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

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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
 
 
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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     

 
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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
 
 
 
 
 
 
 
 
 
 
 
 
 
1
 
High temperature and high Pressure ceramic check valves in power station
 
ZL 200420029890.0
 
Wang Chen
 
10/10/2004
 
2/1/2006
 
Tianjin Shengkai
2
 
Preventing slag at the bottom of the wedge and abrasion-resistant ceramic slag-off valves
 
ZL 200420029889.8
 
Wang Chen
 
10/10/2004
 
2/1/2006
 
Tianjin Shengkai
3
 
Anti-fouling ceramic seal discharge valves
 
ZL 200420029887.9
 
Wang Chen
 
10/10/2004
 
12/7/2005
 
Tianjin Shengkai
4
 
Reciprocating sliding dual- plate ceramic sealing valves
 
ZL 200420029886.4
 
Wang Chen
 
10/10/2004
 
2/1/2006
 
Tianjin Shengkai
5
 
New ceramic replica valves
 
ZL 200420029885.X
 
Wang Chen
 
10/10/2004
 
11/9/2005
 
Tianjin Shengkai
6
 
External composite armor plate for tank
 
ZL 2004 2 0029600.2
 
Wang Chen
 
8/24/2004
 
8/3/2005
 
Tianjin Shengkai
7
 
The new V-shaped channel spherical valves
 
ZL 2004 2 0029601.7
 
Wang Chen
 
8/3/2004
 
8/3/2005
 
Tianjin Shengkai
8
 
Cavitation and erosion-resistant high-pressure adjusting valves
 
ZL 2004 2 0029602.1
 
Wang Chen
 
8/24/2004
 
8/3/2005
 
Tianjin Shengkai
9
 
New ceramic three links valves
 
ZL 2004 2 0029603.6
 
Wang Chen
 
8/24/2004
 
8/3/2005
 
Tianjin Shengkai
10
 
Ceramic valves with purge devices
 
ZL 200820002560
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
11
 
Throttle ceramic valves
 
ZL 200820002561.5
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
12
 
Fast-opening ceramic adjusting valves
 
ZL 200820002565.3
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
13
 
Eccentric anti-seize abrasion-resistant spherical valves
 
ZL 200820002564.9
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
 
 
25

 
 
14
 
Spherical ceramic adjusting valves
 
ZL 200820002562.X
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
15
 
Ceramic butterfly valves
 
ZL 200820002563.4
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
16
 
Ceramic seal switching valves
 
ZL 200820002566.8
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
17
 
Fine-tuning ceramic adjusting valves
 
ZL 200820002567.2
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
18
 
Hemispherical ceramic adjusting valves
 
ZL 200820002559.8
 
Wang Chen
 
1/22/2008
 
2/1/2008
 
Tianjin Shengkai
19
 
Ceramic ball check valves
 
200920179548.1
 
Wang Chen
 
10/12/2009
 
11/4/2009
 
Tianjin Shengkai
20
 
Three links switching ceramic cut-off valves
 
200920179544.3
 
Wang Chen
 
10/12/2009
 
11/4/2009
 
Tianjin Shengkai
21
 
Pneumatic ceramic seal shut-off valve
 
200920179546.2
 
Wang Chen
 
10/12/2009
 
11/4/2009
 
Tianjin Shengkai
22
 
An enhanced ceramic sphere
 
200920179545.8
 
Wang Chen
 
10/12/2009
 
11/4/2009
 
Tianjin Shengkai
23
 
Ceramic ball cut-off valves
 
200920179547.7
 
Wang Chen
 
10/12/2009
 
9/28/2010
 
Tianjin Shengkai
24
 
High pressure ceramic flat gate valve
 
200920179550.9
 
Wang Chen
 
10/12/2009
 
9/10/2010
 
Tianjin Shengkai
25
 
Ceramic seal swing check valves
 
200920179549.6
 
Wang Chen
 
10/12/2009
 
5/11/2011
 
Tianjin Shengkai
26
 
Throttle ceramic cut-off valve
 
200920179551.3
 
Wang Chen
 
10/12/2009
 
6/22/2011
 
Tianjin Shengkai
27
 
Ceramic Liner
 
201020576395.7
 
Wang Chen
 
10/26/2010
 
5/11/2011
 
Tianjin Shengkai
28
 
High Temperature Ceramic Nozzle
 
201020576411.2
 
Wang Chen
 
10/26/2010
 
5/25/2011
 
Tianjin Shengkai
29
 
Ceramic Spray Nozzle
 
201020576415.0
 
Wang Chen
 
10/26/2010
 
5/11/2011
 
Tianjin Shengkai
30
 
Ceramic Piston Pump
 
201020576428.8
 
Wang Chen
 
10/26/2010
 
6/8/2011
 
Tianjin Shengkai
31
 
Ceramic Pump
 
201020576436.2
 
Wang Chen
 
10/26/2010
 
6/15/2011
 
Tianjin Shengkai
32
 
Ceramic Valv Stem
 
201020576439.6
 
Wang Chen
 
10/26/2010
 
5/4/2011
 
Tianjin Shengkai
33
 
Ceramic Plunger
 
201020576448.5
 
Wang Chen
 
10/26/2010
 
4/27/2011
 
Tianjin Shengkai
34
 
Thermocouple Protection
 
201020576462.5
 
Wang Chen
 
10/26/2010
 
6/8/2011
 
Tianjin Shengkai
35
 
Ceramic Butterfly Disc
 
201120264468.3
 
Wang Chen
 
7/26/2011
 
5/9/2012
 
Tianjin Shengkai
36
 
Invisible Rod Knife-shape Ceramic Gate Valve
 
201120264469.8
 
Wang Chen
 
7/26/2011
 
3/21/2012
 
Tianjin Shengkai
37
 
Ceramic Ball used in Corrosive Media
 
201120264470.0
 
Wang Chen
 
7/26/2011
 
5/9/2012
 
Tianjin Shengkai
38
 
Flat Ceramic Gate Valve with Diversion Hole
 
201120265746.7
 
Wang Chen
 
7/26/2011
 
3/28/2012
 
Tianjin Shengkai
39
 
Full-lined Sliding Gate
 
201120265747.1
 
Wang Chen
 
7/26/2011
 
2/15/2012
 
Tianjin Shengkai
40
 
Large-diameter Ball Valve Structure
 
201120265748.6
 
Wang Chen
 
7/26/2011
 
2/15/2012
 
Tianjin Shengkai
41
 
Coat Ceramic Ball
 
201120265749.0
 
Wang Chen
 
7/26/2011
 
3/28/2012
 
Tianjin Shengkai
42
 
High Pressure Fixed Ceramic Ball Valve
 
201120265750.3
 
Wang Chen
 
7/26/2011
 
3/14/2012
 
Tianjin Shengkai
43
 
High Pressure Valve in Coal-chemical System
 
201120265771.5
 
Wang Chen
 
7/26/2011
 
2/8/2012
 
Tianjin Shengkai
44
 
Ceramic Plug Valve
 
201120265773.4
 
Wang Chen
 
7/26/2011
 
2/15/2012
 
Tianjin Shengkai
45
 
Anti-body Deformation of the Large-diameter Gate Valve
 
201120265772.x
 
Wang Chen
 
7/26/2011
 
2/8/2012
 
Tianjin Shengkai
46
 
Ceramic Disc Grinding Cylindrical Fixture
 
201120265775.3
 
Wang Chen
 
7/26/2011
 
3/21/2012
 
Tianjin Shengkai
 
 
26

 
Shengkai has patent applications pending for the following products:

Name
 
Patent No.
 
Application Date
Ceramic Valve Ball Machining Tooling
 
201120265774.9
 
7/26/2011

Trademarks and Domain Names

Shengkai has registered seven trademarks for “SK” and “Shengkai” with the Trademark Bureau under the State of Administration for Industry & Commerce in China, and one trademark for “SKYCERA” with United States Patent and Trademark Office, all of which are effective:
 
Trademark
 
Certificate
No.
 
Category
 
Registrant
 
Valid Term
“SK”
 
No.1717597
 
No.6: metal valves (parts of non-machinery), metallic pipe fittings, metallic pipe reinforcement material, metallic pipes fittings of compressed air pipes, metallic pipes, metallic pipes of air conditioning equipment, metallic drip valves, metallic sleeve, conduits and pipes of central heating equipments, metallic pipes of central heating
 
Tianjin Shengkai
 
2/21/2002 to 2/20/2022
 
No.4152529
 
No.2: black clear lacquer, chinaware silver lacquer, platinum glaze for brightening ceramic materials, ceramic coating, white dye or paint, non-viscous chemical coating, within and external walls of bright water-soluble spray plastic, metal anti-rust formulations, metal used protection formulations, ceramic materials with paint, antirust oil
 
Tianjin Shengkai
 
5/7/2007 to 5/6/2017
 
No.4152532
 
No.20: non-metallic valves, non-metallic ball valves, plastic water pipe valves, plastic drip valves
 
Tianjin Shengkai
 
5/7/2007 to 5/6/2017
 
No.4152527
 
No.7:   mud pumps for petroleum, power station boilers and auxiliary equipments, centrifugal pumps, pumps, valves, the flap valves, pressure valves and give up valves, hydraulic valves, control valves, engine nozzles, electrostatic industrial equipments, conveyor
 
Tianjin Shengkai
 
10/14/2006 to 10/13/2016
 
 
27

 
 
 
No.4152528
 
No.6:   Armored plates, metallic valves (non-machinery parts), metallic ceramics, metallic drip valves, metallic pipes, metallic water pipes, metallic spray-head, metallic nozzles, metallic piping elbows
 
Tianjin Shengkai
 
10/14/2006 to 10/13/2016
 
No.4152533
 
No.11: slag of furnace automatic transmission installations, valves steam heating equipments, taps, plumbing plugs, sewer equipments, plumbing modulator switches, water equipments, air purification equipments and machinery, gas purification devices, ionizing air handling equipments, flues, flues in chimney, air filtration equipments
 
Tianjin Shengkai
 
10/14/2006 to 10/13/2016
“SKYCERA”
 
Reg. No. 4,176,270
 
For: Manually operated ceramic valves for industrial applications, other than parts of machines; spare parts for manually operated ceramic valves for industrial applications, other than parts of machines, in Class 20 (U.S. Cls. 2, 13, 22, 25, 32 and 50)
 
Shengkai Innovations, Inc.
 
7/17/2012 to 7/17/2022
 

Shengkai has registered the following domain names:

Domain Name
 
Owner
 
Registration Date
 
Expiration Date
“Shengkai.com”
 
Tianjin Shengkai
 
N/A
 
6/15/2014 (extended from 6/15/2010)
“Shengkaiinnovations.com”
 
Shengkai Innovations, Inc.
 
11/13/2009
 
11/23/2012
“shengkai.mobi”
 
Tianjin Shengkai
 
2/14/2011
 
2/14/2014
 
Tianjin Shengkai
 
2/14/2011
 
2/14/2014
 
Tianjin Shengkai
 
2/14/2011
 
2/14/2014
 
Tianjin Shengkai
 
2/14/2011
 
2/14/2014
“skvalve.cn”
 
Tianjin Shengkai
 
2/14/2011
 
2/14/2014
“Skycera.com”
 
Shengkai Innovations, Inc.
 
12/7/2011
 
12/7/2012
“Skycera.net”
 
Shengkai Innovations, Inc.
 
12/7/2011
 
12/7/2012

Employees

 
28

 
As of September 20, 2012, the Company had 135 employees, 84 of which possess a diploma over junior college level, representing 62.2% of the work force recruited. We currently have 8 senior-level professionals and 18 mid-level professionals with undergraduate or higher degrees.

Employee benefits include five state-mandated insurance plans:

·  
Old-age insurance: We withhold a portion of each employee’s average monthly salary from the prior year, as determined by the provincial government, generally 8%, and contribute an additional amount determined by law, up to approximately 20% of such average monthly salary.
·  
Medical insurance: We withhold approximately 2% of each employee’s average monthly salary from the prior year and contribute an additional amount totaling approximately 10% of such average monthly salary.
·  
Unemployment insurance: We withhold approximately 1% of each employee’s average monthly salary from the prior year, and contribute an additional amount totaling approximately 2% of such average monthly salary.
·  
Maternity insurance: We contribute an amount totaling approximately 0.8% of each employee’s average monthly salary from the prior year.
·  
Industrial injury insurance: we contribute an amount totaling approximately 0.5% of each employee’s average monthly salary from the prior year.

