10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2009

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

For the transition period from _______ to _______

Commission file number: 001-34587

SHENGKAI INNOVATIONS, INC.

(Exact name of small business issuer as specified in its charter)

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

NO. 27, WANG GANG ROAD

JIN NAN (SHUANG GANG) ECONOMIC AND TECHNOLOGY DEVELOPMENT AREA

TIANJIN, PEOPLE’S REPUBLIC OF CHINA

(Address of principal executive offices)

(8622) 2858-8899

(Registrant’s telephone number, including area code)

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

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

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

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

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

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

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 23,012,500 shares of common stock, $.001 par value, were outstanding as of February 10, 2010.

TABLE OF CONTENTS

		Page
	PART I
Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	33
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39
Item 4.	Controls and Procedures	39
	PART II
Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	40
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3.	Defaults Upon Senior Securities	40
Item 4.	Submission of Matters to a Vote of Security Holders	40
Item 5.	Other Information	40
Item 6.	Exhibits	40
SIGNATURES		41

2

PART I – FINANCIAL INFORMATION

Item 1.                       Financial Statements

SHENGKAI INNOVATIONS, INC.

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

CONTENTS	PAGES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	4
CONSOLIDATED BALANCE SHEETS	5 – 6
CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME	7
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY	8
CONSOLIDATED STATEMENTS OF CASH FLOWS	9 – 10
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS	11 – 31

3

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., LL.B., P.C.LL., Barrister-at-law, C.P.A.(Practising).

The Board of Directors and Stockholders of

Shengkai Innovations, Inc.

(F/K/A Southern Sauce Company, Inc.)

Report of Independent Registered Public Accounting Firm

We have reviewed the accompanying interim consolidated balance sheets, and the related consolidated statements of income, stockholders’ equity and cash flows of Shengkai Innovations, Inc. and consolidated subsidiaries as of December 31, 2009 and 2008, and for the six-month period then ended. These interim financial information statements are the responsibility of the company's management.

We conducted our review in accordance with standards established by the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

Hong Kong, China	Albert Wong & Co.
February 9, 2009	Certified Public Accountants

4

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED BALANCE SHEETS

AS AT DECEMBER 31, 2009 AND JUNE 30, 2009

(Stated in US Dollars) (Unaudited)

	Note		December 31, 2009		June 30, 2009
			(Unaudited)		(Audited)
ASSETS
Current assets
Cash and cash equivalents			$	37,160,406	$	38,988,958
Pledged deposits		4		4,959,811		940,488
Trade receivables				6,558,667		4,061,706
Notes receivable				14,626		292,193
Other receivables		5		40,354		22,979
Prepaid VAT				-		194,535
Advances to suppliers				880,196		328,785
Inventories		6		903,820		907,799
Total current assets			$	50,517,880	$	45,737,443
Plant and equipment, net		7		12,425,112		5,173,269
Intangible assets, net		8		8,894,270		9,342,322
TOTAL ASSETS			$	71,837,262	$	60,253,034
LIABILITIES AND
STOCKHOLDERS’ EQUITY
Current liabilities
Notes payable			$	2,278,965	$	984,561
Accounts payable				1,971,770		1,121,185
Advances from customers				1,285,956		242,986
Other payables		9		1,087,502		794,754
Accruals				75,746		131,581
Income tax payable				1,387,544		1,471,380
Total current liabilities			$	8,087,483	$	4,746,447
TOTAL LIABILITIES			$	8,087,483	$	4,746,447
Commitments and contingencies		15	$	-	$	-

See accompanying notes to consolidated financial statements

5

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED BALANCE SHEETS (Continued)

AS AT DECEMBER 31, 2009 AND JUNE 30, 2009

(Stated in US Dollars) (Unaudited)

