XNAS:VALV Annual Report 10-K Filing - 9/10/2012

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f10k_092012.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K
 
(Mark One)
 
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended June 30, 2012

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

Commission file number: 001-34587

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

Florida
 
11-3737500
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
No. 106 Zhonghuan South Road
Airport  Industrial  Park
Tianjin, People’s Republic of China
 
300308
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code + (86) 22-5883-8509
 
Securities registered under Section 12(b) of the Exchange Act:
 
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $0.001 per share
 
 
The NASDAQ Stock Market LLC
 
 
Securities registered pursuant to section 12(g) of the Act
 
Common Stock, par value $0.001 per share
 
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.o Yes x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.o Yes x  No
 
 
1

 
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o                                                                                                           Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)       Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes   x No

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

Note – If a determination as to whether a particular person or entity is an affiliate cannot be made without involving unreasonable effort and expense, the aggregate market value of the common stock held by non-affiliates may be calculated on the basis of assumptions reasonable under the circumstances, provided that the assumptions are set forth in this Form.
 
The aggregate market value of the voting and non-voting common stock of the issuer held by non-affiliates was approximately $9,885,666 based upon the closing price of the common stock ($1.26) as quoted by NASDAQ on December 30, 2011.
 
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
 
 
 
2

 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  o Yes o No
 
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
 
As of September 20, 2012, there were 17,196,229 issued and outstanding shares of the issuer’s common stock.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g. Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2) Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. The listed documents should be clearly described for identification purposes (e.g. annual report to security holders for fiscal year ended December 24, 1980).




 


 
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FORWARD LOOKING STATEMENTS
 
This Annual Report on Form 10-K contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this Annual Report on Form 10-K. Additionally, statements concerning future matters are forward-looking statements.
 
Although forward-looking statements in this Annual Report on Form 10-K reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the headings “Risks Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” You are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. We file reports with the SEC. The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
 
We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Annual Report on Form 10-K, except as required by law. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Annual Report, which are designed to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

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

Unless otherwise noted, all currency figures in this filing are in U.S. dollars. References to "yuan" or "RMB" are to the Chinese yuan, which is also known as the Renminbi. According to the currency exchange website www.xe.com, on September 14, 2012, $1.00 was equivalent to 6.3168 yuan.

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

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

Unless otherwise specified or required by context, references to “we,” “the Company”, “our” and “us” refer collectively to (i) Shengkai Innovations, Inc., (ii) the subsidiaries of the Company, Shen Kun International Limited, a British Virgin Islands limited liability company (“Shen Kun”), Shengkai (Tianjin) Limited, a wholly foreign-owned enterprise under the laws of the PRC (“SK WFOE”), Shengkai (Tianjin) Trading Ltd., a wholly-owned subsidiary of SK WFOE incorporated under the laws of the PRC, and (iii) Tianjin Shengkai.
 
References to Tianjin Shengkai’s “registered capital” are to the equity of Tianjin Shengkai, which under PRC law is measured not in terms of shares owned but in terms of the amount of capital that has been contributed to a company by a particular shareholder or all shareholders. The portion of a limited liability company’s total capital contributed by a particular shareholder represents that shareholder’s ownership of the company, and the total amount of capital contributed by all shareholders is the company’s total equity. Capital contributions are made to a company by deposits into a dedicated account in the company’s name, which the company may access in order to meet its financial needs. When a company’s accountant certifies to PRC authorities that a capital contribution has been made and the company has received the necessary government permission to increase its contributed capital, the capital contribution is registered with regulatory authorities and becomes a part of the company’s “registered capital.”
 
 
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SHENGKAI INNOVATIONS, INC.
FORM 10-K
For the Fiscal Year Ended June 30, 2012

  TABLE OF CONTENTS

   
PAGE
PART I
   
     
6
38
49
49
50
50
     
PART II
   
     
50
52
52
59
59
60
60
61
     
PART III
   
     
62
68
72
75
75
     
PART IV
   
     
76
     
   
 
 
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PART I
 
Item 1. Business.
 
Corporate History and Structure

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

By a Stock Purchase and Sale Agreement dated February 14, 2008, we experienced a change in control whereby Vision Opportunity China LP and a number of other investors acquired an aggregate of 1,287,500 shares of common stock from former shareholders for a purchase price of $635,000. Upon this change in control, our board of directors determined that the implementation of our business plan prior to the change in control was no longer financially feasible, and we adopted an acquisition strategy focused on pursuing growth by acquiring undervalued businesses with a history of operating revenues. We utilized several criteria to evaluate prospective acquisitions, including whether the business to be acquired (1) was an established business with viable services or products, (2) had an experienced and qualified management team, (3) had room for growth and/or expansion into other markets, (4) was accretive to earnings, (5) offered the opportunity to achieve and/or enhance profitability, and (6) increased shareholder value.

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

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



 
 
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Shen Kun was incorporated under the laws of the British Virgin Islands on November 7, 2007, and Shen Kun formed SK WFOE under the name “Sheng Kai (Tianjin) Ceramic Valves Co., Ltd.” as a wholly foreign-owned enterprise under the laws of the PRC on April 9, 2008. SK WFOE, one of our operating entities, was subsequently renamed as “Shengkai (Tianjin) Limited” on April 15, 2010.