In the year ended June 30, 2012, our average compensation per employee per month was RMB4,360, or approximately $690. We also pay benefits in the form of social security insurance fees for employees required such insurance under PRC law.

We have a system of human resource performance review and incentive policies that allow personnel reviews to be carried out monthly or bi-monthly, depending on the length of service.
 
Government Regulation
 
We are subject to a wide range of regulation covering every aspect of our business. The most significant of these regulations are set forth below. In each case, we have passed the most recent required inspections and have received appropriate and up-to-date licenses, certificates and authorizations, as set forth in the next subsection of this 10-K.

Regulations on Safety Supervision for Special Equipment

On March 11, 2003, the State Council issued Regulations on Safety Supervision for Special Equipment (“Special Equipment Regulations”) with came into effect on June 1, 2003 and was amended on January 24, 2009. According to Special Equipment Regulations, an enterprise, which manufactures elements for pressure pipeline, such as valves, is required to obtain the manufacture license of special equipment issued by competent special equipment safety supervision authorities before relevant business operations.

Foreign Investment in PRC Operating Companies

The Foreign Investment Industrial Catalogue jointly issued by the MOFCOM and the National Development and Reform Commission or the NDRC in 2011 classified various industries/businesses into three different categories: (i) encouraged for foreign investment; (ii) restricted to foreign investment; and (iii) prohibited from foreign investment. For any industry/business not covered by any of these three categories, they will be deemed industries/businesses permitted to have foreign investment. Except for those expressly provided restrictions, encouraged and permitted industries/businesses are usually 100% open to foreign investment and ownership. With regard to those industries/businesses restricted to or prohibited from foreign investment, there is always a limitation on foreign investment and ownership. The PRC Subsidiary’s business does not fall under the industry categories that are restricted to, or prohibited from foreign investment and is not subject to limitation on foreign investment and ownership.

 
29

 
Regulation of Foreign Currency Exchange

Foreign currency exchange in the PRC is primarily governed by a series of regulations, including the Regulations on Exchange Control of the PRC (2008), and the Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996), as amended. Under these regulations, the Renminbi is freely convertible for trade and service-related foreign exchange transactions, but not for direct investment, loans or investments in securities outside the PRC without the prior approval of the SAFE. Pursuant to the Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996), foreign invested enterprises (“FIEs”), such as SK WFOE, may purchase foreign exchange without the approval of the SAFE for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. They may also retain foreign exchange, subject to a cap approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. However, the relevant PRC government authorities may limit or eliminate the ability of FIEs to purchase and retain foreign currencies in the future. In addition, foreign exchange transactions for direct investment, loan and investment in securities outside the PRC are still subject to limitations and require approvals from the SAFE.

Regulation of FIEs’ Dividend Distribution
 
The principal laws and regulations in the PRC governing distribution of dividends by FIEs include:
 
(i)
The Sino-foreign Equity Joint Venture Law (1979), as amended, and the Regulations for the Implementation of the Sino-foreign Equity Joint Venture Law (1983), as amended;
(ii)
The Sino-foreign Cooperative Enterprise Law (1988), as amended, and the Detailed Rules for the Implementation of the Sino-foreign Cooperative Enterprise Law (1995), as amended;
(iii)
The Foreign Investment Enterprise Law (1986), as amended, and the Regulations of Implementation of the Foreign Investment Enterprise Law (1990), as amended.
(iv)
Regulations on Exchange Control of the PRC (2008)
(v)
Administrative Regulations Regarding Settlement, Sale and Payment of Foreign Exchange (1996)

Under these regulations, FIE in the PRC may pay dividends only out of the FIE’s profits, if any, after the payment of its enterprise income tax and contributions to its reserve fund, employee bonus and welfare fund and enterprise development fund at percentages that are decided by its board of directors; and such net profits shall be distributed in proportion to the contributions to the registered capital of the parties to the venture. Moreover, the registered capital contribution of an FIE must be fully paid before any profit or dividend of the FIE is remitted abroad; where the registered capital contribution of an FIE is not been fully paid due to special circumstances, profits or dividends of the FIE can be remitted abroad only if approvals from competent authorities have been obtained; furthermore, an FIE may only remit profits or dividends abroad at authorized banks and must comply with certain procedural requirements, such as providing the Foreign Invested Enterprise Foreign Exchange Registration Certificate, the resolution of the board of directors for the distribution of profits, the capital verification report issued by certified public accountants, the audit report and the tax payment documentation, etc.
 
Regulation of a Foreign Currency’s Conversion into RMB and Investment by FIEs
 
On August 29, 2008, the SAFE issued a Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises or Notice 142, to further regulate the foreign exchange of FIEs. According to the Notice 142, FIEs shall obtain verification report from a local accounting firm before converting its registered capital of foreign currency into Renminbi. The Notice 142 provides that the Renminbi capital converted from foreign currency registered capital of a FIE may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC, unless it is provided for otherwise. In addition, on July 18, 2011, the SAFE issued a supplementary notice of Notice 142 to address further explanation on the related conducting rules of Notice 142, which became effective as of August 1, 2011.
 
 
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Regulation of Foreign Exchange in Certain Onshore and Offshore Transactions
 
On October 21, 2005, the SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or SAFE Notice 75, which became effective as of November 1, 2005; and on May 20, 2011, the SAFE issued the specific conducting rules of Notice 75 namely Operating Rules for Fund-raising and Return Investment Activities of Domestic Residents through Special Purpose Companies, which became effective as of July 1, 2011. SAFE Notice 75 states that PRC residents, whether natural or legal persons, must register with the relevant local SAFE branch prior to establishing or taking control of an offshore entity established for the purpose of overseas equity financing involving onshore assets or equity interests held by them. The term “PRC legal person residents” as used in SAFE Notice 75 refers to those entities with legal person status or other economic organizations established within the territory of the PRC. The term “PRC natural person residents” as used in SAFE Notice 75 includes all PRC citizens and all other natural persons, including foreigners, who habitually reside in the PRC for economic benefit.

PRC residents are required to complete amended registrations with the local SAFE branch upon: (i) injection of equity interests or assets of an onshore enterprise to the offshore entity, or (ii) subsequent overseas equity financing by such offshore entity. PRC residents are also required to complete amended registrations or filing with the local SAFE branch within 30 days of any material change in the shareholding or capital of the offshore entity, such as changes in share capital, share transfers and long-term equity or debt investments or, providing security, and these changes do not relate to return investment activities. PRC residents who have already organized or gained control of offshore entities that have made onshore investments in the PRC before SAFE Notice 75 was promulgated must register their shareholdings in the offshore entities with the local SAFE branch on or before March 31, 2006.
 
Under SAFE Notice 75, PRC residents are further required to repatriate into the PRC all of their dividends, profits or capital gains obtained from their shareholdings in the offshore entity within 180 days of their receipt of such dividends, profits or capital gains. The registration and filing procedures under SAFE Notice 75 are prerequisites for other approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investments or shareholders loans, or capital outflow to the offshore entity, such as the payment of profits or dividends, liquidating distributions, equity sale proceeds, or the return of funds upon a capital reduction.

Government Regulations Relating to Taxation

On March 16, 2007, the National People’s Congress, approved and promulgated the EIT Law, which took effect on January 1, 2008. Under the EIT Law, FIEs and domestic companies are subject to a uniform tax rate of 25%. The EIT Law provides a five-year transition period starting from its effective date for those enterprises which were established before the promulgation date of the EIT Law and which were entitled to a preferential lower tax rate under the then-effective tax laws or regulations.
 
On December 26, 2007, the State Council of the PRC issued Circular 39, providing that the enterprises that had been approved to enjoy a low tax rate prior to the promulgation of the EIT Law will be eligible for a five-year transition period since January 1, 2008, during which time the tax rate will be increased step by step to the 25% unified tax rate set out in the EIT Law. From January 1, 2008, for the enterprises whose applicable tax rate was 15% before the promulgation of the EIT Law, the tax rate will be increased to 18% for year 2008, 20% for year 2009, 22% for year 2010, 24% for year 2011, and 25% for year 2012. For the enterprises whose applicable tax rate was 24%, the tax rate was changed to 25% beginning on January 1, 2008.

Under the EIT Law, enterprises are classified as “resident enterprise” and “non-resident enterprise” and an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. On December 6, 2007, the State Council promulgated the implementation rules to the EIT Law, which also became effective on January 1, 2008 and define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

 
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On April 22, 2009, the State Administration of Taxation issued the Notice Regarding the Determination of PRC-Controlled Offshore Incorporated Enterprises as PRC Tax Resident Enterprises on the Basis of De Facto Management Bodies, or SAT Circular 82. SAT Circular 82 provides certain specific criteria for determining whether the "de facto management body" of a PRC-controlled offshore-incorporated enterprise is located in the PRC. “PRC-controlled offshore enterprise” refers to an enterprise which is formed and registered abroad by an enterprise or enterprise group located in the PRC as the major controlling investor under the law of a foreign country (region).

According to the SAT Circular 82, a PRC-controlled offshore incorporated enterprise will be regarded as a PRC tax resident by virtue of having "de facto management body" in the PRC only if all of the following conditions set forth in the SAT Circular 82 are met: (i) the primary location of the day-to-day operational management is in the PRC; (ii) decisions relating to the enterprise's financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the enterprise's primary assets, accounting books and records, company seals, and board and shareholder resolutions are located or maintained in the PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC.

Furthermore, a PRC-controlled enterprise may file a resident enterprise application to the competent tax authority of the place where its de facto management body or where the major PRC investor is located, and the competent tax authority shall, after the preliminary examination, report, level by level, its identity of resident enterprise to the State Administration of Taxation for confirmation. If an overseas PRC-controlled enterprise fails to file a resident enterprise application, the competent tax authority of the place where its major PRC investor is located may make a preliminary judgment about whether it is a PRC resident enterprise according to the information available to it, and report to the State Administration of Taxation for confirmation.

Although SAT Circular 82 only applies to offshore enterprises controlled by PRC enterprises, not those controlled by PRC individuals, the determining criteria set forth in the SAT Circular 82 may reflect the State Administration of Taxation's general position on how the "de facto management body" test may be applied in determining the tax resident status of offshore enterprises.

Currently, the tax resident status of an enterprise is subject to determination by the competent PRC tax authorities and uncertainties remain with respect to the interpretation of the term "de facto management body" as applicable to our offshore entities, we may be considered a resident enterprise. If the PRC tax authorities determine that we are “resident enterprise” for PRC enterprise income tax purposes, a number of PRC tax consequences could follow. Firstly, we may be subject to enterprise income tax at a rate of 25% on our worldwide taxable income, as well as PRC enterprise income tax reporting obligations. Secondly, dividends paid to us from our PRC Subsidiary may qualify as “tax-exempt income”, but we cannot guarantee that such dividends will not be subject to PRC withholding tax. In addition, it could result in a situation in which a 10% PRC tax is imposed on dividends we pay to our non-PRC shareholders and gains derived by our non-PRC shareholders from transferring our shares, if such income is considered PRC-sourced income by the relevant PRC authorities.

According to Notice of the State Administration of Taxation on Issuing the Interim Measures for the Administration of Source-based Withholding of Enterprise Income Tax on Non-resident Enterprise (No. 3 [2009] of the State Administration of Taxation), the source-based withholding shall apply to the incomes from return on equity investment such as dividends and bonuses, interest, rents, royalties, income from assignment of property and other incomes subject to the enterprise income tax derived from the PRC by non-resident enterprise, and the entities or individuals which are directly liable to make the relevant payments to the non-resident enterprises under the relevant legal or contractual provisions shall be the withholding agents; where the withholding agent failed to withhold or cannot perform the withholding obligations, the non-resident enterprise shall, within seven days after the payment or payment due for the dividends, file enterprise incoming tax to the competent tax authorities; where both parties to an equity transfer transaction which is conducted outside the PRC are non-resident enterprise, the non-resident enterprise which obtains the income shall fine file a tax return to the competent tax authority of the enterprise whose equity interests are transferred. The enterprise whose equity interests are transferred shall assist the tax authority in taxing the non-resident enterprise; where the non-enterprise again fails to pay tax within a certain time limit under a tax authority’s warning notice, the competent tax authority has the right to collect the enterprise incoming tax and charge late-payment surcharges from the non-enterprise’s income from other project(s) and its payable person in China, and send a Notice of Tax-related Matters, other income projects and it payable person is liable for the payable tax and overdue fine.

