-	Likewise, other payables decreased in both comparison periods, bringing cash outflow of approximately $0.2 million and $1.6 million, respectively, in the nine months ended March 31, 2013 and 2012.

-	Income tax expenses and amounts payable have been decreasing because of decreasing taxable income as a result of slowdown of business, resulting in cash outflow of approximately $0.2 million and $1.5 million, respectively, in the nine months ended March 31, 2013 and 2012.

On the other hand,

-

Accounts receivables decreased as a result of decrease in sales revenue during the nine months ended March 31, 2013, primarily due to slowdown of our business, providing cash flow of approximately $2.8 million; while during the comparable period in fiscal 2012 decrease in accounts receivable provided an even higher cash flow of approximately $6.3 million, also primarily due to slowdown of business and thus decrease in sales.

-

Advances to suppliers increased by approximately $2.4 million during the nine months ended March 31, 2013, representing approximately an increase of $2.2 million in cash consumption than in the comparable period in fiscal 2012. This $2.4 million incremental during the nine months ended March 31, 2013 mainly included advance payments of approximately $0.8 million for purchase of patented technology, approximately $0.5 million for upgrade of valve testing system, approximately $0.5 million for maintenance of buildings, and approximately $0.6 million for purchase of a numerical control cutting machine.

 

48

---

 

Net Cash Provided by (Used in) Investing Activities

Net cash used in investing activities was $391,826 for the nine months ended March 31, 2013, as compared to $596,464 net cash provided by investing activities for the nine months ended March 31, 2012, a decrease in cash inflow of $988,290. The change was primarily attributable to the decrease in release of restricted cash in the nine months ended March 31, 2013.

Net Cash Provided by (Used in) Financing Activities

There was no cash provided by or used in financing activities for the nine months ended March 31, 2013 and 2012.

Trends

In response to the business disruptions and changes in the global ceramic valves industry as well as in PRC’s economic conditions as described earlier, management of the Company has decided to gradually phase out its less profitable domestic market segments including the electric power market and focus on expanding its presence in the more profitable domestic and foreign oil and chemical industries where ceramic valve products typically command higher prices. The Company has increased its product sales price since fiscal 2012 to match industry levels and to reflect its superior product quality. The Company has also been making efforts to streamline operations through headcount reduction and other cost-saving measures to conserve capital and reduce the impact of revenue loss. Finally, the Company will continue to leverage its self-developed ceramic material technologies to continue in-house and joint research and development of innovative and superior-performance products for the international oil and chemical markets and commit its resources to expanding the acceptance of its products overseas.

As such, we expect that in the immediately following quarter ending June 30, 2013, total revenues would remain flat on a quarter-over-quarter basis; and major contribution to our sales would continue to be from the petrochemical and chemical industry. Such situation may persist until our marketing and sales efforts on some new customers and projects pay off, and the expansion in the international market picks up meaningfully. Successful penetration into international oil and chemical markets would also require the Company to obtain various certifications, including but not limited to different class API certification, such as API 6A which covers higher pressure valve products, and other firm-specific supplier qualifications, which will take time to go through various application procedures, develop new products and invest in additional or different equipment.

Inflation

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

VIE Structure

Our VIE corporate structure was set up under the PRC laws in order to consolidate the operations of Tianjin Shengkai, our VIE, in the PRC. It is very common for foreign companies to have VIE arrangements with the PRC companies. Our VIE arrangements allow us, through SK WFOE, to substantially influence our VIE’s daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholder approval. As a result of these contractual arrangements, which enable us to control our VIE and operate our business in the PRC through our VIE, we are considered the primary beneficiary of our VIE.

We believe our contractual arrangements with Tianjin Shengkai, our VIE, as described in this report, are in compliance with existing PRC laws, rules and regulations and legally enforceable. However, there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations and the PRC government authorities may ultimately take a view that such contracts contravene PRC laws and regulations or are otherwise not enforceable for public policy reasons, which could limit the Company’s ability to enforce these contractual arrangements and may result in deconsolidation of our VIE.