Tianjin Shengkai, our other operating entity, was organized under the laws of the PRC in June 1994 under the name Tianjin Shengkai Industrial Technology Development Company. Tianjin Shengkai’s business was formerly operated as a collective-owned enterprise. The business was reorganized under the laws of the PRC as a limited liability company under its current name, Tianjin Shengkai Industrial Technology Development Co., Ltd. in April 1999.
 
Shengkai (Tianjin) Trading Ltd., which is wholly-owned by SK WFOE, was organized as a foreign invested enterprise under the laws of the PRC on June 25, 2010 with a total registered capital of RMB500,000. Shengkai (Tianjin) Trading Ltd. is primarily engaged in the international trading of non-valve products to better serve the Company’s international customers.

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

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

Reverse Merger and Private Placements

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

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

Restructuring Transaction: Under the laws of the PRC, certain restrictions are placed on round trip investments, which are defined under PRC law as an acquisition of a PRC entity by an offshore special purpose vehicle owned by one or more PRC residents. As a result, SK WFOE entered into a series of agreements with Tianjin Shengkai which we believe gives us effective control over the business of Tianjin Shengkai.
  
Reverse Merger Transaction:  In the reverse merger transaction, through our wholly-owned subsidiary Shen Kun Acquisition Sub Limited, we acquired control of Shen Kun, a British Virgin Islands company and the parent company of SK WFOE, by issuing to the Shen Kun Shareholders 10,275,000 shares of our common stock, as consideration for all of the outstanding capital stock of Shen Kun.

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

 
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Additionally, on July 18, 2008, we sold Units to Blue Ridge Investments, LLC for aggregate gross proceeds of $5,000,000, at a price of $2.5357 per Unit (the “July 2008 Financing”). Each Unit consists of one share of Series A Preferred Stock, convertible into 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 Series A Preferred Stock.

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

PRC Restructuring

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

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

Consigned Management Agreement

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

Technology Service Agreement

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

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

 
8

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

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

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

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

Exclusive Purchase Option Agreement    

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

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

Equity Pledge Agreement

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

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

The PRC Restructuring Agreements were executed on May 30, 2008. As of June 30, 2012, 100% of the registered capital of SK WFOE had been contributed in accordance with the PRC restructuring agreements.

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

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

 
 
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Reverse Merger Transaction

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

Under the terms of the Merger Agreement and Plan of Reorganization, we acquired control of Shen Kun, a British Virgin Islands company and the parent company of SK WFOE, a wholly foreign-owned entity organized under the laws of the PRC, by issuing 10,275,000 shares of common stock to the Shen Kun shareholders as merger consideration for 100% of the common stock of Shen Kun. Immediately after the closing of the Merger Agreement and Plan of Reorganization, we had a total of 11,056,250 shares of common stock outstanding, with the Shen Kun shareholders (and their assignees) owning approximately 92.9% of our outstanding common stock on a non-diluted basis. Shen Kun Acquisition Sub Limited was dissolved and Shen Kun, the surviving entity, became our wholly-owned subsidiary.
 
Private Placement (June 2008 Financing)

In connection with the consummation of the reverse merger transaction, on June 11, 2008 we consummated a financing for the sale of Units for the aggregate gross proceeds of $15,000,000, at a price of $2.5357 per Unit (“the June 2008 Financing”). Each Unit consists of one share of the Company’s Series A Preferred Stock, convertible into 0.5 share of common stock, and one Warrant equal to 120% of the number of shares of common stock issuable upon conversion of the Series A Preferred Stock. The description of other material terms and conditions of the June 2008 Financing are set forth below.

Securities Purchase Agreement

In connection with the reverse merger transaction, on June 10, 2008 we entered into and on June 11, 2008 consummated a Securities Purchase Agreement (the “June 2008 Purchase Agreement”) with certain Purchasers, namely Vision Opportunity China LP, for the sale of Units at an aggregate purchase price of $15,000,000, each unit consisting of one share of Series A Preferred Stock and one Warrant with an exercise price of $7.04 per share, exercisable for a period of five years from the closing date.

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

Each share of Series A Preferred Stock is convertible, at the option of the holder, into 0.5 share of our common stock, subject to certain limitations, conditions and anti-dilutive adjustments, and to a 9.9% limitation on beneficial ownership of stock. As such, the Series A Preferred Stock are convertible into an aggregate of 2,957,763 shares of our common stock. In the event that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party, a holder has the right to exercise certain buy-in rights, pursuant to which the Company shall either (i) compensate the actual loss suffered by the holder in this required transaction due to failure of delivery of common stock by the Company (based on that (x) the amount of the total purchase price exceeds (y) the amount obtained from the sale order), or either (i) reinstate the shares of the Series A Preferred Stock that was intended to be converted, or (ii) deliver the number of shares of common stock that should have been issued if the conversion had been honored.