 
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In such event, we may be required to withhold a 10% PRC tax on any dividends paid to non-resident investors. In addition, non-resident investors may be responsible for paying PRC tax at a rate of 10% on any gain realized from the sale or transfer of our shares if such non-resident investors and the gain satisfy the requirements under the EIT Law and its implementing rules, and we would not have an obligation to withhold income tax in respect of such gains.

If the PRC tax authorities determine that we are non-resident enterprises, dividends paid to us from our PRC Subsidiary will be subject to PRC withholding tax. The EIT Law and the implementing rules of the EIT Law provide that (A) an income tax rate of 25% will normally be applicable to non-resident enterprises which (i) have establishments or premises of business inside the PRC, and (ii) the income in connection with their establishment or premises of business is sourced from the PRC or the income is earned outside the PRC but has actual connection with their establishments or places of business inside the PRC, and (B) an income tax rate of 10% will be applicable to non-resident enterprises which (i) do not have an establishment or place of business in the PRC or (ii) have an establishment or place of business in the PRC, but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends are derived from sources within the PRC.

On December 10, 2009, the SAT issued the Notice on Strengthening Administration of Enterprise Income Tax for Equity Transfers by Non-PRC Resident Enterprises, or SAT Circular 698 with retroactive effect from January 1, 2008. Under SAT Circular 698, if a non-resident enterprise transfers the equity interests of a PRC resident enterprise indirectly by disposition of the equity interests of an overseas holding company, or Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5%, or (ii) does not tax foreign income of its residents, the non-resident enterprise, being the transferor, shall report to the PRC competent tax authority of the PRC resident enterprise this Indirect Transfer. Using a “substance over form” principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding, or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC withholding tax at a rate of up to 10%. SAT Circular 698 also provides that, where a non-PRC resident enterprise transfers its equity interests in a PRC resident enterprise to its related parties at a price lower than the fair market value, the relevant tax authority has the power to make a reasonable adjustment to the taxable income of the transaction. On March 28, 2011, the SAT released SAT Public Notice 24 to clarify several issues related to Circular 698. SAT Public Notice 24 became effective on April 1, 2011. According to SAT Public Notice 24, the term “effective tax” refers to the effective tax on the gain derived from disposition of the equity interests of an overseas holding company; and the term “does not impose income tax” refers to the cases where the gain derived from disposition of the equity interests of an overseas holding company is not subject to income tax in the country/region where the overseas holding company is a resident. There is uncertainty as to the application of SAT Circular 698. If SAT Circular 698 was determined by the tax authorities to be applicable to us and our non-resident investors, we and our non-resident investors may be required to expend valuable resources to comply with this circular or to establish that we or our non-resident investors should not be taxed under SAT Circular 698, which may adversely affect us or our non-resident investors.

Regulations of Overseas Investments and Listings
 
On August 8, 2006, six PRC regulatory agencies, including the MOFCOM, the CSRC, the SASAC, the SAT, the SAIC and the SAFE, jointly amended and released the M&A Rules, which became effective on September 8, 2006. The M&A Rules are applicable to (i) foreign investors acquire equity interests or subscribe the capital increase of a PRC non-foreign investment company, or (ii) foreign investors establish a foreign investment company to acquire and operate assets of a PRC non-foreign investment company, or acquire assets of a PRC non-foreign investment company to establish a foreign investment company for operating such assets. The M&A Rules requires that, if an overseas company established or controlled by PRC domestic companies or citizens intends to acquire equity interests or assets of any other PRC domestic company affiliated with the PRC domestic companies or citizens, such acquisition must be submitted to the MOFCOM, rather than local regulators, for approval. The M&A Rules further address that the special purpose vehicle, or “SPV” refers to an offshore company directly or indirectly controlled by a PRC individual or company for the purpose of taking the interests of its domestic company to list on an overseas stock market and further regulate that listing and trading of a SPV on an overseas stock market whose shareholders intend to acquire a PRC company in consideration of the SPV’s equity (“cross-border equity swap” ) shall be subject to the examination and approval of CSRC..
 
 
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On September 21, 2006, the CSRC published on its official website procedures regarding its approval of overseas listings by SPVs. Other than documents required to be submitted, no other details with respect to the timing, criteria and process for obtaining any required approval from CSRC have been specified. Therefore, it remains unclear how the M&A Rules or the CSRC procedures will be interpreted, amended and implemented by the relevant authorities.
 
Environmental Regulations
 
On December 26, 1989, the Standing Committee of the National People’s Congress issued the Environment Protection Law, setting forth the legal framework for environment protection in the PRC. The Environmental Protection Law requires the State Administration of Environmental Protection to implement uniform supervision and administration of environmental protection standards nationwide and to establish national waste discharge standards. Local environmental protection bureaus are responsible for environmental protection in their jurisdictions and may set stricter local standards which are required to be registered at the State Administration of Environmental Protection. Companies are required to comply with the stricter of the two standards. Enterprises producing environmental contamination and other public hazards must incorporate the relevant environmental protection standards into their planning and establish environmental protection systems. These companies must also adopt effective measures to prevent environmental contamination and hazardous emissions, such as waste gas, waste water, deposits, dusts, pungent gases and radioactive matters as well as noise, vibration and magnetic radiation. Companies discharging contaminated wastes in excess of the discharge standards prescribed by the State Administration of Environmental Protection must pay non-standard discharge fees in accordance with national regulations and be responsible for the applicable remediation. Government authorities may impose different penalties against persons or companies in violation of the environmental protection laws and regulations depending on individual circumstances. Such penalties may include warnings, fines, imposition of deadlines for remediation, orders to cease certain operations, orders to reinstall contamination prevention and remediation facilities that have been removed or left unused, imposition of administrative actions against the responsible persons or orders to close down the company. Where the violation is deemed serious, responsible persons may be required to pay damages, and may be subject to criminal liability.

Regulations Relating to Employee Share Options
 
In December 2006, the People’s Bank of China promulgated the Administrative Measures of Foreign Exchange Matters for Individuals, setting forth the respective requirements for foreign exchange transactions by individuals (both PRC or non−PRC citizens) under either the current account or the capital account. In January 2007, the SAFE issued implementing rules for the Administrative Measures of Foreign Exchange Matters for Individuals, which, among other things, specified approval requirements for certain capital account transactions, such as a PRC citizen’s participation in employee stock ownership plans or share option plans of an overseas publicly listed company. On March 28, 2007, the SAFE promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Ownership Plan or Stock Option Plan of Overseas Listed Company, or the Stock Option Rules. The purpose of the Stock Option Rules is to regulate the foreign exchange administration of PRC domestic individuals who participate in employee stock holding plans and share option plans of overseas listed companies.

According to the Stock Option Rules, if a PRC domestic individual participates in any employee stock ownership plan or share option plan of an overseas listed company, a PRC domestic qualified agent or the PRC subsidiary of such overseas listed company must, among other things, file, on behalf of such individual, an application with the SAFE or its local counterpart to obtain approval for an annual allowance with respect to the purchase of foreign exchange in connection with stock holding or share option exercises as PRC domestic individuals may not directly use overseas funds to purchase shares or exercise share options. Concurrent with the filing of such application with the SAFE or its local counterpart, the PRC domestic qualified agent or the PRC subsidiary shall obtain approval from the SAFE or its local counterpart to open a special foreign exchange account at a PRC domestic bank to hold the funds required in connection with the stock purchase or option exercise, any returned principal or profits upon sales of shares, any dividends issued on the stock and any other income or expenditures approved by the SAFE or its local counterpart. The PRC domestic qualified agent or the PRC subsidiary is also required to obtain approval from the SAFE or its local counterpart to open an overseas special foreign exchange account at an overseas trust bank with custody qualifications to hold overseas funds used in connection with any shares purchase.

 
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Many issues with respect to the Stock Option Rules require further interpretation. We and our PRC citizen employees who have been granted share options, or PRC optionees, will be subject to these rules when our company becomes an overseas publicly-listed company. If we or our PRC optionees fail to comply with these regulations, we or our PRC optionees may be subject to fines and legal sanctions. However, as these rules have only been recently promulgated, it is currently unclear as to how these rules will be interpreted and implemented.

Regulation on Intellectual Property Rights

 Patent Law

The National People’s Congress adopted the Patent Law of the People’s Republic of China in 1984, and amended it in 1992, 2000 and 2008, respectively. A patentable invention, utility model or design must meet three conditions: novelty, inventiveness and practical applicability. Patents cannot be granted for scientific discoveries, rules and methods for intellectual activities, methods used to diagnose or treat diseases, animal and plant breeds or substances obtained by means of nuclear transformation. The Patent Office under the State Council is responsible for receiving, examining and approving patent applications. A patent is valid for a twenty-year term in the case of an invention and a ten-year term in the case of a utility model or design, starting from the application date. A third-party user must obtain consent or a proper license from the patent owner to use the patent except for certain specific circumstances provided by law. Otherwise, the use will constitute an infringement of the patent rights.

Trademark Law

Both the PRC Trademark Law, adopted in 1982 and revised in 1993 and 2001, and the Implementation Regulation of the PRC Trademark Law adopted by the State Council in 2002, give protection to the holders of registered trademarks. The Trademark Office, under the authority of the State Administration for Industry and Commerce, handles trademark registrations and grants rights for a term of ten years for registered trademarks, which may be renewed by the Trademark Office. The PRC Trademark Law has adopted a “first-to-file” principle with respect to trademark registration. Where a trademark for which a registration has been made is identical or similar to another trademark which has already been registered or been subject to a preliminary examination and approval for use on the same kind of or similar commodities or services, the application for registration of such trademark may be rejected. Any person applying for the registration of a trademark may not prejudice the existing right first obtained by others, nor may any person register in advance a trademark that has already been used by another party and has already gained a “sufficient degree of reputation” through such party’s use. Trademark license agreements must be filed with the Trademark Office or its regional offices.

Regulation on Employment

On June 29, 2007, the National People’s Congress promulgated the Labor Contract Law of PRC, or the Labor Law, which became effective as of January 1, 2008. On September 18, 2008, the PRC State Council issued the PRC Labor Contract Law Implementation Rules, which became effective as of the date of issuance.

Pursuant to the PRC Labor Contract Law and its implementation rules, employers must execute written labor contracts with full-time employees. All employers must compensate their employees with wages equal to at least the local minimum wage standards. All employers are required to establish a system for labor safety and sanitation, strictly abide by state rules and standards and provide employees with workplace safety training. Violations of the PRC Labor Contract Law may result in the imposition of fines and other administrative liabilities. Criminal liability may arise for serious violations.

 
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In addition, employers in the PRC are obliged to provide employees with welfare schemes covering pension insurance, unemployment insurance, maternity insurance, work-related injury insurance, medical insurance and housing funds.

Approvals, Licenses and Certificates

We require a number of approvals, licenses and certificates in order to operate our business. Our principal approvals, licenses and certificates are set forth below.

Tianjin Shengkai

·  
Business License (No. 120191000015144) by Tianjin Administration for Industry and Commerce, valid from June 7, 1994 through May 17, 2024.

·  
Organization Code Certificate issued by Tianjin Quality Supervision and Inspection Bureau (code No. 23967678-2, and registration No. Zu Dai Guan 120191-045813), valid from August 24, 2010 through August 23, 2014. The company has passed the 2012 annual inspection.

·  
Taxation Registration Certificate (Jin Shui Zheng Zi No. 120115239676782) issued by the Tianjin Economic-Technological Development Area Branch of the State Administration of Taxation on October 30, 2010.

·  
Customs Declaration Registration Certificate for Consignees or Consignors of Import & Export of the PRC Customs (the Certificate code No.1207268124) issued by Tianjin Customs District of the PRC respectively on August 27, 2009, valid through August 28, 2015.

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

·  
The American Petroleum Institute issued to Shengkai Certificates of Authority to use the Official API Monogram (No.6D-0460) on June 9, 2006. The certificate expired on June 09, 2012. Currently the Company is awaiting the final approval on the extension of the valid term for the certificate, which is expected in October, 2012.