Additionally, the VIE agreements may not be as effective in providing us with control over our VIE as direct ownership. If our VIE or its shareholders fail to perform the obligations under the VIE agreements, we would be required to resort to legal remedies available under the PRC laws, including seeking specific performance or injunctive relief, or claiming damages. Such remedies may not provide us with effective means of causing our VIE to meet its obligations, or recovering any losses or damages as a result of non-performance. Under these circumstances, there is a possibility of deconsolidation of our VIE.

 

49

---

 

Restricted Net Assets

Statutory Reserve

As all of the Company’s business operations are now conducted through its PRC subsidiary, SK WFOE, and the VIE, Tianjin Shengkai, the Company’s ability to pay dividends is primarily dependent on receiving distributions of funds from SK WFOE and Tianjin Shengkai. Relevant PRC statutory laws and regulations permit payments of dividends by SK WFOE and Tianjin Shengkai only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations and after it has met the PRC requirements for appropriation to statutory reserves. Paid in capital of SK WFOE and Tianjin Shengkai included in the Company’s consolidated net assets are also nondistributable for dividend purposes.

In accordance with the PRC regulations on Enterprises with Foreign Investment, a wholly foreign-owned enterprise established in the PRC is required to provide certain statutory reserves, namely general reserve fund, the enterprise expansion fund and staff welfare and bonus fund which are appropriated from net profit as reported in the enterprise’s PRC statutory accounts. A wholly foreign-owned enterprise is required to allocate at least 10% of its annual after-tax profit to the general reserve until such reserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. Appropriations to the enterprise expansion fund and staff welfare and bonus fund are at the discretion of the board of directors. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends. SK WFOE is subject to the above mandated restrictions on distributable profits. As it is in loss every year, SK WFOE’s reserve has not reached 50% of its registered capital.

Additionally, in accordance with the Company Law of the PRC, a domestic enterprise is required to provide a statutory common reserve of at least 10% of its annual after-tax profit until such reserve has reached 50% of its registered capital based on the enterprise’s PRC statutory accounts. A domestic enterprise is also required to provide for a discretionary surplus reserve, at the discretion of the board of directors. The aforementioned reserves can only be used for specific purposes and are not distributable as cash dividends. Tianjin Shengkai is subject to the above mandated restrictions on distributable profits.   Tianjin Shengkai has stopped allocating funds to its statutory reserve as the reserve reached 50% of its registered capital.

As a result of these PRC laws and regulations, SK WFOE and Tianjin Shengkai are restricted in their ability to transfer a portion of their net assets to the Company. As of March 31, 2013, restricted net assets in the aggregate, which includes paid-in capital and statutory reserve funds of SK WFOE and Tianjin Shengkai that are included in the Company’s consolidated net assets, were approximately $55.0 million.

Withholding Tax

The New PRC Enterprise Income Tax (“EIT”) Law, which was effected on January 1, 2008, also imposed a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous EIT law. SK WFOE is subject to the withholding requirement of the EIT Law.

Foreign Exchange Regulation

The ability of the Company’s PRC subsidiaries to make dividends and other payments to the Company may also be restricted by changes in applicable foreign exchange and other laws and regulations.

Foreign currency exchange regulation in China is primarily governed by the following rules:

·	Foreign Exchange Administration Rules (1996), as amended in August 2008, or the Exchange Rules;

·	Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules.

 

50

---

 

Currently, under the Administration Rules, Renminbi is freely convertible for current account items, including the distribution of dividends, interest payments, trade and service related foreign exchange transactions, but not for capital account items, such as direct investments, loans, repatriation of investments and investments in securities outside of China, unless the prior approval of the State Administration of Foreign Exchange (the “SAFE”) is obtained and prior registration with the SAFE is made. Foreign-invested enterprises like SK WFOE that need foreign exchange for the distribution of profits to its shareholders may effect payment from their foreign exchange accounts or purchase and pay foreign exchange rates at the designated foreign exchange banks to their foreign shareholders by producing board resolutions for such profit distribution. Based on their needs, foreign-invested enterprises are permitted to open foreign exchange settlement accounts for current account receipts and payments of foreign exchange along with specialized accounts for capital account receipts and payments of foreign exchange at certain designated foreign exchange banks.