 
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The Warrants are exercisable in the aggregate for up to 3,549,316 shares of our common stock, or 120% of the total number of shares of common stock issuable upon conversion of the Series A Preferred Stock purchased by each Purchaser, subject to a 9.9% limitation on beneficial ownership of common stock. The Warrants are exercisable for a term of five years from June 10, 2008 and may be exercised at any time after 18 months following June 10, 2008 if we do not have an effective registration statement to cover the common stock underlying the Warrants.  In the event that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party, a holder has the right to exercise certain buy-in rights, pursuant to which the Company shall (i) compensate the actual loss suffered by the holder in this required transaction due to failure of delivery of common stock by the Company (based on that (x) the amount of the total purchase price exceeds (y) the amount obtained from the sale order), and either (i) reinstate the shares of the Series A Preferred Stock that was intended to be converted, or (ii) deliver the number of shares of common stock that should have been issued if the conversion had been honored.

On September 16, 2007, the Company entered into a Financial Consulting Agreement (the “Mass Harmony Agreement”) with Mass Harmony Asset Management Limited (“Mass Harmony”). Pursuant to the Mass Harmony Agreement, Mass Harmony received an aggregate of 225,000 shares of common stock and 5% of the gross proceeds of the June 2008 Financing in Warrants, equivalent to warrants exercisable in the aggregate of up to 106,534 shares of our common stock. The services provided by Mass Harmony under the Mass Harmony Agreement include performing initial due diligence on the Company, preparing our business plan, and assisting in the corporate restructuring and financial documentation.
 
Pursuant to the Second Amendment to the June 2008 Purchase Agreement dated as of July 31, 2008, we are required to list and trade our shares of common stock on the Nasdaq Capital Market, the Nasdaq Global Market, the American Stock Exchange or any successor market thereto within eighteen (18) months of the First Closing, or our principal shareholder, Li Shaoqing (the “Principal Shareholder”), will be required to deliver to Vision Opportunity China LP an aggregate of 375,000 shares of common stock.

The Purchase Agreement also grants the following significant rights to Vision Opportunity China LP and places the following significant restrictions and obligations on us:
 
·
Subsequent financing participation. For two years after the date on which the initial registration statement to be filed by the Company under the registration rights agreement described below is declared effective by the Securities and Exchange Commission (“SEC”), Purchasers who continue to hold Series A Preferred Stock have the right to participate in any subsequent sale of securities by the Company in order to purchase up to its pro rata portion of the total amount of securities sold in the subsequent sale equal to the percentage of the total Series A Preferred Stock issued in the June 2008 Financing.
 
·
Consent for asset sale. We may not sell all or a substantial portion of our assets, except to a subsidiary, without the consent of the holders of a majority of the then-outstanding Series A Preferred Stock.
 
·
Chief Financial Officer/Vice President of Investor Relations. As soon as possible after the First Closing, we are required to use our best efforts to appoint an individual who is fluent in English and acceptable to Vision Opportunity China LP to serve as Chief Financial Officer and/or Vice President of Investor Relations.
 
·
Investor relations fund. We must maintain an escrow account with $500,000 in connection with monies to be used for investor and public relations services. The escrow account was established through the Investor and Public Relations Escrow Agreement described below and was funded at the Closing. Out of this amount, $150,000 shall be released from escrow once we appoint a Chief Financial Officer or Vice President of Investor Relations. An additional $150,000 will be released to us after we engage a new independent registered accounting firm that is listed as one of the top 20 firms by stock market client number as calculated by Hemscott Group Limited, a division of Morningstar, Inc. As of June 30, 2012, all of the $500,000 had been released back to the Company.
 
 
12

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

On June 10, 2008 we entered into and on June 11, 2008 consummated a securities escrow agreement with Vision Opportunity China LP, as representative of the Purchasers under the June 2008 Purchase Agreement, the Principal Shareholder, and Loeb & Loeb LLP, as escrow agent (the “Securities Escrow Agreement”). In the Securities Escrow Agreement, as an inducement to the Purchasers to enter into the June 2008 Purchase Agreement, the Principal Shareholder agreed to deliver an aggregate of 2,957,763 shares of our common stock (the amount of common stock underlying the Series A Preferred Stock) (the “Vision Escrow Shares”) to the escrow agent for the benefit of the Purchasers, and to forfeit some or all of those shares to the Purchasers in the event we fail to achieve certain financial performance thresholds for the 12-month periods ending June 30, 2008 and June 30, 2009.

Pursuant to the Second Amendment to the June 2008 Purchase Agreement and the First Amendment to the June 2008 Securities Escrow Agreement, both dated as of July 31, 2008, if we fail to list our common stock on the Nasdaq Capital Market, Nasdaq Global Market, American Stock Exchange or any successor market thereto within eighteen (18) months of June 10, 2008, 375,000 shares of common stock owned by Principal Shareholder will be distributed to Vision Opportunity China LP.

As of June 30, 2012, pursuant to the terms of the Securities Escrow Agreement, all shares held in escrow had been released back to the Principal Shareholder.