·  
Quality Certificate (ISO9001:2000)(No.0170-2003-AQ-RGC-RvA) issued by Det Norske Veritas Certification B.V. on December 6, 2002. The expiration date is December 6, 2014

·  
Tianjin Finance Bureau, Tianjin State Taxation Bureau, Tianjin Local Taxation Bureau and Tianjin Scientific Technology Committee issued the Certificates of High Technology Enterprise (No.2003-011 and No.0612007B5003) to Tianjin Shengkai on June 8, 2009. The valid terms are three years and the expiration date is June 8, 2012. We are currently in the process of applying for renewal for this certificate and expect to receive the approval in the second quarter of fiscal year 2013.

·  
Manufacturer License of Special Equipment (TS2712014-2012) issued by Tianjin Bureau of Quality and Technical Supervision on October 15, 2008, valid through October 14, 2012.

·  
Manufacturer License of Special Equipment (TS2710P74-2013) issued by Tianjin Bureau of Quality and Technical Supervision on February 14, 2011, valid through September 29, 2013.
 
 
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·  
CE (No.DGR-0036-QS-516-06) issued by TUV SUD Industrie Service GmbH on November 14, 2006. The expiration date is November 13, 2012.

·  
Registration Form for Operators of Foreign Trading (the code No. 00498476, and import & export enterprise code No.1200239676782) issued by Tianjin Commission of Commerce on December 5, 2007.

·  
OHSAS 18001:2007 (No.115336-2012-HSO-RGC-DNV) issued by Det Norske Veritas Certification B.V. on June 11, 2012. The expiration date is June 11, 2015.

·  
ISO 14001:2004 (No.115335-2012-AE-RGC-RvA) issued by Det Norske Veritas Certification B.V. on June 11, 2012. The expiration date is June 11, 2015.

SK WOFE

·  
Business License (No. 120000400054373) by Tianjin Administration for Industry and Commerce, valid from April 9, 2008 through April 8, 2028.

·  
Certificate of Approval for Establishment of Enterprises with Foreign Investment in the PRC (No. of Issuance: 1200032322), approved by Tianjin City People’s Government on March 24, 2008.

·  
Taxation Registration Certificate (Jin Shui Zheng Zi No. 12011667149649X) issued by the Tianjin Economic-Technological Development Area Branch of the State Administration of Taxation on April 28, 2010.

·  
Organization Code Certificate issued by Tianjin Quality Supervision and Inspection Bureau (code No. 67149649-X, and registration No. Zu Dai Guan 120192-021898), valid from April 23, 2010 through April 22, 2014. The company has passed the 2012 annual inspection.

·  
Customs Declaration Registration Certificate for Consignees or Consignors of Import & Export of the PRC Customs (the Certificate code No.1210949067) issued by Tianjin Customs District of the PRC, valid through June 15, 2015.

·  
Registration Form for Operators of Foreign Trading (the code No. 01019766, and import & export enterprise code No.120067149649X) issued by Tianjin Commission of Commerce on June 21, 2011.

Shengkai (Tianjin) Trading Ltd.
 
·  
Business License (No. 120192000064551) by Tianjin Administration for Industry and Commerce, valid from June 25, 2010 through June 24, 2100.

·  
Organization Code Certificate issued by Tianjin Quality Supervision and Inspection Bureau (code No. 55653836-7, and registration No. Zu Dai Guan 120192-023438), valid from September 15, 2010 through September 14, 2014. The company has passed the 2012 annual inspection.

·  
Taxation Registration Certificate (Jin Shui Zheng Zi No. 120116556538367) issued by the Tianjin Economic-Technological Development Area Branch of the State Administration of Taxation on September 19, 2010.

·  
Customs Declaration Registration Certificate for Consignees or Consignors of Import & Export of the PRC Customs (the Certificate code No.1207461833) issued by Tianjin Customs District of the PRC, valid through March 10, 2014.

·  
Registration Form for Operators of Foreign Trading (the code No. 01007534, and import & export enterprise code No.1200556538367) issued by Tianjin Commission of Commerce on September 21, 2010.
 
 
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Item 1A. Risk Factors.
 
An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below and the other information contained in this report before deciding to invest in our common stock.

Risks Related to Our Business and Industry
 
Our current organizational structure makes it difficult for us to evaluate our future business prospects.
 
Prior to May 30, 2008, our business was operated through Tianjin Shengkai. Under the present structure, although there is no change in personnel, we have agreements with Tianjin Shengkai pursuant to which we manage and derive the profit from Tianjin Shengkai’s business by providing the exclusive supporting services from SK WFOE to Tianjin Shengkai. It is possible that the change in our business structure may impair our ability to operate our business.

The PRC government may determine that the VIE Agreements are not in compliance with applicable PRC laws, rules and regulations.

We manage and operate Tianjin Shengkai, one of our operating entities, through SK WFOE pursuant to the rights it holds under the contractual agreements (the “VIE” Agreements”). By reason of the VIE Agreements, Tianjin Shengkai is a variable interest entity (“VIE”).  Almost all economic benefits and risks arising from Tianjin Shengkai’ s operations are transferred to SK WFOE under these agreements.  Details of the VIE Agreements are set out in the “PRC Restructuring” section.

There are risks involved with the operation of our business in reliance on the VIE Agreements, including the risk that the VIE Agreements may be determined by PRC regulators or courts to be unenforceable. Our PRC counsel, Beijing Deheng Law Offices, has advised us that the VIE Agreements are binding and enforceable under the PRC law, but has further advised that if the VIE Agreements were for any reason determined to be in breach of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such breach, including:

·  
imposing economic penalties;
·  
discontinuing or restricting the operations of SK WFOE or Tianjin Shengkai;
·  
imposing conditions or requirements with respect to the VIE Agreements with which SK WFOE or Tianjin Shengkai may not be able to comply;
·  
requiring our company to restructure the relevant ownership structure or operations;
·  
taking other regulatory or enforcement actions that could adversely affect our company’s business; and
·  
revoking the business licenses and/or the licenses or certificates of SK WFOE, and/or voiding the VIE Agreements.

Any of these actions could adversely affect our ability to manage, operate and gain the financial benefits of Tianjin Shengkai, which would have a material adverse impact on our business, financial condition and results of operations. If we are unable to restructure our relationship with Tianjin Shengkai in such circumstances, our operations in the valve industries will be materially affected.
 
Our ability to manage and operate Tianjin Shengkai under the VIE Agreements may not be as effective as direct ownership.
 
We conduct our business in the PRC and generate substantially all of our revenues through the VIE Agreements. We depend on Tianjin Shengkai to hold and maintain contracts with our customers.  Our plans for future growth are based substantially on growing the operations of Tianjin Shengkai. However, the VIE Agreements may not be as effective in providing us with control over Tianjin Shengkai as direct ownership.

 
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We do not have any ownership interest in Tianjin Shengkai. Although we have been advised by Beijing Deheng Law Offices, our PRC legal counsel, that each contract under SK WFOE’s contractual arrangements with Tianjin Shengkai is valid, binding and enforceable under current PRC laws and regulations, these contractual arrangements may not be as effective in providing us with control over Tianjin Shengkai as direct ownership of Tianjin Shengkai would be. In addition, Tianjin Shengkai may breach the contractual arrangements. For example, Tianjin Shengkai may decide not to make contractual payments to SK WFOE, and consequently to our company, in accordance with the existing contractual arrangements. In the event of any such breach, we may have to (i) incur substantial costs and resources to enforce such arrangements, and (ii) rely on legal remedies under PRC law, which we cannot be sure would be always effective in light of uncertainties in the PRC legal system.

Therefore, if we are unable to effectively control Tianjin Shengkai, it may have an adverse effect on our ability to achieve our business objectives and grow our revenues.

As the VIE Agreements are governed by PRC law, we would be required to rely on PRC law to enforce our rights and remedies under them; PRC law may not provide us with the same rights and remedies as are available in contractual disputes governed by the law of other jurisdictions.

The VIE Agreements are governed by the PRC law and provide for the resolution of disputes through legal proceedings pursuant to PRC law. If Tianjin Shengkai 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 law, including seeking specific performance or injunctive relief, or claiming damages. We cannot be sure that such remedies would provide us with effective means of causing to meet its obligations, or recovering any losses or damages as a result of non-performance. Further, the legal environment in China is not as developed as in other jurisdictions. Uncertainties in the application of various laws, rules, regulations or policies in the PRC legal system could limit our ability to enforce the VIE Agreements and protect our interests.

SK WFOE’s contractual arrangements with Tianjin Shengkai and the payment arrangement thereunder may be challenged by the PRC tax authorities and may result in adverse tax consequences to us.

We generate our revenues through the payments we receive pursuant to the VIE Agreements. We could face adverse tax consequences if the PRC tax authorities determine that the VIE Agreements were not entered into based on arm’s length negotiations. For example, PRC tax authorities may adjust WFOE’s and/or Tianjin Shengkai’s income and expenses for PRC tax purposes in the form of a transfer pricing adjustment. A transfer pricing adjustment could result in a reduction, for the PRC tax purposes, of adjustments recorded by Tianjin Shengkai, which could adversely affect us by increasing Tianjin Shengkai’s tax liability without reducing SK WFOE’s tax liability, which could further result in late payment fees and other penalties to Tianjin Shengkai for underpaid taxes.
 
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may materially adversely affect us.
  
In October 2005, the PRC State Administration of Foreign Exchange, or SAFE, issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Round-Trip Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75. The policy announced in this notice required PRC residents to register with the relevant SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, which became public in May 2007 (known as Notice 106), expanded the reach of Circular 75. In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006; this date was subsequently extended indefinitely by Notice 106, which also required that the registrant establish that all foreign exchange transactions undertaken by the SPV and its affiliates were in compliance with applicable laws and regulations. Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.
 
 
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We believe we comply with the applicable regulations. Currently, Wang Chen, Guo Wei, Zhao Yanqiu, Ji Haihong, Zhang Ying, Miao Yang, Wu Yanping and Liu Naifan are PRC residents who, in accordance with Circular 75 and Notice 106, have each completed registration with the Tianjin branch of SAFE for the foreign exchange of overseas investment. We cannot however assure you that, if challenged by government agencies, the structure of our organization has fully complied with all applicable registrations or approvals required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. A failure by such PRC resident beneficial holders or future PRC resident shareholders to comply with Circular 75 and Notice 106, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.
 
Because we may require additional financing to expand our operations, our failure to obtain necessary financing may impair our operations.

At June 30, 2012, we had working capital of $78,948,043. Our capital requirements in connection with the development of our business are significant. During the fiscal year ended June 30, 2012, we spent approximately $13,562,923 for the purchase of raw materials and supplies and equipment and other fixed assets, of which $11,876,469 was used to purchase raw materials and supplies and $1,686,454 was used to purchase equipment and other fixed assets.
 
We cannot assure you that we will be able to get additional financing on any terms, and, if we are able to raise funds, it may be necessary for us to sell our securities at a price which is at a significant discount from the market price and on other terms which may be disadvantageous to us. In connection with any such financing, we may be required to provide registration rights to the investors and pay damages to the investor in the event that the registration statement is not filed or declared effective by specified dates. The price and terms of any financing which would be available to us could result in both the issuance of a significant number of shares and significant downward pressure on our stock price.

Because our products are marketed both in the domestic and international markets, we are subject to both domestic and international competition.
 
The Company faces two types of competitors: (i) manufacturers of metal valves, which currently still represent the majority market share in the entire valve market, competing with ceramic valves with its lower price; and (ii) Chinese and international companies that are better known and have greater financial resources than we have. Many of the international companies, in particular, have longer operating histories and have more established relationships with customers and end users. Some of our international competitors also may have a greater ability to attract and retain users than we do because they are engaged in major markets of general industrial products and cutting edge technology fields. If our competitors are successful in providing similar or better valve products or make their services easier to access, we could experience a decline in demand for our products.
 
An increase in the cost of raw materials will affect sales and revenues.
 
Raw materials required for valve production includes metal materials and ceramic materials like aluminum oxide and zinc oxide; a large number of spare parts in various specifications are also purchased during production. Any increase in the prices of these raw materials will affect the price at which we can sell our product. If we are not able to raise our prices to pass on increased costs, we would be unable to maintain our margins.
 
 
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If we fail to effectively manage our growth when our business and operations experience rapid growth, our business and operating results could be harmed.
 