Although the current Exchange Rules allow the convertibility of Chinese Renminbi into foreign currency for current account items, conversion of Chinese Renminbi into foreign exchange for capital items, such as foreign direct investment, loans or securities, requires the approval of SAFE, which is under the authority of the People’s Bank of China. These approvals, however, do not guarantee the availability of foreign currency conversion. The Company cannot be sure that it will be able to obtain all required conversion approvals for its operations or the Chinese regulatory authorities will not impose greater restrictions on the convertibility of Chinese Renminbi in the future. Currently, most of the Company’s retained earnings are generated in Renminbi. Any future restrictions on currency exchanges may limit the Company’s ability to use its retained earnings generated in Renminbi to make dividends or other payments in U.S. dollars or fund possible business activities outside China.

As of March 31, 2013, there were approximately $86.3 million retained earnings in the aggregate, which were generated by Tianjin Shengkai in Renminbi included in the Company’s consolidated net assets that may be affected by increased restrictions on currency exchanges in the future and accordingly may further limit SK WFOE and Tianjin Shengkai’s ability to make dividends or other payments in U.S. dollars to the Company.

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).

Principles of consolidation

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

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

 

51

---

 

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

 

Pursuant to a restructuring plan intended to ensure compliance with the PRC rules and regulations, on May 30, 2008, SK WOFE entered into a series of contractual arrangements (the “Contractual Arrangements”) with Tianjin Shengkai and/or all of the shareholders of Tianjin Shengkai as described below:

Consigned Management Agreement

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

Technology Service Agreement

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

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

Loan Agreement     

The Loan Agreement, among SK WFOE and all of the shareholders of Tianjin Shengkai, provides that SK WFOE will make a loan in the aggregate principal amount of RMB49,000,000 (approximately $7,153,702) to the shareholders of Tianjin Shengkai, each shareholder receiving a share of the loan proceeds proportional to its shareholding in Tianjin Shengkai, and in exchange each shareholder agreed (i) to contribute all of its proceeds from the loan to the registered capital of Tianjin Shengkai in order to increase the registered capital of Tianjin Shengkai, (ii) to cause Tianjin Shengkai to complete the process of registering the increase in its registered capital with PRC regulatory authorities within 30 days after receiving the loan, and (iii) to pledge their equity to SK WFOE under the Equity Pledge Agreement described below.

 The loan is repayable at the option of SK WFOE either in cash or by transfer of Tianjin Shengkai equity or all of its assets to SK WFOE. The loan does not bear interest, except that if (x) SK WFOE is able to purchase the equity or assets of Tianjin Shengkai, and (y) the lowest allowable purchase price for that equity or those assets under PRC law is greater than the principal amount of the loan, then, insofar as it is allowable under PRC law, interest will be deemed to have accrued on the loan in an amount equal to the difference between the lowest allowable purchase price for Tianjin Shengkai and the principal amount of the loan. The effect of this interest provision is that, if and when permitted under PRC law, SK WFOE may acquire all of the equity or assets of Tianjin Shengkai by forgiving the loan, without making any further payment.

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

 

52

---

 

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

Exclusive Purchase Option Agreement    

The Exclusive Purchase Option Agreement, among SK WFOE, Tianjin Shengkai, and all of the shareholders of Tianjin Shengkai, provides that Tianjin Shengkai will grant SK WFOE an irrevocable and exclusive right to purchase all or part of Tianjin Shengkai’s assets, and the shareholders of Tianjin Shengkai will grant SK WFOE an irrevocable and exclusive right to purchase all or part of their equity interests in Tianjin Shengkai. Either right may be exercised by SK WFOE in its sole discretion at any time that the exercise would be permissible under PRC law, and the purchase price for SK WFOE’s acquisition of equity or assets will be the lowest price permissible under PRC law. Tianjin Shengkai and its shareholders are required to execute purchase agreements and related documentation within 30 days of receiving notice from SK WFOE that it intends to exercise its right to purchase.