Investor and Public Relations Escrow Agreement
 
On June 10, 2008 we entered into and on June 11, 2008 consummated an Investor and Public Relations Agreement with Vision Opportunity China LP and Sichenzia Ross Friedman Ference LLP, as escrow agent. Pursuant to the agreement, $500,000 of the proceeds of the June 2008 Financing was deposited into an escrow account with Sichenzia Ross Friedman LLP for use in investor and public relations services. The escrow account was established through the Investor and Public Relations Escrow Agreement described below and was funded at the closing. Out of this amount, $150,000 shall be released from escrow once we appoint a Chief Financial Officer or Vice President of Investor Relations. An additional $150,000 will be released to us after we engage a new independent registered accounting firm that is listed as one of the top 20 firms by stock market client number as calculated by Hemscott Group Limited, a division of Morningstar, Inc. As of June 30, 2012, all of the $500,000 had been released back to the Company.

Registration Rights Agreement

On June 10, 2008 we entered into and on June 11, 2008 consummated a Registration Rights Agreement with Vision Opportunity China LP (the “Vision RRA”), under which we agreed to prepare and file with the SEC and maintain the effectiveness of a “resale” registration statement pursuant to Rule 415 under the Securities Act (“Rule 415”) providing for the resale of (i) all of the shares of common stock issuable on conversion of the Series A Preferred Stock, (ii) all of the shares of common stock issuable upon exercise of the Warrants, (iii) 652,375 shares of common stock held by certain shareholders before the Reverse Merger Transaction, (iv) all of the Vision Escrow Shares delivered to Vision Opportunity China LP under the Securities Escrow Agreement described above, and (v) all of the 375,000 shares of common stock that the Principal Shareholder will be required to deliver to Vision Opportunity China LP in case the Company does not meet the deadline for listing on a national securities exchange.
 
 
13

 
Under the terms of the Vision RRA, we are required to have a registration statement filed with the SEC within 45 days after the earlier of the date of the Second Closing or June 30, 2008, and declared effective by the SEC not later than November 27, 2008. We filed the registration statement on August 7, 2008, and it was declared effective by the SEC on August 21, 2008.
 
We are required to pay liquidated damages in an amount equal to 1 percent of Vision Opportunity China LP’s initial acquisition of Series A Preferred Stock pursuant to the June 2008 Purchase Agreement for each month past the relevant deadline that the registration statement is not filed or not declared effective, for any period that we fail to keep the registration statement effective, or for any period that we cause our common stock to be delisted from the Over-the-Counter Bulletin Board (or other principal exchange on which it is traded), up to a maximum of 10 percent of the purchase amount of the Units. The number of shares of Series A Preferred Stock issuable pursuant to the liquidated damages provision is subject to reduction based on the maximum number of shares that can be registered under Rule 415.

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

The terms of the Vision RRA are subject to a registration rights agreement that was consummated on June 11, 2008 by and between the Company and certain shareholders pre-existing the reverse merger (the “Shareholder RRA”). Under the terms of the Shareholder RRA, the Company granted registration rights to certain shareholders existing prior to the reverse merger transaction, by which the shareholders were granted registration rights for the registration of an aggregate of 652,375 shares of common stock. The shareholders will be entitled to cash liquidated damages in the amount equal to .75% of the value of each shareholder’s registrable securities (using a value of $5.08 per share to calculate the amount of such shareholder’s registrable securities) on the date that it fails to register the securities under the terms of the agreement and for each calendar month or portion thereof until the failure is cured, up to a maximum amount of 10% of the value of the shareholder’s securities (using a value of $5.08 per share to calculate the amount of such shareholder’s registrable securities).

Lock-Up Agreement

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

The shareholders subject to the Lock-Up Agreement are:  

·  
Wang Chen, our CEO.
·  
Li Shaoqing
·  
Guo Wei
·  
Liu Xiaoqian
·  
He Li
·  
Ruan Xiangyi
·  
Li Juan

 
14

 
Private Placement (July 2008 Financing)

On July 18, 2008, we sold to Blue Ridge Investment, LLC, Units for aggregate gross proceeds of $5,000,000, at a price of $2.5357 per Unit (the “July 2008 Financing”). As in the June 2008 Financing, each Unit consists of one share of Series A Preferred Stock, convertible into 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 Series A Preferred Stock. The description of other material terms and conditions of the July 2008 Financing are set forth below.

Securities Purchase Agreement

On July 18, 2008, we entered into and consummated a Securities Purchase Agreement (the “July 2008 Purchase Agreement”) with Blue Ridge Investments, LLC for the sale of Units at an aggregate purchase price of $5,000,000, each unit consisting of one share of Series A Preferred Stock and one Warrant with an exercise price of $7.04 per share, exercisable for a period of five years from issuance.
 
Each share of Series A Preferred Stock is convertible, at the option of the holder, into one share of our common stock, subject to certain limitations, conditions and anti-dilutive adjustments, and to a 9.9% limitation on beneficial ownership of stock. As such, the Series A Preferred Stock are convertible into an aggregate of 985,921 shares of our common stock. In the event that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party, a holder has the right to exercise certain buy-in rights, pursuant to which the Company shall either (i) compensate the actual loss suffered by the holder in this required transaction due to failure of delivery of common stock by the Company (based on that (x) the amount of the total purchase price exceeds (y) the amount obtained from the sale order), or either (i) reinstate the shares of the Series A Preferred Stock that was intended to be converted, or (ii) deliver the number of shares of common stock that should have been issued if the conversion had been honored.