We had experienced rapid growth in our operations, which had placed significant demands on our management, operational and financial infrastructure. If in future our operations resume rapid growth and we do not effectively manage our growth, the quality of our products and services could suffer, which could negatively affect our operating results. To effectively manage any such rapid growth in future, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. These systems enhancements and improvements may require significant capital expenditures and management resources. Failure to implement these improvements could hurt our ability to manage our growth and our financial position.

Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand.
 
Our patents, trademarks, trade secrets, copyrights and other intellectual property rights are important assets for us. Various events outside of our control pose a threat to our intellectual property rights as well as to our products and services. For example, effective intellectual property protection may not be available in China and other countries in which our products are sold. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results.
 
 Because we depend on third parties to market our products in the international market, any problems encountered by these third parties could affect our sales.
 
Although the market for valve products is international, most of our products are sold to companies in the PRC. We depend on other companies to market our products in the international market. As a result, we are dependent upon third parties, over which we have no control, to develop and implement an international marketing effort. Any problems encountered by these third parties, including potential violations of laws of the PRC or other countries, may affect their ability to sell our products which would, in turn, affect our net sales.
 
We rely on highly skilled personnel and the continuing efforts of our executive officers and, if we are unable to retain or motivate key personnel or hire qualified personnel, our business may be severely disrupted if we lose their services.
 
Our performance largely depends on the talents and efforts of highly skilled individuals and in particular, the technology and expertise held by our Chief Executive Officer, Wang Chen. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. Our continued ability to compete effectively depends on our ability to attract new technology developers and to retain and motivate our existing contractors.

We do not maintain key man life insurance on any of our executive officers. If one or more of our executive officers are unable or unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may be severely disrupted, and we may incur additional expenses to recruit and retain new officers. In addition, if any of our executives joins a competitor or forms a competing company, we may lose some of our customers. Our chief executive officer is a party to contractual agreements as described elsewhere in this registration statement. However, if any disputes arise between our executive officer and us, we cannot assure you, in light of uncertainties associated with the PRC legal system, the extent to which any of these agreements could be enforced in China, where some of our executive officers reside and hold some of their assets.

Because we have inadequate insurance coverage in the PRC, we may not be protected from risks that are customarily covered by insurance in the United States.
 
 
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We do not presently maintain product liability insurance in the PRC, and our property and equipment insurance does not cover the full value of our property and equipment, which leaves us with exposure in the event of loss or damage to our properties or claims filed against us.

We currently do not carry any product liability or other similar insurance in the PRC. We cannot assure you that we would not face liability in the event of the failure of any of our products. This is particularly true given our plan to significantly expand our sales into international markets, like the United States, where product liability claims are more prevalent.

Except for automobile insurance, we do not have other insurance such as business liability or disruption insurance coverage for our operations in the PRC. We do not maintain a reserve fund for warranty or defective products claims. Our costs could substantially increase if we experience a significant number of warranty claims. We have not established any reserve funds for potential warranty claims since historically we have experienced few warranty claims for our products so that the costs associated with our warranty claims have been low. If we experience an increase in warranty claims or if our repair and replacement costs associated with warranty claims increase significantly, it would have a material adverse effect on our financial condition and results of operations.

Certain key technology for our business is uninsured and inaccessible in the absence of key individuals.

The “recipe” to our unique method for creating structural ceramic valves is held by Wang Chen, our CEO, and his mother, Guo Chuanye. This technology is recorded but is uninsured and inaccessible by anyone but Mr. Wang, Guo Chuanye, and Guo Wei. If either of these three key individuals were to lose the ability to recall this technology, either through death or incapacity, we would lose key technology that could have a material adverse effect on our financial condition and results of operations.

Our Chief Executive Officer has strong influence on us through his position and stock ownership and his interests may differ from other shareholders.

Since the exercise on August 5, 2009 of a call option agreement entered into on June 9, 2008 by and between Wang Chen and Li Shaoqing, our Chief Executive Officer, Mr. Wang, beneficially owns 48.05% of our common stock through his 100% holding in Long Sunny Limited. As a result, Mr. Wang will be able to influence the outcome of shareholder votes on various matters, including the election of directors and extraordinary corporate transactions such as business combinations. Mr. Wang’s interests may differ from that of other shareholders.
 
Our operations may be adversely affected by the unilateral decisionmaking structure of Tianjin Shengkai, the entity through which substantially all of our business is conducted.

Mr. Wang Chen currently serves as executive director of Tianjin Shengkai. Tianjin Shengkai’s Articles of Association provides for its governance by an executive director, instead of a board of directors, to be appointed by Tianjin Shengkai’s shareholders. The PRC Company Act permits PRC companies with a smaller number of shareholders or registered capital to be governed by a sole executive director. Pursuant to Tianjin Shengkai’s Articles of Association, the executive director’s actions are overseen by a supervisor, Guo Chuanji, who holds no interest in the company. Notwithstanding such supervision, the governance of Tianjin Shengkai by a single executive director could result in inadequately vetted business decisions that could negatively affect the performance of our operations.

We rely on energy and transportation services or others in providing products and services to our users, and any failure or interruption in the services and products provided by these third parties could harm our ability to operate our business and damage our reputation.
 
 
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Our systems are heavily reliant on the availability of electricity. If we were to experience a major power outage, we would have to rely on back-up generators. These back-up generators may not operate properly and their fuel supply could be inadequate during a major power outage. This could result in a disruption of our business.
 
If we fail to obtain all required licenses, permits, or approval, we may be unable to expand our operations.
 
Before we can develop certain products, we must obtain a variety of approvals from local and municipal governments. There no assurance that we will be able to obtain all required licenses, permits, or approvals from government authorities. If we fail to obtain all required licenses, permits or approvals, we may be unable to expand our operations.
 
If we make any acquisitions, they may disrupt or have a negative impact on our business.
 
Although we have no present plans for any acquisitions, in the event that we make acquisitions, we could have difficulty integrating the acquired companies’ personnel and operations with our own. In addition, the key personnel of the acquired business may not be willing to work for us. We cannot predict the affect expansion may have on our core business. Regardless of whether we are successful in making an acquisition, the negotiations could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition to the risks described above, acquisitions are accompanied by a number of inherent risks, including, without limitation, the following:
 
·  
the difficulty of integrating acquired products, services or operations;
·  
the potential disruption of the ongoing businesses and distraction of our management and the management of acquired companies;
·  
the difficulty of incorporating acquired rights or products into our existing business;
·  
difficulties in disposing of the excess or idle facilities of an acquired company or business and expenses in maintaining such facilities;
·  
difficulties in maintaining uniform standards, controls, procedures and policies;
·  
the potential impairment of relationships with employees and customers as a result of any integration of new management personnel;
·  
the potential inability or failure to achieve additional sales and enhance our customer base through cross-marketing of the products to new and existing customers;
·  
the effect of any government regulations which relate to the business acquired;
·  
potential unknown liabilities associated with acquired businesses or product lines, or the need to spend significant amounts to retool, reposition or modify the marketing and sales of acquired products or the defense of any litigation, whether or not successful, resulting from actions of the acquired company prior to our acquisition.

Our business could be severely impaired if and to the extent that we are unable to succeed in addressing any of these risks or other problems encountered in connection with these acquisitions, many of which cannot be presently identified, these risks and problems could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations.

Because the holders of our warrants have cashless exercise rights, we may not receive proceeds from the exercise of the outstanding warrants if the underlying shares are not registered.
 
The holders of our warrants have cashless exercise rights, which provide them with the ability to receive common stock with a value equal to the appreciation in the stock price over the exercise price of the warrants being exercised. This right is not exercisable prior to December 10, 2009 (in the case of warrants issued in connection with our June 2008 financing) or January 18, 2010 (in the case of warrants issued in connection with our July 2008 financing). Thereafter the right is only exercisable if the underlying shares are not subject to an effective registration statement. To the extent that the holders exercise the cashless exercise rights, we will not receive any proceeds on exercise of warrants.
 
 
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Risks Related to Doing Business in China

 Adverse changes in political and economic policies of the Chinese government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and materially and adversely affect our competitive position. 
 
Our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including

·  
the amount of government involvement;
·  
the level of development;
·  
the growth rate;
·  
the control of foreign exchange; and
·  
the allocation of resources.
 
While the Chinese economy has grown significantly in the past 20 years, the growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to regulate its economic growth and guide the allocation of resources. Some of these measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.
 
The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of the productive assets in China is still owned by the PRC government. The continued control of these assets and other aspects of the national economy by the Chinese government could materially and adversely affect our business. The PRC government also exercises significant control over Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Efforts by the PRC government to slow the pace of growth of the Chinese economy could result in decreased capital expenditure by solar energy users, which in turn could reduce demand for our products.
 
Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of renewable energy investments and expenditures in China, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our businesses.
 
 Fluctuation in the value of the Renminbi may have a material adverse effect on your investment.
 
The change in value of the Renminbi against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an appreciation of Renminbi against U.S. dollar, which is continuing. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar. As a portion of our costs and expenses is denominated in Renminbi, the revaluation in July 2005 and potential future revaluation has and could further increase our costs. In addition, as we rely entirely on dividends paid to us by our operating subsidiaries, any significant revaluation of the Renminbi may have a material adverse effect on our revenues and financial condition, and the value of, and any of our dividends payable on our ordinary shares in foreign currency terms. For example, to the extent that we need to convert U.S. dollars we receive from this offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us.
 
 
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Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.
 
All of our revenues and most of our expenses are denominated in Renminbi. If our revenues denominated in Renminbi increase or expenses denominated in Renminbi decrease in the future, we may need to convert a portion of our revenues into other currencies to meet our foreign currency obligations, including, among others, payment of dividends declared, if any, in respect of our ordinary shares. Under China’s existing foreign exchange regulations, we are able to pay dividends in foreign currencies, without prior approval from the State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, we cannot assure you that that the Chinese government will not take further measures in the future to restrict access to foreign currencies for current account transactions.

Capital outflow policies in the PRC may hamper our ability to remit income to the United States.
 
The People’s Republic of China has adopted currency and capital transfer regulations. These regulations may require that we comply with complex regulations for the movement of capital and as a result we may not be able to remit all income earned and proceeds received in connection with our operations or from the sale of our operating subsidiary to the U.S. or to our shareholders.

Our operations and assets in the PRC are subject to significant political and economic uncertainties.
 
Government policies are subject to rapid change and the PRC government may adopt policies which have the effect of hindering private economic activity and greater economic decentralization. There is no assurance that the PRC government will not significantly alter its policies from time to time without notice in a manner which reduces or eliminates any benefits from its present policies of economic reform. In addition, a substantial portion of productive assets in China remains government-owned. For instance, all lands are state owned and leased to business entities or individuals through governmental granting of state-owned land use rights. The granting process is typically based on government policies at the time of granting, which could be lengthy and complex. This process may adversely affect our business. The PRC government also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency and providing preferential treatment to particular industries or companies. Uncertainties may arise with changing of governmental policies and measures. In addition, changes in laws and regulations, or their interpretation, or the imposition of confiscatory taxation, restrictions on currency conversion, imports and sources of supply, devaluations of currency, the nationalization or other expropriation of private enterprises, as well as adverse changes in the political, economic or social conditions in China, could have a material adverse effect on our business, results of operations and financial condition.
 
A downturn in the economy of China may slow our growth and profitability.
 
The growth of the Chinese economy has been uneven across geographic regions and economic sectors. There can be no assurance that growth of the Chinese economy will be steady or that any downturn will not have a negative effect on our business.  
 
Because PRC law governs almost all of our material agreements, we may not be able to enforce our legal rights within China or elsewhere, which could result in a significant loss of business, business opportunities, or capital.  
 
PRC law governs almost all of our material agreements. We cannot assure you that we will be able to enforce any of our material agreements or that remedies will be available outside of China. The system of laws and the enforcement of existing laws in China may not be as certain in implementation and interpretation as in the United States. The inability to enforce or obtain a remedy under any of our future agreements could result in a significant loss of business, business opportunities or capital.
 
 
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It will be extremely difficult to acquire jurisdiction and enforce liabilities against our officers, directors and assets based in China.  
 
Substantially all of our assets will be located in the PRC and our officers and our present directors reside outside of the United States.  As a result, it may not be possible for United States investors to enforce their legal rights, to effect service of process upon our directors or officers or to enforce judgments of United States courts predicated upon civil liabilities and criminal penalties of our directors and officers under Federal securities laws. Moreover, we have been advised that China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the United States. Further, it is unclear if extradition treaties now in effect between the United States and China would permit effective enforcement of criminal penalties of the Federal securities laws.  
 