The Exclusive Purchase Option Agreement contains agreements from Tianjin Shengkai and its shareholders that they will refrain from taking actions, such as voting to dissolve or declaring dividends, that could impair SK WFOE’s security interest in the equity of Tianjin Shengkai or reduce its value. These agreements are substantially the same as those contained in the Loan Agreement described above.

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

Equity Pledge Agreement

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

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

In 2008, SK WOFE invested US$7,153,702 (RMB 49,000,000) in Tianjin Shengkai (“Variable Interest Entity” or “VIE”) based on the loan amount entered into the Loan Agreement between SK WOFE and VIE. This is an implicit arrangement that SK WOFE has provided financial support to the VIE. Besides, SK WOFE had exercised the Consigned Management Service Agreement and Technology Service Agreement, SK WOFE had the operation control and the obligation to absorb loss or right to receive residual gain from VIE. Moreover, the SK WOFE gained control of the Board of Directors of VIE through the exercise of Equity Pledge Agreement. Those are the explicit arrangement that the SK WOFE had exercised actual control of the operation of the VIE.  The SK WOFE also has an option to exercise the Exclusive Purchase Option Agreement in the future to actually control VIE and turned it into direct control subsidiary.

 

53

---

 

The above five agreements represent interlocking agreements making SK WOFE becomes Primary Beneficiary of the Tianjin Shengkai. This fact and circumstances do not have any change up to the current period. In short, these five agreements met the ASC 810-10-25-5A analysis and the Company concluded that the VIE should be consolidated into the Group financial statements in all aspects.

 

Accounting for the impairment of long-lived assets

 

The Company periodically evaluates the carrying value of long-lived assets to be held and used, including intangible assets subject to amortization, when events and circumstances warrant such a review, pursuant to the guidelines established in Statement of Financial Accounting Standards (“SFAS”) No. 144 (now known as "ASC 360"). The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost to dispose.

Revenue recognition

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

 

Intangible assets

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

Foreign currency translation

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

 

New Financial Accounting Pronouncements

 

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

 

54

---

 

In December 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. ASU No. 2011-11 is intended to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this Update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented.

In December 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU No. 2011-11 is intended to supersede certain pending paragraphs in Accounting Standards Update No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to effectively defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments out of accumulated other comprehensive income. The amendments will be temporary to allow the Board time to redeliberate the presentation requirements for reclassifications out of accumulated other comprehensive income for annual and interim financial statements for public, private, and non-profit entities. All other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter.

In July 2012, the FASB issued Accounting Standards Update (ASU) No. 2012-02, Intangibles--Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This ASU states that an  entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Codification Subtopic 350-30, Intangibles--Goodwill and Other, General Intangibles Other than Goodwill. Under the guidance in this ASU, an entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments in this ASU are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance.

In August 2012, the FASB released Accounting Standards Update (ASU) No. 2012-03, Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22. This ASU amends various SEC paragraphs: (a) pursuant to the issuance of Staff Accounting Bulletin No. 114; (b) pursuant to the issuance of the SEC’s Final Rule, Technical Amendments to Commission Rules and Forms Related to the FASB’s Accounting Standards Codification, Release Nos. 33-9250, 34-65052, and IC-29748 August 8, 2011; and (c) related to ASU No. 2010-22, Accounting for Various Topics.

 

55

---

 

In October 2012, FASB issued Accounting Standards Update (ASU) No. 2012-04, Technical Corrections and Improvements. This ASU make technical corrections, clarifications, and limited-scope improvements to various Topics throughout the Codification. The amendments in this ASU that will not have transition guidance will be effective upon issuance for both public entities and nonpublic entities. For public entities, the amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2012. For nonpublic entities, the amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2013.

In October 2012, FASB has issued Accounting Standards Update (ASU) No. 2012-05, Statement of Cash Flows (Topic 230). This ASU addresses how cash receipts arising from the sale of certain donated financial assets, such as securities, should be classified in the statement of cash flows of not-for-profit entities (NFPs). Some NFPs classify those cash receipts as investing cash inflows, while other entities classify them as either operating cash inflows or financing cash inflows, consistent with their treatment of inflows arising from cash contributions. The objective of this Update is for an NFP to classify cash receipts from the sale of donated financial assets consistently with cash donations received in the statement of cash flows if those cash receipts were from the sale of donated financial assets that upon receipt were directed without the NFP imposing any limitations for sale and were converted nearly immediately into cash. The amendments in the ASU are effective prospectively for fiscal years, and interim fiscal periods within those years, beginning after June 15, 2013. Retrospective application to all periods presented upon the date of adoption is permitted. Early adoption from the beginning of the fiscal year of adoption is permitted.