	Note		December 31, 2009		June 30, 2009
			(Unaudited)		(Audited)
STOCKHOLDERS’ EQUITY
Preferred Stock – $0.001 par value
15,000,000 share authorized ;
7,187,368 and 7,887,368 issued
and outstanding as of December 31,
2009 and June 30, 2009 respectively.		10	$	7,187	$	7,887
Common stock - $0.001 par value
50,000,000 shares authorized;
22,812,500 and 22,112,500 shares
issued and outstanding as of  December 31,
2009 and June 30, 2009 respectively.		11		22,813		22,113
Additional paid-in capital		11		30,666,631		30,666,631
Statutory reserves				7,081,706		4,693,020
Retained earnings				23,261,697		17,456,857
Accumulated other comprehensive
income				2,709,745		2,660,079
			$	63,749,779	$	55,506,587
TOTAL LIABILITIES AND
STOCKHOLDERS’ EQUITY			$	71,837,262	$	60,253,034

See accompanying notes to consolidated financial statements

6

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars) (Unaudited)

			Six months ended December 31,						Three months ended December 31,
	Notes		2009			2008			2009			2008
Net revenues			$	23,652,020		$	17,340,054		$	12,541,851		$	8,142,807
Cost of sales				(9,482,017	)		(7,011,661	)		(5,161,926	)		(3,404,087	)
Gross profit			$	14,170,003		$	10,328,393		$	7,379,925		$	4,738,720
Operating expenses:
Selling				(2,117,990	)		(1,756,476	)		(1,116,378	)		(885,639	)
General and administrative				(1,514,850	)		(1,102,185	)		(767,122	)		(505,699	)
Operating income			$	10,537,163		$	7,469,732		$	5,496,425		$	3,347,382
Other income				15,595			7,316			15,595			-
Interest income				308,511			66,111			20,799			43,265
Income before income tax			$	10,861,269		$	7,543,159		$	5,532,819		$	3,390,647
Income tax		12		(2,667,743	)		(1,884,281	)		(1,387,740	)		(858,086	)
Net income			$	8,193,526		$	5,658,878		$	4,145,079		$	2,532,561
Basic earnings per share		13	$	0.366		$	0.140		$	0.184		$	0.115
Diluted earnings per share		13	$	0.265		$	0.103		$	0.130		$	0.084
Basic weighted average share
outstanding		13		22,382,719			22,112,500			22,570,742			22,112,500
Diluted weighted average
share outstanding		13		30,923,656			29,999,868			31,999,449			29,999,868

See accompanying notes to consolidated financial statements

7

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY

FOR THE YEAR ENDED JUNE 30, 2009 AND SIX MONTHS ENDED DECEMBER 31, 2009

(Stated in US Dollars) (Unaudited)

															Accumulated
	Common stock							Additional							other
	Number				Preferred			paid-in		Statutory		Retained			comprehensive
	of share		Amount		stock			capital		reserves		earnings			Income		Total
Balance, June 30, 2008		22,112,500	$	22,113	$	5,916		$	23,494,626	$	2,875,066	$	8,257,303		$	2,526,518	$	37,181,542
Net income		-		-		-			-		-		13,577,694			-		13,577,694
Proceeds from shares
issued in private
placement, net of
transaction costs of
$386,210		-		-		1,971			4,611,819		-		-			-		4,613,790
Appropriations to
statutory reserves		-		-		-			-		1,817,954		(1,817,954	)		-		-
Dividends		-		-		-			2,560,186		-		(2,560,186	)		-		-
Foreign currency
translation adjustment		-		-		-			-		-		-			133,561		133,561
Balance, June 30, 2009		22,112,500	$	22,113	$	7,887		$	30,666,631	$	4,693,020	$	17,456,857		$	2,660,079	$	55,506,587
Balance, June 30, 2009		22,112,500	$	22,113	$	7,887		$	30,666,631	$	4,693,020	$	17,456,857		$	2,660,079	$	55,506,587
Net income		-		-		-			-		-		8,193,526			-		8,193,526
Appropriations to
statutory reserves		-		-		-			-		2,388,686		(2,388,686	)		-		-
Conversion of
preferred stock		700,000		700		(700	)		-		-		-			-		-
Dividends		-		-		-			-		-		-			-		-
Foreign currency
translation adjustment		-		-		-			-		-		-			49,666		49,666
Balance, December 31, 2009		22,812,500	$	22,813	$	7,187		$	30,666,631	$	7,081,706	$	23,261,697		$	2,709,745	$	63,749,779