We may have difficulty establishing adequate management, legal and financial controls in China, which could impair our planning processes and make it difficult to provide accurate reports of our operating results.   
 
China historically has not followed Western style management and financial reporting concepts and practices, and its access to modern banking, computer and other control systems has been limited. Although we will be required to implement internal controls, we may have difficulty in hiring and retaining a sufficient number of qualified employees to work in China in these areas. As a result of these factors, we may experience difficulty in establishing the required controls and instituting business practices that meet Western standards, making it difficult for management to forecast its needs and to present the results of our operations accurately at all times. If we are unable to establish the required controls, market makers may be reluctant to make a market in our stock and investors may be reluctant to purchase our stock, which would make it difficult for you to sell any shares of common stock that you may own or acquire.
 
Because our funds are held in banks which do not provide insurance, the failure of any bank in which we deposit our funds could affect our ability to continue in business.
 
Banks and other financial institutions in the PRC do not provide insurance for funds held on deposit. As a result, in the event of a bank failure, we may not have access to funds on deposit. Depending upon the amount of money we maintain in a bank that fails, our inability to have access to our cash could impair our operations, and, if we are not able to access funds to pay our suppliers, employees and other creditors, we may be unable to continue in business.
 
Imposition of trade barriers and taxes may reduce our ability to do business internationally, and the resulting loss of revenue could harm our profitability.    
 
We may experience barriers to conducting business and trade in our targeted emerging markets in the form of delayed customs clearances, customs duties and tariffs. In addition, we may be subject to repatriation taxes levied upon the exchange of income from local currency into foreign currency, substantial taxes of profits, revenues, assets and payroll, as well as value-added tax. The markets in which we plan to operate may impose onerous and unpredictable duties, tariffs and taxes on our business and products, and there can be no assurance that this will not reduce the level of sales that we achieve in such markets, which would reduce our revenues and profits.

Failure to comply with the United States Foreign Corrupt Practices Act could subject us to penalties and other adverse consequences.
 
We are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some that may compete with us, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the PRC. We can make no assurance, however, that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
 
 
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Risks Related to Ownership of our Common Stock
 
The trading price for our common stock has been and may continue to be volatile.
 
The market price of our common stock has experienced fluctuations and may continue to fluctuate significantly. The market price of our common shares may be adversely affected by various factors, including enforcement of existing laws, innovation and technological changes, the emergence of new competitors, the perception of desirability of investing in Chinese companies, quarterly variations in revenue and results of operations, speculation in the press or analyst community and general market conditions or market conditions specific to particular industries.

The rights of the holders of common stock may be impaired by the potential issuance of preferred stock.
 
We have been required to amend our articles of incorporation to provide for a class of preferred stock. As a result, the board of directors may, without shareholder approval, issue preferred stock with voting, dividend, conversion, liquidation or other rights that could adversely affect the voting power and equity interest of the holders of common stock. Preferred stock, which could be issued with the right to more than one vote per share, could be utilized as a method of discouraging, delaying or preventing a change of control. The possible impact on takeover attempts could adversely affect the price of our common stock. Although we have no present intention to issue any additional shares of preferred stock or to create any new series of preferred stock and the certificate of designation relating to the Series A Preferred Stock restricts our ability to issue additional series of preferred stock, we may issue such shares in the future. Without the consent of the holders of 75% of the outstanding Series A Preferred Stock, we may not alter or change adversely the rights of the holders of the Series A Preferred Stock or increase the number of authorized shares of Series A Preferred Stock, create a class of stock which is senior to or on a parity with the Series A Preferred Stock, amend our articles of incorporation in breach of these provisions or agree to any of the foregoing.
 
The issuance of shares through our stock compensation plans may dilute the value of existing shareholders and may affect the market price of our stock.
 
We have used, and in the future we may further use stock options, stock grants and other equity-based incentives, either pursuant to the 2010 and 2011 Incentive Stock Plans or outside of the 2010 and 2011 Incentive Stock Plans, to provide motivation and compensation to our officers, employees and key independent consultants. The award of any such incentives will result in an immediate and potentially substantial dilution to our existing shareholders and could result in a decline in the value of our stock price. The exercise of these options and the sale of the underlying shares of common stock and the sale of stock issued pursuant to stock grants may have an adverse effect upon the price of our stock.

We will continue to incur significant costs as a result of operating as a public company, and management will be required to devote substantial time to new compliance requirements.  If we fail to comply in a timely manner, our business could be harmed and our stock price could decline.

As a public company, we incur significant legal, accounting and other expenses under the Sarbanes-Oxley Act of 2002, together with rules implemented by the SEC and applicable market regulators. These rules impose various requirements on public companies, including requiring certain corporate governance practices. Management and other personnel will need to devote a substantial amount of time to these new compliance requirements. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly.

Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of U.S. public companies’ internal control over financial reporting, and attestation of this assessment by their independent registered public accountants. While the Dodd-Frank Wall Street Reform and Consumer Protection Act exempts smaller reporting companies with respect to the attestation by their independent registered public accountants as to our financial controls, this exception does not affect the requirement that we include a report of management on our internal controls over financial reporting and will not affect the requirement to include the auditor's attestation if our public float exceeds $75 million and we cease to be smaller reporting company. Existing standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards. As of June 30, 2012, management has concluded that our controls and procedures were effective.  However, we cannot guarantee the implementation of controls and procedures in future years to be without any significant deficiency or material weakness.

 
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The issuance and sale of the common stock issuable upon conversion of the Series A Preferred Stock and exercise of warrants could result in a change of control.
 
If we issue all of the shares of common stock issuable upon conversion of the Series A Preferred Stock and exercise of warrants, the 5,825,237 shares of common stock so issuable would constitute approximately 25.3% of our then outstanding common stock. The percentage would increase to the extent that we are required to issue any additional shares of common stock become upon conversion of the Series A Preferred Stock pursuant to the anti-dilution and adjustment provisions and pursuant to the liquidated damages provisions of the registration rights agreements executed in connection with the Series A Preferred Stock. Any sale of all or a significant percentage of those shares to a person or group could result in a change of control.

We have not and do not anticipate paying any dividends on our common stock.
 
We have paid no dividends on our common stock to date and it is not anticipated that any dividends will be paid to holders of our common stock in the foreseeable future. While our future dividend policy will be based on the operating results and capital needs of the business, it is currently anticipated that any earnings will be retained to finance our future expansion and for the implementation of our business plan. As an investor, you should take note of the fact that a lack of a dividend can further affect the market value of our stock, and could significantly affect the value of any investment in our Company.

Our common stock could be delisted from The NASDAQ Global Market if we are not able to satisfy continued listing requirements, and if this occurs, the price of our common stock and our ability to raise additional capital may be adversely affected and the ability to buy and sell our stock may be less orderly and efficient.  

Our common stock is currently listed on the NASDAQ Global Market. Continued listing of a security on the NASDAQ Global Market is conditioned upon compliance with various continued listing standards. There can be no assurance that we will continue to satisfy the requirements for maintaining a NASDAQ Global Market listing.  The standards for continued listing require, among other things, that the closing minimum bid price for the listed securities be at least $1.00 per share for 30 consecutive trading days. The closing bid price for our shares has been less than $1.00 per share since May 18, 2012, and there can be no assurances made that we will satisfy the $1.00 minimum bid price required for continued listing of our common stock on the NASDAQ Global Market.

We received a letter dated July 2, 2012, from NASDAQ's Listing Qualifications Department, notifying us that during the preceding 30 consecutive business days, the closing bid price of our common stock was below the $1.00 minimum bid price per share required for continued listing on the NASDAQ Global Market.  This notification did not result in the immediate delisting of the Company’s common stock from the NASDAQ Global Market.

In accordance with NASDAQ rules, the Company has 180 calendar days, or until December 31, 2012, to regain compliance with the minimum bid price requirement by maintaining a closing bid price of $1.00 per share or higher for a minimum of 10 consecutive business days. Under the Listing Rules, the NASDAQ staff may exercise its discretion to extend this 10-day period. As of the filing of this Annual Report on Form 10-K with the SEC, the Company has not regained compliance with the minimum bid price requirement and does not know if it will be able to regain compliance prior to December 31, 2012. If the Company does not achieve compliance, NASDAQ will provide notice to the Company that its common stock is subject to delisting from the NASDAQ Global Market.  If the Company receives this notice, it may appeal the delisting determination to the NASDAQ Hearing Panel or may apply to transfer the listing of its common stock to the NASDAQ Capital Market if the Company satisfies all criteria for initial listing on the NASDAQ Capital Market, other than compliance with the minimum bid price requirement. If such application to the NASDAQ Capital Market is approved, then the Company may be eligible for an additional grace period of 180 days.

 
48

 
If we are not able to satisfy continued listing requirements of The NASDAQ Global Market, our common stock could be delisted and the price of our common stock and our ability to raise additional capital may be adversely affected. As a result, the ability to buy and sell our stock may be less orderly or efficient.

If our common stock is delisted from The NASDAQ Stock Market, the Company may be subject to the risks relating to penny stocks.
 
If our common stock is delisted from trading on The NASDAQ Stock Market and the trading price of the common stock is below $5.00 per share on the date the common stock is delisted, trading in our common stock may be subject to the requirements of certain rules promulgated under the Securities Exchange Act of 1934, as amended. These rules require additional disclosure by broker-dealers in connection with any trades involving a stock defined as a "penny stock" and impose various sales practice requirements on broker-dealers who sell penny stocks to persons other than established customers and accredited investors, generally institutions. These additional requirements may discourage broker-dealers from effecting transactions in securities that are classified as penny stocks, which could severely limit the market price and liquidity of such securities and the ability of purchasers to sell such securities in the secondary market. A penny stock is defined generally as any non-exchange listed equity security that has a market price of less than $5.00 per share, subject to certain exceptions.

Item 1B. Unresolved Staff Comments.
 
Not Applicable.
 
Item 2. Properties.
 
Our main office and our manufacturing facilities are located in Tianjin, China, on a plot of land of approximately 43,566.3 square meters in size. We have been issued a Land Use Right Certificate for the land until January 23, 2059 by the municipal government of Tianjin, which may be renewed. The construction of our new manufacturing facility and office building on this land has been substantially completed and we are in the process of applying for the title certificate from the local government. We currently own five buildings and lease one premise as listed below. We believe that our existing facilities are well maintained and in good operating condition.

Our land use rights are set forth below:

Land Use Rights through Grants from Land Management Authority
 
     
Plot A
 
Plot B
 
Land No.
 
No. 01-17-(3)-8
 
No. 1201104020180020001
 
Land Use Right Certificate No.
 
Jin Nan Dan Guo Yong (2001) Geng 2 Zi No.045
 
Bao Dan Guo Yong (2009) No. 022
 
User of the Land
 
Tianjin Shengkai
 
SK WFOE
 
Location
 
Wang Gang Road, Shuangang, Jinnan Economic & Technology Development Area, Tianjin
 
No. 106 Zhonghuan South Road, Economic Zone, Airport Industrial Park, Tianjin
 
Usage
 
Commercial Services
 
Commercial Services
 
Area ( m2 )
 
10,023.0
 
43,566.3
 
 
49

 
 
Form of Acquisition
 
Grant from related Land Management Authority
 
Grant from related Land Management Authority
 
Expiration Date
 
September 21, 2048
 
January 23, 2059
 
Encumbrances
 
None
 
None
 
We currently own the following buildings, as set forth below:

Owned Premises

 
Part 1
 
Part 2
 
Part 3
 
Part 4
 
Part 5
 
Certificate No.
No. 11230902147
 
Owner
Tianjin Shengkai
 
Location
Wang Gang Road, Shuangang, Jinnan Economic& Technology Development Area, Tianjin
 
Category
Private
 
Area ()
931.06
 
1192.90
 
493.64
 
824.74
 
2691.41
 
Usage of Design
Industry
 
Industry
 
Industry
 
Industry
 
Industry
 
Structure
Mixture
 
Mixture
 
Mixture
 
Mixture
 
Mixture
 
Encumbrances
None
 

We currently lease the following premise:

Leased Premises

No.
 