In January 2013, FASB issued Accounting Standards Update (ASU) No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. This ASU clarifies that ordinary trade receivables and receivables are not in the scope of ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. Specifically, ASU 2011-11 applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in the FASB Accounting Standards Codification™ (Codification) or subject to a master netting arrangement or similar agreement. The FASB undertook this clarification project in response to concerns expressed by U.S. stakeholders about the standard’s broad definition of financial instruments. An entity is required to apply the amendments in ASU 2013-01 for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented. The effective date is the same as the effective date of ASU 2011-11.

In February 2013, FASB issued Accounting Standards Update (ASU) No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This ASU improves the transparency of reporting these reclassifications. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in this ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP.

The new amendments will require an organization to:

·

Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income - but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period;

·

Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense.

 

56

---

 

The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual). A private company is required to meet the reporting requirements of the amended paragraphs about the roll forward of accumulated other comprehensive income for both interim and annual reporting periods. However, private companies are only required to provide the information about the effect of reclassifications on line items of net income for annual reporting periods, not for interim reporting periods. The amendments are effective for reporting periods beginning after December 15, 2012, for public companies and are effective for reporting periods beginning after December 15, 2013, for private companies. Early adoption is permitted.

In February 2013, FASB issued Accounting Standards Update (ASU) No. 2013-03, Financial Instruments (Topic 825). This ASU clarifies the scope and applicability of a disclosure exemption that resulted from the issuance of Accounting Standards Update No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendment clarifies that the requirement to disclose "the level of the fair value hierarchy within which the fair value measurements are categorized in their entirety (Level 1, 2, or 3)" does not apply to nonpublic entities for items that are not measured at fair value in the statement of financial position, but for which fair value is disclosed. This ASU is the final version of Proposed Accounting Standards Update 2013-200—Financial Instruments (Topic 825) which has been deleted. The amendments are effective upon issuance.

In February 2013, FASB issued Accounting Standards Update (ASU) No. 2013-04, Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date. This ASU provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this ASU is fixed at the reporting date, except for obligations addressed within existing guidance in U.S. GAAP. The guidance requires an entity to measure those obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance in this ASU also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2014, and interim periods and annual periods thereafter. The amendments in this ASU should be applied retrospectively to all prior periods presented for those obligations resulting from joint and several liability arrangements within the ASU’s scope that exist at the beginning of an entity’s fiscal year of adoption. An entity may elect to use hindsight for the comparative periods (if it changed its accounting as a result of adopting the amendments in this ASU) and should disclose that fact. Early adoption is permitted.

In March 2013, FASB issued Accounting Standards Update (ASU) No. 2013-05, Foreign Currency Matters (Topic 830). This ASU resolve the diversity in practice about whether Subtopic 810-10, Consolidation—Overall, or Subtopic 830-30, Foreign Currency Matters—Translation of Financial Statements, applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights)within a foreign entity. In addition, the amendments in this Update resolve the diversity in practice for the treatment of business combinations achieved in stages (sometimes also referred to as step acquisitions) involving a foreign entity. This ASU is the final version of Proposed Accounting Standards Update EITF11Ar—Foreign Currency Matters (Topic 830), which has been deleted. The amendments in this Update are effective prospectively for fiscal years (and interim reporting periods within those years) beginning after December 15, 2013. For nonpublic entities the amendments in this Update are effective prospectively for the first annual period beginning after December 15, 2014, and interim and annual periods thereafter. The amendments should be applied prospectively to derecognition events occurring after the effective date. Prior periods should not be adjusted. Early adoption is permitted. If an entity elects to early adopt the amendments, it should apply them as of the beginning of the entity’s fiscal year of adoption.