The Warrants are exercisable in the aggregate for up to 1,183,106 shares of our common stock, or 120% of the total number of shares of common stock issuable upon conversion of the Series A Preferred Stock purchased by each Purchaser, subject to a 9.9% limitation on beneficial ownership of common stock. The Warrants are exercisable for a term of five years from July 18, 2008 and may be exercised at any time after 18 months following July 18, 2008 if we do not have an effective registration statement to cover the common stock underlying the Warrants. In the event that the Company is unable to deliver the shares upon conversion while the holder has transacted to sell such underlying shares to a third party, a holder has the right to exercise certain buy-in rights, pursuant to which the Company shall (i) compensate the actual loss suffered by the holder in this required transaction due to failure of delivery of common stock by the Company (based on that (x) the amount of the total purchase price exceeds (y) the amount obtained from the sale order), and either (i) reinstate the shares of the Series A Preferred Stock that was intended to be converted, or (ii) deliver the number of shares of common stock that should have been issued if the conversion had been honored.

Pursuant to the Mass Harmony Agreement dated as of September 16, 2007, Mass Harmony also received 5% of the gross proceeds of the July 2008 Financing in Warrants, equivalent to warrants exercisable in the aggregate of up to 35,512 shares of our common stock. The services provided by Mass Harmony under the Mass Harmony Agreement include performing initial due diligence on the Company, preparing our business plan, and assisting in the corporate restructuring and financial documentation.
 
Pursuant to the First Amendment to the July 2008 Purchase Agreement dated as of July 31, 2008, we are required to list and trade our shares of common stock on the Nasdaq Capital Market, Nasdaq Global Market, American Stock Exchange or any successor market thereto within eighteen (18) months of July 18, 2008, or the Principal Shareholder, will be required to deliver to Blue Ridge Investments, LLC an aggregate of 125,000 shares of common stock.
 
 
15

 
The July 2008 Purchase Agreement also grants the following significant rights to Blue Ridge Investments, LLC and places the following significant restrictions and obligations on us:

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

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

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

·  
Investor relations fund. We must maintain an escrow account with $500,000 in connection with monies to be used for investor and public relations services. The escrow account was established through the Investor and Public Relations Escrow Agreement entered into by and between the Company, Vision Opportunity China LP and Sichenzia Ross Friedman Ference LLP, as escrow agent, dated as of June 10, 2008 and was funded on June 11, 2008. Out of this amount, $150,000 shall be released from escrow once we appoint a Chief Financial Officer or Vice President of Investor Relations. An additional $150,000 will be released to us after we engage a new independent registered accounting firm that is listed as one of the top 20 firms by stock market client number as calculated by Hemscott Group Limited, a division of Morningstar, Inc. As of June 30, 2012, all of the $500,000 had been released back to the Company.

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

Securities Escrow Agreement

On July 18, 2008, we consummated a securities escrow agreement with Blue Ridge Investments, LLC, the Principal Shareholder, and Loeb & Loeb LLP, as escrow agent (the “July 2008 Securities Escrow Agreement”). In the Securities Escrow Agreement, as an inducement to Blue Ridge Investments, LLC to enter into the July 2008 Purchase Agreement, the Principal Shareholder agreed to deliver an aggregate of 985,921 shares of our common stock (the amount of common stock underlying the Series A Preferred Stock) (the “Blue Ridge Escrow Shares”) to the escrow agent for the benefit of Blue Ridge Investments, LLC, and to forfeit some or all of those shares to Blue Ridge Investments, LLC in the event we fail to achieve certain financial performance thresholds for the 12-month periods ending June 30, 2008 (“2008”) and June 30, 2009 (“2009”).
 
Pursuant to the First Amendment to the July 2008 Purchase Agreement and the First Amendment to the July 2008 Securities Escrow Agreement, both dated as of July 31, 2008, if we fail to list our common stock on the Nasdaq Capital Market, Nasdaq Global Market, American Stock Exchange or any successor market thereto within 18 months of July 18, 2008, 125,000 shares of common stock owned by Principal Shareholder will be distributed to Blue Ridge Investments, LLC.
 
 
16

 
As of June 30, 2012, pursuant to the terms of the Securities Escrow Agreement, all shares held in escrow had been released back to the Principal Shareholder.

Registration Rights Agreement

On July 18, 2008 we entered into and consummated a Registration Rights Agreement with Blue Ridge Investments, LLC (the “Blue Ridge RRA”), under which we agreed to prepare and file with the SEC and maintain the effectiveness of a “resale” registration statement pursuant to Rule 415 under the Securities Act (“Rule 415”) providing for the resale of: (i) all of the shares of common stock issuable on conversion of the Series A Preferred Stock, (ii) all of the shares of common stock issuable upon exercise of the Warrants, (iii) all of the Blue Ridge Escrow Shares delivered to Blue Ridge Investments, LLC under the July 2008 Securities Escrow Agreement described above, and (iv) all of the 125,000 shares of common stock that the Principal Shareholder will be required to deliver to Blue Ridge Investments, LLC in case the Company does not meet the deadline for listing on a national securities exchange.
 