Lessor
 
Location
 
Term
 
Rent per Year
(USD)
 
1
 
Tianjin Development Zone Binhai Investment Service Co., Ltd.
 
Room A3112, Part II, 122 Dongting Road, Tianjin Development Zone
 
November 17, 2011 to January 16, 2013
  $
1,109
 
 
Item 3. Legal Proceedings.
 
We know of no material, active, pending or threatened proceeding against us or our subsidiaries, nor are we, or any subsidiary, involved as a plaintiff or defendant in any material proceeding or pending litigation.
 
Item 4. Mine Safety Disclosures.

Not applicable.
PART II
 
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.
 
Market Information
 
The Company’s common stock has been quoted on NASDAQ Stock Market LLC under the symbol “VALV” since May 25, 2010.  Its common stock previously was traded on the NYSE MKT under the symbol “SHE” between December 23, 2009 and May 24, 2010, and was quoted on the Over-the-Counter Bulletin Board (“OTCBB”) under the symbol “SKII”, “SOSA,” and “SSAU” prior to December 23, 2009.
 
 
50

 
The high and low prices for the Company’s common stock for the quarters of the last two years ended June 30, 2012 and 2011 is listed below. The prices are taken from NASDAQ, which prices have been retroactively restated to reflect the Reverse Stock Split effected on March 9, 2012.
 
Fiscal Quarter
 
High Price
 
Low Price
2011 First Quarter  
 
$17.00
 
$11.80
2011 Second Quarter
 
$15.20
 
$11.00
2011 Third Quarter
 
$12.18
 
$6.76
2011 Fourth Quarter
 
$7.82
 
$2.56
2012 First Quarter  
 
$7.70
 
$1.72
2012 Second Quarter
 
$2.10
 
$1.12
2012 Third Quarter
 
$2.88
 
$1.04
2012 Fourth Quarter
 
$2.04
 
$0.68

As of September 20, 2012, we had approximately 2,600 shareholders of record of our common stock, including the shares held in street name by brokerage firms. The holders of common stock are entitled to one vote for each share held of record on all matters submitted to a vote of shareholders. Holders of the common stock have no preemptive rights and no right to convert their common stock into any other securities. There are no redemption or sinking fund provisions applicable to the common stock.

Dividends

We have not paid dividends on our common stock and do not anticipate paying such dividends in the foreseeable future. We will rely on dividends from SK WFOE for our funds and PRC regulations may limit the amount of funds distributed to us from SK WFOE, which will affect our ability to declare any dividends.

Securities Authorized for Issuance under Equity Compensation Plans
 
The following table gives information about the Company’s common stock that may be issued upon the exercise of options granted to employees, directors and consultants under its 2010 and 2011 Incentive Stock Plans as of June 30, 2012. On February 8, 2010, the Company’s board of directors and a majority of the Company’s holders of common stock approved establishment of the 2010 Incentive Stock Plan. On March 4, 2011, the Company’s board of directors and a majority of the Company’s holders of common stock approved establishment of the 2011 Incentive Stock Plan.
 
Equity Compensation Plan Information
 
Plan category
 
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
   
Weighted-average
exercise price of
outstanding options,
warrants and rights
   
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a)
 
                   
   
(a)
   
(b)
   
(c)
 
Equity compensation plans approved by security holders
    1,043,772 (1)    $ 14.74       331 (2)
Equity compensation plans not approved by security holders
                       
Total
    1,043,772     $ 14.74       331  

 
51

(1) This number only includes shares to be issued upon exercise of outstanding options under the 2010 Incentive Stock Plan, excluding those options terminated or forfeited due to termination of employment, and does not include the 1,335,000 shares of common stock awarded to the Company's employees under the 2011 Incentive Stock Plan.

(2) Up to 1,335,331 shares of common stock are authorized to be issued under the 2011 Incentive Stock Plan. As of June 30, 2012, 331 shares of common stock remain available for future issuance under this plan.

Recent Sales of Unregistered Securities
 
None. 

Item 6. Selected Financial Data.

Not applicable.
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion of the financial condition and results of operation of the Company for the fiscal years ended June 30, 2012 and 2011 should be read in conjunction with the selected financial data, the financial statements and the notes to those statements that are included elsewhere in this registration statement. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors, Cautionary Notice Regarding Forward-Looking Statements and Business sections in this registration statement. We use terms such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions to identify forward-looking statements.

General

SK WFOE and Tianjin Shengkai, the entities through which we run our operations, are prominent ceramic valve manufacturers. We have more than 18 years of experience and possess a unique method for creating ceramic valves.

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 able to produce large-sized ceramic valves with calibers of 6" (150mm) or more. The Company's product portfolio includes a broad range of valves that are sold throughout the PRC, to Europe, North America, Middle East and other countries in the Asia-Pacific region. The Company has over 150 customers, and is the only ceramic valve supplier qualified to supply SINOPEC. The Company 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.
 
Results of Operations
 
Comparison of the Years Ended June 30, 2012 and 2011
 
Revenue

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 timely collect accumulated trade receivables from their customers.
 
 
52

 
As a result, revenue for the fiscal year ended June 30, 2012 decreased by $61,133,848 or 65.4% to $32,317,525 from $93,451,373 for the fiscal year ended June 30, 2011. Total ceramic valves output for the fiscal year ended June 30, 2012 was 5,461 sets, compared with 23,298 sets for the fiscal year ended June 30, 2011. This is also in line with our previous announcements forecasting the continuation of loss of customers and business in the domestic market, particularly in electric power industry, as a result of the Company’s strategic shifting of business focus and increase in the sales price of our products.

Approximately 89.1% of our source of revenue came from customers in the electric power, petrochemical and chemical industries for the fiscal year ended June 30, 2012, compared with 91.1% for the fiscal year ended June 30, 2011.

Unlike previously, the electric power industry contributed significantly less to our revenue, generating approximately 26.7% of total revenue for the fiscal year ended June 30, 2012, compared with 61.7% for the fiscal year ended June 30, 2011. Revenue from the electric power industry was $8,635,808 for the fiscal year ended June 30, 2012, a decrease of $49,034,702 or 85.0% from $57,670,510 for fiscal 2011.

Revenue from the petrochemical and chemical industry accounted for approximately 62.3% of total revenue for the fiscal year ended June 30, 2012, compared with 29.4% for the fiscal year ended June 30, 2011. The revenue from the petrochemical and chemical industry was $20,148,481 for the fiscal year ended June 30, 2012, a decrease of $7,356,784 or 26.7% from $27,505,265 for fiscal 2011. The decrease was primarily due to the general slowdown in economy in the PRC and the increase in the sales price of our products.

Revenue from other industries, including the aluminum and metallurgy industries, accounted for approximately 10.9% of total revenue for the fiscal year ended June 30, 2012, compared with 8.9% for the fiscal year ended June 30, 2011. The revenue for other industries was $3,533,236 for the fiscal year ended June 30, 2012, a decrease of $4,742,362 or 57.3% from $8,275,598 for fiscal 2011. 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. In fiscal 2011, there was an increase in revenue from some iron and steel mills who introduced new blast furnace gas cleaning systems, which required highly anti-abrasive ceramic valves. Orders from those new projects had been completed by the end of the fiscal year ended June 30, 2011.

Cost of Sales and Gross Profit
 
Cost of sales for the fiscal year ended June 30, 2012 was $18,341,149, a decrease of $21,986,353 or 54.5% as compared to $40,327,502 for the fiscal year ended June 30, 2011, primarily due to decline in revenue. The cost of sales as a percentage of net revenues increased by approximately 13.6% to 56.8% in the fiscal year ended June 30, 2012 from 43.2% during fiscal 2011.

Gross profit for the fiscal year ended June 30, 2012 was $13,976,376, a decrease of $39,147,495 or 73.7% as compared to $53,123,871 for the fiscal year ended June 30, 2011. The decrease was attributable to both decrease in revenue and increase in certain costs such as depreciation expenses. The gross margin for the fiscal year ended June 30, 2012 was 43.2%, as compared to 56.8% for fiscal 2011. The decrease in gross margin between the two comparable years was primarily attributed to increase in depreciation expenses and material prices, which were spread over a smaller revenue base, partially mitigated by the increase in product sales price. During the two fiscal years ended June 30, 2011 and 2012, total new fixed assets of approximately $53.7 million were added to property, plant and equipment. The depreciation expenses recorded in cost of sales for the fiscal year ended June 30, 2012 was approximately $3.3 million, an increase of approximately $1.8 million or 119.3% as compared to approximately $1.5 million for fiscal 2011. During fiscal 2012, prices for steel raw materials and steel die-casting components, our major raw materials, were approximately 11.6% higher than those in fiscal 2011.

 
53

 
Selling Expenses
 
Selling expenses for the fiscal year ended June 30, 2012 were $3,746,972, a decrease of $4,593,335 or 55.1%, from $8,340,307 for the fiscal year ended June 30, 2011. The major component of selling expenses was commissions paid to agents for introducing new sales, which was approximately $2.6 million for the fiscal year ended June 30, 2012, a decrease of approximately $4.9 million or 65.4% from approximately $7.5 million for the fiscal year ended June 30, 2011. Selling expenses as a percentage of total sales revenue increased to 11.6% for the fiscal year ended June 30, 2012 from 8.9% for fiscal 2011, since certain minor components of selling expenses such as sales staff’s salaries and after-sale service expenses are flat-rate and did not diminish proportionally to revenue decrease, and also because we attended more trade shows and incurred more marketing expenses in fiscal 2012 as a result of our efforts to develop new markets.

General and Administrative Expenses
 
General and administrative (“G&A”) expenses for fiscal year ended June 30, 2012 were $9,497,603, a decrease of $5,699,698 or 37.5% as compared to $15,197,301 for the fiscal year ended June 30, 2011. Included in G&A expenses for the fiscal year ended June 30, 2012 was a non-cash charge of $4,864,530, which was the share-based compensation costs on: i) the options to independent directors, management and key employees issued in March and June, 2010, under the Company’s 2010 Incentive Stock Plan, and ii) the stock awards to management and key employees issued in September 2011, under the Company’s 2011 Incentive Stock Plan. The non-cash share-based compensation costs included in the G&A expenses for fiscal 2011 was $9,674,402. G&A expenses (excluding the non-cash items) for the fiscal year ended June 30, 2012 were $4,633,073, a decrease of $889,826 or 16.1% as compared to $5,522,899 for the fiscal year ended June 30, 2011.The decrease in G&A (excluding the non-cash items) expenses over the comparable periods of fiscal 2011 and 2012 was primarily attributable to decrease in expenses and professional fees incurred for our U.S. capital market-related activities of $412,913; decrease in other miscellaneous G&A expenses including moving expenses of $531,574; as well as decrease in salary and welfare costs of $87,466 attributed to reduced number of employees, offset by the increase in depreciation costs of $160,241 as a result of the new headquarters building.

Changes in Fair Value of Instruments
 
For the fiscal year ended June 30, 2012, the Company incurred non-cash gain in an aggregate amount of approximately $2.2 million 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 fiscal year ended June 30, 2012. Fair value of the instruments was primarily a function of the price of our common stock. A decrease in our stock price over the year resulted in a decrease in fair value of the instruments, which are liabilities; hence a gain was recognized for the reporting period. For the fiscal year ended June 30, 2011, the Company recognized a non-cash gain of approximately $69.7 million due to the decrease in our stock price over that year.

 
54

 
Provision for Income Taxes
 
Provision for income taxes for the fiscal year ended June 30, 2012 was $1,597,693, a decrease of $4,789,161 or 75.0% from $6,386,854 for the fiscal year ended June 30, 2011. Excluding the approximately $4.9 million share-based compensation cost and the approximately $2.2 million gain from changes in fair value of instruments, adjusted income before taxes was approximately $6.7 million for the fiscal year ended June 30, 2012 compared with approximately $39.8 million for fiscal 2011, after adjusting for the approximately $9.7 million share-based compensation cost and approximately $69.7 million 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 of each of 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%. Currently Tianjin Shengkai is in the process of renewing the “high technology” enterprise status. Management believes that it is likely that such renewal will be approved. Based on such belief and common practice as accepted by relevant tax authority, Tianjin Shengkai used the 15% enterprise income tax rate to provide and pay for income tax expenses for the quarters ended March 31 and June 30, 2012. In the event that such renewal is not finally approved, however, we will need to apply the standard rate of 25% and make up the 10% difference in income tax expenses for the quarters ended March 31 and June 30, 2012.