 

57

---

 

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.

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 Linbin Zhang, the Company’s Interim 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, 2013. Based upon that evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were 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, and 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.

Changes in Internal Controls over Financial Reporting

Our management, with the participation of our CEO and CFO, performed an evaluation as to whether any change in our internal controls over financial reporting occurred during the quarter ended March 31, 2013. Based on that evaluation, our CEO and CFO concluded that no change occurred in the Company's internal controls over financial reporting during the quarter ended March 31, 2013 that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting.

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. 

 

Not applicable.

 

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

None.

   

Item 3.       Defaults Upon Senior Securities.

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

 

Item 4.       Mine Safety Disclosures.

Not applicable.

 

58

---

 

Item 5.       Other Information.

None.

Item 6.       Exhibits.

 (a) Exhibits

Exhibit Number		Description of Exhibit
3.1 (1)		Articles of Incorporation.
3.2 (2)		Articles of Amendment to the Articles of Incorporation.
3.3 (6)		Articles of Amendment to the Articles of Incorporation of Shengkai Innovations, Inc.
3.4 (1)		Bylaws.
3.5 (3)		Articles of Amendment to the Articles of Incorporation, setting forth the Certificate of Designations authorizing the Series A Preferred Stock.
3.6 (5)		Articles of Amendment to the Articles of Incorporation filed on November 2, 2010 with the state of Florida.
3.7 (3)		Specimen of common stock certificate.
4.1 (3)		Form of Series A Warrant, June 2008 Financing.
4.2 (3)		Securities Purchase Agreement, dated as of June 10, 2008, by and among the Company and the Purchasers.
4.3 (3)		First Amendment to Securities Purchase Agreement, dated as of June 23, 2008, by and among the Company and the Purchasers.
4.4 (3)		Registration Rights Agreement, dated as of June 10, 2008, by and among the Company and the Purchasers.
4.5 (3)		Registration Rights Agreement dated as of June 10, 2008, by and among the Company and the Shell Shareholders.
4.6 (3)		Form of Lock-Up Agreement, dated as of June 10, 2008, by and among the Company and certain Shareholders.
4.7 (4)		Form of Series A Warrant, July 2008 Financing.
4.8 (4)		Securities Purchase Agreement, dated as of July 18, 2008, by and among the Company and Blue Ridge Investments, LLC.
4.9 (4)		Registration Rights Agreement, dated as of July 18, 2008, by and among the Company and Blue Ridge Investments, LLC.
31.1		Certification of Principal Executive Officer pursuant to Section 302 Of the Sarbanes-Oxley Act of 2002.**
31.2		Certification of Principal Financial Officer pursuant to Section 302 Of the Sarbanes-Oxley Act of 2002.**
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
101.INS		XBRL Instance Document*
101.SCH		XBRL Schema Document*
101.CAL		XBRL Calculation Linkbase Document*
101.LAB		XBRL Label Linkbase Document*
101.PRE		XBRL Presentation Linkbase Document*
101.DEF		XBRL Definition Linkbase Document*

 

59

---

 

(1)	Incorporated by reference to the exhibit of the same number to our registration statement on Form SB-2 filed with the SEC on May 26, 2005.
(2)	Incorporated by reference to our current report on Form 8-K filed with the SEC on April 14, 2008.
(3)	Incorporated by reference to our current report on Form 8-K/A filed with the SEC on June 23, 2008.
(4)	Incorporated by reference to our current report on Form 8-K filed with the SEC on July 24, 2008.
(5)	Incorporated by reference to our quarterly report on Form 10-Q filed with the SEC on November 15, 2011.
(6)	Incorporated by reference to our current report on Form 8-K filed with the SEC on March 9, 2012.

 

* Furnished herewith.

** Filed herewith

 

 

60

---

 

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: May 15 , 2013	By:	/s/ Wang Chen
		Name: Wang Chen
		Title: Chief Executive Officer
		(principal executive officer)

Date: May 15 , 2013	By:	/s/ Linbin Zhang
		Name: Linbin Zhang
		Title: Interim Chief Financial Officer
		(principal financial and accounting officer)

 

 

61

---