Under the terms of the Blue Ridge RRA, we are required to have a registration statement filed with the SEC within 45 days after the date of the Closing Date, or September 1, 2008, and declared effective by the SEC not later than December 15, 2008.

We are required to pay liquidated damages to Blue Ridge Investments, LLC in an amount equal to 1% of Blue Ridge Investments, LLC initial acquisition of Series A Preferred Stock pursuant to the July 2008 Purchase Agreement for each month past the relevant deadline that the registration statement is not filed or not declared effective, for any period that we fail to keep the registration statement effective, or for any period that we cause our common stock to be delisted from the Over-the-Counter Bulletin Board (or other principal exchange on which it is traded), up to a maximum of 10% of the purchase amount of the Units. The number of shares of Series A Preferred Stock issuable pursuant to the liquidated damages provision is subject to reduction based on the maximum number of shares that can be registered under Rule 415.
   
The registration rights agreement also provides for additional demand registration rights in the event that Vision Opportunity China LP unable to register all of the registrable securities in the initial registration statement and grants holders of registrable securities customary piggy back rights during any time when there is not an effective registration statement providing for the resale of the registrable securities.

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

The terms of the Blue Ridge RRA are also subject to the Shareholder RRA. Under the terms of the Shareholder RRA, the Company granted registration rights to certain shareholders existing prior to the reverse merger transaction, by which the shareholders were granted registration rights for the registration of an aggregate of 652,375 shares of common stock, as described in more detail in the section entitled “Private Placement (June 2008 Financing)” above.

Warrant Amendment Agreement

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

 
17

 
Recent Public Offerings

On November 19, 2010, we entered into an underwriting agreement with Maxim Group LLC and Global Hunter Securities, LLC relating to the issuance and sale in a public offering of 1,228,400 shares of the Company’s common stock, at a price of $11.00 per share for an aggregate gross purchase consideration of $13,512,400. The sale and purchase of the shares closed on November 24, 2010.

On December 17, 2010, we entered into another underwriting agreement with Maxim Group LLC and Global Hunter Securities, LLC relating to the issuance and sale in a public offering of 529,323 shares of the Company’s common stock, at a price of $11.00 per share for an aggregate gross purchase consideration of $5,822,553. The sale and purchase of the shares closed on December 22, 2010.

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

Reverse Stock Split

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 Annual Report on Form 10-K, in the consolidated financial statements and accompanying notes has been retroactively restated to reflect this reverse stock split.

Subsidiaries

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

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

The Company develops ceramic products with more than 776 types and specifications in 36 series, under 9 categories. Of these, 46 national patents have been obtained for its valve products. Our product won the title of “National Key New Product” four times from 1999-2003 and won a silver medal in the Shanghai International Industry Fair in 2002. In 2003, we obtained API authentication allowing export to North America and the Asia-Pacific region and CE authentication allowing export to EU in 2003.

 
18

 
Presently, the technology of most other domestic and overseas industrial ceramic valves manufacturers limits production to small-bore ball valves. In contrast, we produce a variety of ceramics in every category (gate valve, ball valve, back valve, adjustable valve, cut-off valve and special valve) and produce more than 776 specifications that sustain a maximum pressure level of 42MPa. The largest ceramic valve caliber that the Company is able to make is 1,000mm. Currently, we believe that most other manufacturers in the world primarily produce ceramic ball valves and ceramic adjustable valves with 150mm caliber or less.

Business History
 
Tianjin Shengkai was established in June 1994 with registered capital of RMB310,000 and an initial business scope covering the production and sales of spray mixtures and ceramic valves. The stock ownership was jointly held by eight shareholders including Wang Chen, the largest shareholder of the company.
 
In October 1995, Tianjin Shengkai increased its registered capital to RMB1 million through capital and equity increase; Wang Chen contributed RMB810,000 and the remaining shares were held by the other seven shareholders. In November 2000, the registered capital increased to RMB15 million and the company’s business scope was changed to the design, manufacturing and sales of ceramic valves, manufacturing and sales of high-tech ceramic material, technical consultation and service, and export of such products and related technologies.
 
Operations of the Company
 
The Company designs, manufactures and distributes ceramic valves in 36 series under 9 categories, covering almost every general type of valve available for industrial use in the world. Our valve sizes range from 32mm to 1000mm and can withstand pressure up to 42MPa. The Company provides a series of services related to industrial ceramic valves, including manufacture, installation and maintenance of general industrial ceramic valves, as well as the design and manufacture of various non-standard ceramic valves as required by customers’ special operating conditions.

Production is comprised of three processes: ceramic piece production, machine-work of ceramic and metal components, and assembly. Currently, the total area of the production plant is approximately 22,000 m2, with 168 sets of machine tools, of which 49 sets are for ceramics, and 119 sets of digitally controlled machine tools for metal components. Ceramic valve output in fiscal year 2012 was 5,461 sets.