Net Income

Net income (per U.S. GAAP) for the fiscal year ended June 30, 2012 was $2,421,921, a decrease of $91,048,838 or 97.4% from $93,470,759 for the fiscal year ended June 30, 2011. Diluted earnings per share were $0.13 for fiscal 2012 as compared to diluted earnings per share of $5.34 for fiscal 2011. For the fiscal year ended June 30, 2012, the number of diluted shares was 18,149,457 compared with 17,515,037 diluted shares for fiscal 2011.

Excluding the approximately $ 4.9 million share-based compensation cost and the approximately $2.2 million gain from changes in fair value of instruments, adjusted net income (non-GAAP) was approximately $5.1 million for the fiscal year ended June 30, 2012 compared with approximately $33.5 million for fiscal 2011, after adjusting for the approximately $9.7 million share-based compensation cost and approximately $69.7 million gain from changes in fair value of instruments. The decrease was attributable to the factors described above. Non-GAAP earnings were $0.28 per diluted share for fiscal 2012 compared with $1.91 per diluted share for fiscal 2011.

Liquidity and Capital Resources

Cash and Cash Equivalents

Our cash and cash equivalents at the beginning of the fiscal year ended June 30, 2012 were $59,870,108 and increased to $64,819,870 by the end of the year, an increase of $4,949,762 or 8.3%.  The increase was primarily attributable to the internal cash flows generated from operations, release of restricted cash, as well as effects of exchange rate change.

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.

 
55

Net Cash Provided by Operating Activities

Net cash provided by operating activities was $3,911,220 for the fiscal year ended June 30, 2012, a decrease of $24,670,596 or 86.3% from $28,581,816 for the fiscal year ended June 30, 2011. The adjusted net income, after deducting the non-cash gain from changes in fair value of instruments and adding back the non-cash share-based compensation cost, was $5,079,074 for the fiscal year ended June 30, 2012, a decrease of $28,373,309 or 84.8% from $33,452,383 for the fiscal year ended June 30, 2011. The decrease in net cash inflow from operations was primarily attributable to the decrease in net income between the two years.

Net Cash Used in Investing Activities

Net cash used in investing activities was $399,290 for the fiscal year ended June 30, 2012, as compared to $9,290,312 for the fiscal year ended June 30, 2011, a decrease of $8,891,022. The change was primarily attributable to significant reduction in capital expenditures and decrease in restricted cash incurred during the fiscal year ended June 30, 2012 as compared to fiscal 2011.

Net Cash Provided by Financing Activities

There was no cash provided by or used in financing activities for the fiscal year ended June 30, 2012. Net cash provided by financing activities was $17,466,689 for the fiscal year ended June 30, 2011, attributable to the proceeds from issuance of common stock in the public offering during the period, net of offering costs.

Capital Expenditures

In October 2008, we successfully won a bid on a land use right over a plot of land approximately 43,566.3 square meters in size. The land is located in Tianjin, PRC and the bid price was approximately $1.9 million (RMB12.6 million). The formal contract was signed with the government on January 23, 2009, with the Company to pay the bid price in full by March 25, 2009. The land was purchased to construct corporate headquarters and to build a new manufacturing facility to expand our production capacity. Expenditures committed under related construction contracts totaled $35,619,130 (RMB224,909,871), of which $34,670,988 (RMB218,923,021) had been paid as of June 30, 2012. The remaining balance of $948,142 (RMB5,986,850) will substantially be settled after completion of inspection and final acceptance of the construction project by relevant government authorities, with certain amount to be held from payment as warranty deposit till approximately one year after such final acceptance. Certain equipment and machinery contracts for the above-mentioned new manufacturing facility have also been executed, total amount of which was approximately $16,562,327 (RMB104,579,500), of which $15,552,674 (RMB98,204,250) had been paid as of June 30, 2012. The remaining balance of $1,009,653 (RMB6,375,250) primarily represented the amount held from payment as warranty deposit till approximately one year after installation and acceptance.

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 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 ended September 30, 2012, total revenues would remain flat, and major contribution to our sales would 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.
 
56

 
Inflation

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

Contractual Obligations

We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, in order to assist in the review of this information within the context of our financial position, results of operations, and cash flows.

The following table summarizes our contractual obligations as of June 30, 2012, and the effect these obligations are expected to have on our liquidity and cash flows in future periods.
  
 
Totals
   
Less Than
1 Year
   
1 to 3
Years
  
 
Thereafter
 
                         
Capital expenditures (1)
 
$
1,957,795
   
$
1,957,795
   
$
-
   
-
 
 
(1) Capital expenditures are commitments for the construction of a new manufacturing facility and for the purchase of new equipment and machinery. See Note 16 - Commitments and Contingency in the notes to the financial statements, included elsewhere in this report. The Company entered into certain construction contracts for building a new manufacturing facility and a headquarters building. The total amount of executed contracts was $35,619,130 (RMB224,909,871), of which $34,670,988 (RMB218,923,021) had been paid as of June 30, 2012. The construction of both the manufacturing facility and the headquarters building were substantially completed in September 2010. The Company has also executed certain equipment and machinery contracts totaling $16,562,327 (RMB104,579,500), of which $15,552,674 (RMB98,204,250) had been paid as of June 30, 2012.

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).
 
 
57

 
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.

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.

 
58

 
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.

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

Not Applicable.

Item 8. Financial Statements and Supplementary Data.
 
 
 
59

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

 
 
 
F-1

 
Report of Independent Registered Public Accounting Firm

ALBERT WONG & CO.
CERTIFIED PUBLIC ACCOUNTANTS
7th Floor, Nan Dao Commercial Building
359-361 Queen’s Road Central
Hong Kong
Tel : 2851 7954
Fax: 2545 4086
 
ALBERT WONG
B.Soc., Sc., ACA., LL.B., C.P.A.(Practising)
 
To:
The board of directors and stockholders of
 
Shengkai Innovations, Inc.
 
Report of Independent Registered Public Accounting Firm
 
We have audited the accompanying consolidated balance sheet of Shengkai Innovations, Inc. and subsidiaries as of June 30, 2012 and the related consolidated statements of income, stockholders' equity and cash flow for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
 
We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
We were not engaged to examine management’s assertion about the effectiveness of the Company’s internal control over financial reporting as of June 30, 2012 included in the Company’s Item 9A “Controls and Procedures” in the Annual Report on Form 10-K and, accordingly, we do not express an opinion thereon.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Shengkai Innovations, Inc. and subsidiaries as of June 30, 2012 and the results of its operations and its cash flow for the years then ended in conformity with accounting principles generally accepted in the United States of America.
 

 
Hong Kong, China
/s/ Albert Wong & Co.
September 20, 2012
Certified Public Accountants
 
F-2

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Stated in US Dollars)
 
   
June 30,
 
   
2012
   
2011
 
             
ASSETS
 
 
   
 
 
Current Assets
 
 
   
 
 
Cash and cash equivalents
  $ 64,819,870     $ 59,870,108  
Restricted cash
    124,433       1,386,873  
Accounts receivable, net
    9,388,820       12,623,359  
Notes receivable
    167,873       217,502  
Other receivables (Note 4)
    2,879,422       2,722,300  
Advances to suppliers
    2,339,362       274,814  
Inventories (Note 5)
    2,750,907       2,532,485  
Total Current Assets
    82,470,687       79,627,441  
Plant and equipment, net (Note 6)
    54,068,143       53,921,084  
Land use rights, net (Note 7)
    2,533,684       2,534,059  
Other intangible assets, net (Note 8)
    4,524,058       5,370,148  
TOTAL ASSETS
  $ 143,596,572     $ 141,452,732  
 
 
 
   
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
   
 
 
Current Liabilities
 
 
   
 
 
Notes payable (Note 9)
    124,433       1,386,873  
Accounts payable
    1,942,262       3,829,491  
Advances from customers
    316,020       227,451  
Other payables and accrued expenses (Note 10)
    899,491       2,350,144  
Income tax payable
    240,438       1,816,995  
Total Current Liabilities
    3,522,644       9,610,954  
Warrant liabilities
    1,761       168,442  
Preferred (conversion option) liabilities
    481,128       5,782,014  
TOTAL LIABILITIES
  $ 4,005,533     $ 15,561,410  
   
 
   
 
 
Commitments and Contingencies (Note 16)
    -     $ -  

See accompanying notes to consolidated financial statements
 
 
F-3

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Continued)
 (Stated in US Dollars)

   
June 30,
 
   
2012
   
2011
 
             
STOCKHOLDERS’ EQUITY
           
Preferred stock – $0.001 par value 15,000,000 share authorized; 1,971,842 and 5,987,368 issued and outstanding as of June 30, 2012 and 2011 respectively. (Note 12)   $ 1,971     $ 5,987  
Common stock – $0.001 par value 100,000,000 shares authorized; 17,196,071 and 14,888,306 shares issued and outstanding as of June 30, 2012 and 2011 respectively. *
    17,197       14,889  
Additional paid-in capital
    71,695,567       63,569,139  
Statutory reserves
    11,196,604       11,196,604  
Retained earnings
    45,091,511       42,669,590  
Accumulated other comprehensive income
    11,588,189       8,435,113  
TOTAL STOCKHOLDERS EQUITY
    139,591,039       125,891,322  
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 143,596,572     $ 141,452,732  

*The number of shares of common stock has been retroactively restated to reflect the Reverse Stock Split effected on March 9, 2012.

See accompanying notes to consolidated financial statements

 
F-4

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Stated in US Dollars)
 
   
Year Ended June 30,
 
   
2012
   
2011
 
             
Revenues
  $ 32,317,525     $ 93,451,373  
Cost of sales
    (18,341,149 )     (40,327,502 )
Gross profit
    13,976,376       53,123,871  
Operating expenses:
               
Selling expenses
    (3,746,972 )     (8,340,307 )
General and administrative expenses
    (9,497,603 )     (15,197,301 )
Total operating expenses
    (13,244,575 )     (23,537,608 )
Income from operations
    731,801       29,586,263  
Other income, net
    227,887       318,701  
Interest income, net
    852,549       259,871  
Changes in fair value of instruments - gain
    2,207,377       69,692,778  
Income before income taxes
    4,019,614       99,857,613  
Income taxes (Note 14)     (1,597,693 )     (6,386,854 )
Net income
    2,421,921       93,470,759  
Foreign currency translation adjustment
    3,153,076       5,401,210  
Comprehensive income
    5,574,997       98,871,969  
                 
Basic earnings per share* (Note 15)   $ 0.15     $ 7.31  
                 
Diluted earnings per share* (Note 15)   $ 0.13     $ 5.34  
                 
Basic weighted average shares outstanding* (Note 15)     16,695,852       12,793,547  
                 
Diluted weighted average shares outstanding* (Note 15)     18,149,457       17,515,037  

* 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.

See accompanying notes to consolidated financial statements
 
 
F-5

 
SHENGKAI INNOVATIONS, INC.
(F/K/A SOUTHERN SAUCE COMPANY, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY
 (Stated in US Dollars)
 
         
Preferred
                     
Accumulated
       
   
Common stock
   
Stock
   
Additional
               
other
       
   
Number
         
Number
         
paid-in
   
Statutory
   
Retained earnings
   
comprehensive
       
   
of shares
   
Amount
   
of shares
   
Amount
   
capital
   
reserves
   
(Accumulated losses)
   
Income
   
Total
 
                                                                         
Balance, June 30, 2010
    23,191,165     $ 23,192      
6,987,368
    $ 6,987     $ 34,259,304     $ 7,081,706     $ (46,686,271     $ 3,033,903     $ (2,281,179  
Net income
                                                  93,470,759               93,470,759  
Conversion from preferred stock to common stock
    1,000,000       1,000       (1,000,000 )     (1,000 )     2,877,831                               2,877,831  
Appropriation of surplus reserve
                                            4,114,898       (4,114,898 )             -  
Proceeds from shares issued in public offering
    2,456,800       2,457                       12,132,279                               12,134,736  
Proceeds from shares issued in public offering
    1,058,646       1,058                       5,330,895                               5,331,953  
Issuance of incentive stocks to employees
    600,000       600                       3,053,400                               3,054,000  
Issuance of incentive stocks to employees
    1,470,000       1,470