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

·  
adding zirconia to alumina ceramics to increase toughness and resistance to corrosion;
·  
successfully using Martensite transformation toughening technology to increase toughness and reduce deformability;
·  
applying nano-sized powder technology to improve toughness and other features; and
·  
altering existing metal processors so as to enable us to apply cold-working techniques to its ceramic products.

The Company has developed a solid solution and agent that lowers firing temperature and enhances the homogeneous dispersion of ceramic pulp, applying the theories of solid solution, chemical dispersion and the rational sintering temperature curve. This technology effectively controls the contraction ratio during the ceramic sintering process to greatly improve the success rate of finished products. Currently, the success rate of sintered finished goods of various calibers of our valve products has reached over 95%, and firing temperatures for our products are 80°C-120°C lower than the world standard in the industry.

The Company has also developed various technologies under various temperatures, so as to solve problems that arise from the combination of ceramics and metal with different coefficients of thermal expansion and to ensure that the valves produced are leak-proof. The Company mainly selects ceramic material of partially stabilized zirconia (PSZ), tetragonal zirconia polycrystal (TZP), zirconia-toughened alumina (ZTA) and zirconia toughened mullite (ZTM).
 
 
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We believe that our ability to produce a comprehensive category of high-quality ceramic products, together with our self-developed ceramic processor, leak-proof valve sealing technology and strong technology development capacity, distinguish us from our domestic and international competitors.
 
The Company expensed all research and development costs as incurred.  Research and development expenses incurred for the years ended June 30, 2012, 2011 and 2010 were $830,453, $885,694, and $865,098, respectively.

Products  
 
The Company mainly produces industrial ceramic valves with calibers primarily ranging from 150mm to 400mm and the largest up to 1,000mm in various types and in different combinations of ceramic and metal coefficients, depending on their use. Ceramic valves perform significantly better than metal valves due to higher wear resistance, corrosion resistance, and high temperature resistance. We estimate that the average service life of our ceramic valves is at least 10 times of that of comparably-sized metal valves currently in the market.
 
Customers and Suppliers
 
Customers
 
For the year ended June 30, 2012, the Company’s top 10 customers and sales amount were as follows:

 
Name
 
Amount (RMB)
 
 
Company A2
 
9,170,598
 
 
Company B2
 
7,933,128
 
 
Company C2
 
6,315,957
 
 
Company D2
 
6,220,504
 
 
Company E2
 
5,858,684
 
 
Company F2
 
5,031,705
 
 
Company G2
 
4,583,692
 
 
Company H2
 
4,553,444
 
 
Company I2
 
4,049,991
 
 
Company J2
 
3,809,402
 

Our top 10 customers contributed approximately 28.02% of total sales in the fiscal year ended June 30, 2012. No customer individually accounted for more than 5.0% of total sales.

For the year ended June 30, 2011, the Company’s top 10 customers and sales amount were as follows:

 
Name
 
Amount (RMB)
 
 
Company A1
 
 15,436,854
 
 
Company B1
 
15,201,218
 
 
Company C1
 
 15,192,477
 
 
Company D1
 
 13,045,152
 
 
Company E1
 
 11,580,546
 
 
Company F1
 
10,227,483
 
 
Company G1
 
9,958,916
 
 
Company H1
 
8,904,200
 
 
Company I1
 
8,187,930
 
 
Company J1
 
8,061,286
 
 
 
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Our top 10 customers contributed approximately 18.67% of total sales in the fiscal year ended June 30, 2011. No customer individually accounted for more than 2.5% of total sales.

For the year ended June 30, 2010, the Company’s top 10 customers and sales amount were as follows:

 
Name
 
Amount (RMB)
 
 
Company A0
 
  14,817,953
 
 
Company B0
 
  12,864,216
 
 
Company C0
 
  10,057,418
 
 
Company D0
 
   9,899,652
 
 
Company E0
 
   9,510,417
 
 
Company F0
 
   9,256,051
 
 
Company G0
 
   8,776,934
 
 
Company H0
 
   8,742,355
 
 
Company I0
 
   8,324,038
 
 
Company J0
 
   8,318,369
 

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

Suppliers

For the year ended June 30, 2012, the Company’s top 10 suppliers and purchase amount were as follows:
  
 
Name
 
Amount (RMB)
 
 
Company K2
 
7,451,607
 
 
Company L2
 
6,255,179
 
 
Company M2
 
4,923,213
 
 
Company N2
 
4,769,632
 
 
Company O2
 
4,352,782
 
 
Company P2
 
4,262,532
 
 
Company Q2
 
4,036,635
 
 
Company R2
 
3,573,453
 
 
Company S2
 
3,244,823
 
 
Company T2
 
3,222,639
 

Our top 10 suppliers accounted for approximately 43.24% of total purchases in the fiscal year ended June 30, 2012. No supplier individually accounted for more than 7.0% of total purchases.

For the year ended June 30, 2011, The Company’s top 10 suppliers and purchase amount were as follows:
  
 
Name
 
Amount (RMB)
 
 
Company K1
 
       19,529,878
 
 
Company L1
 
       18,280,829
 
 
Company M1
 
       17,852,974
 
 
Company N1
 
       16,260,701
 
 
Company O1
 
       15,646,681
 
 
Company P1
 
       15,167,910
 
 
Company Q1
 
       15,016,554
 
 
Company R1
 
       14,157,778
 
 
Company S1
 
       13,781,855
 
 
Company T1
 
       13,775,086
 

 
21

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

For the year ended June 30, 2010, the Company’s top 10 suppliers and purchase amount were as follows:
  
 
Name
 
Amount (RMB)
 
 
Company K0
 
   10,993,789
 
 
Company L0
 
     8,873,372
 
 
Company M0
 
     8,083,137
 
 
Company N0
 
     6,471,029
 
 
Company O0
 
     5,826,316
 
 
Company P0
 
     5,397,730
 
 
Company Q0
 
     4,635,150
 
 
Company R0
 
     4,619,398
 
 
Company S0
 
     4,354,719
 
 
Company T0
 
     4,337,680
 

Our top 10 suppliers accounted for approximately 32.29% of total purchase in the fiscal year ended June 30, 2010. No supplier individually accounted for more than 5.6% of total purchases.

Marketing and Sales

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

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

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

Sales training: Each member of sales personnel in the Company is trained in grass-roots production before starting work, so as to become familiar with production flow and product characteristics. The HR department has prepared a training plan aimed at sales personnel to educate them in sales and product. To ensure the professionalism of our employees, all of our sales personnel must pass an exam following training before they may start work.
 
Value-added services: The Company is working to enhance the quality of our before-sales, during sales and after-sales service. Shengkai has developed before-sales technical design service to achieve a perfect connection of product with customer demand.
 
Competition
 
Competitive Environment
 
 
22

 
Currently, the world ceramic valve industry is still in its infancy. Ceramic valves represent a very small proportion in the industrial valve industry.
  
The Company’s main competitors are manufacturers of metal valves, which currently still represent the majority market share in the valve market. Although the unit price of metal valves is typically cheaper than the unit price of ceramic valves, ceramic valves are more durable than metal valves and as such are more cost-effective than metal valves. Primary Chinese metal valve competitors include Henan Kaifeng High Pressure Valve Co., Ltd., CNNC Sufa Technology Industry Co., Ltd, Neway Valve (Suzhou) Co., Ltd. and Lanzhou High-Pressure Valves Co., Ltd., etc.
 
Within the ceramic valve industry, the business of our primary ceramic valve competitors is briefly described below:
 
Cera System GmbH. Primary line of business: high quality ceramic ball valve and ceramic pipeline manufacture. Single equipment is used for structural ceramics production, resulting in few varieties, small caliber and high production cost of ceramic valves.

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

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

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

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

Our Competitive Advantages

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

Presently, the technology of other domestic and overseas industrial ceramic valve manufacturers limits their production to small-bore ball valves. In contrast, the Company produces a variety of ceramic valves in every category (gate valve, ball valve, back valve, adjustable valve, cut-off valve and special valve, etc.) and produces more than 776 specifications that sustain a maximum pressure level of 42MPa. The largest ceramic valve caliber the Company is able to make is 1,000mm. Currently, we believe that most of other manufacturers in the world only produce ceramic ball valves and ceramic adjustable valves with 150mm caliber or less. We believe that our ability to produce a comprehensive category of high-quality ceramic products, together with our self-developed ceramic processor, leak-proof valve sealing technology and strong technology development capacity, set us apart from our domestic and international competitors.

Our Future Goals
 
 
23

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

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

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

·  
Internationalization. We plan to make further efforts to gain brand awareness in the overseas valve market. As such, we will keep expanding market share in the international market.

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

The commercial production at our new manufacturing plant officially began in September 2010. Our headquarters building was also completed in September 2010. The new facility increases our annual production capacity to 24,000 sets of ceramic valves based on one-shift operation. In the event that we reach 100% production capacity at the new facility, we will be able to further increase our production capacity by adding shifts for some of the production processes and/or by adding additional machines at space available within the same facility.
 
In the past one and half 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. This has resulted in considerable loss of business since June 2011, and a higher turnover in the Company’s sales agents and representatives. Some of the Company’s other customers have seized this opportunity to demand price cuts from the Company. Meanwhile, some of the Company’s competitors also have seized this opportunity to take away our customers. In addition, in the year ended June 30, 2012, 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 survive with prolonged collection of accumulated trade receivables.

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

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

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

Raw Materials and Equipment

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

 
24

 
Technology Development

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

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

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

Patents

We have applied for and obtained 46 patents in the PRC for the following products:

No.
 
Utility Models
 
Utility Models No.
 
Designer
 
Application
Date
 
Authorized
Announce-
ment Date
 
Owner
 
 
 
 
 

XNAS:VALV Annual Report 10-K Filling

XNAS:VALV Stock - Get Annual Report SEC Filing of XNAS:VALV stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

XNAS:VALV Annual Report 10-K Filing - 9/10/2012
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