See accompanying notes to consolidated financial statements

8

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars) (Unaudited)

	six months ended December 31,
	2009			2008
Cash flows from operating activities
Net income	$	8,193,526		$	5,658,878
Depreciation		209,176			83,329
Amortization		458,345			382,544
Adjustments to reconcile net income to net
cash provided by operating activities:
Trade receivables		(2,491,947	)		(262,560	)
Notes receivable		277,836			8,756
Other receivables		(17,346	)		9,631
Prepaid VAT		194,712			-
Deposits and prepaid expenses		-			2,550
Advances to suppliers		(550,935	)		(266,158	)
Inventories		4,987			(544,614	)
Notes payable		1,293,051			128,862
Accounts payable		849,169			(36,621	)
Advances from customers		1,042,491			200,458
Other payables		291,807			(13,607	)
Accruals		(55,970	)		(4,541	)
Income tax payable		(85,454	)		(95,522	)
Net cash provided by operating activities	$	9,613,448		$	5,251,385
Cash flows from investing activities
Purchase of property, plant and equipment	$	(7,453,817	)	$	(103,563	)
Deposit for land use right auction		-			(379,392	)
Increase in pledged deposits		(4,017,931	)		(128,862	)
Net cash used in investing activities	$	(11,471,748	)	$	(611,817	)
Cash flows from financing activities
Proceeds from stock issued, net of transaction costs
of $386,210	$	-		$	4,613,790
Net cash provided by financing activities	$	-		$	4,613,790

See accompanying notes to consolidated financial statements

9

SHENGKAI INNOVATIONS, INC.

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

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars) (Unaudited)

	2009			2008
Net cash and cash equivalents (used) / sourced	$	(1,858,300	)	$	9,253,358
Effect of foreign currency translation on cash
and cash equivalents		29,748			34,982
Cash and cash equivalents–beginning of the period		38,988,958			21,313,484
Cash and cash equivalents–end of the period	$	37,160,406		$	30,601,824
Supplementary cash flow information:
Interest received	$	308,511		$	66,111
Tax paid	$	2,753,197		$	1,979,803

See accompanying notes to consolidated financial statements

10

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

1.      ORGANIZATION AND PRINCIPAL ACTIVITIES

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

On June 9, 2008, the Company executed a reverse-merger with Shen Kun International Limited (“Shen Kun”) by an exchange of shares whereby the Company issued 20,550,000   common shares at $0.001 par value in exchange for all Shen Kun shares.

The exchange transaction was accounted for as a reverse acquisition in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations” (formerly included under Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations). For financial reporting purposes, this transaction is classified as a recapitalization of the Company and Shen Kun. The accompanying audited consolidated financial statements were retroactively adjusted to reflect the effects of the recapitalization of the financial statements of the Company and the historical financial statements of Shen Kun. The 1,562,500 shares of Shengkai Innovations, Inc. outstanding prior to this stock exchange transaction were accounted for at the net book value at the time of the transaction, which was a deficit of $62,206. The consolidated statements of income include the results of operations of Tianjin Shengkai Industrial Technology Development Co., Ltd for the period ended December 31, 2009 and 2008.

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

The Company, through its subsidiaries and Shengkai, (hereinafter, collectively referred to as “the Group”), is now in the business of manufacturing and selling of ceramic valve.

11

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Method of Accounting

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

(b) Principles of Consolidation

The consolidated financial statements, which include the Company and its subsidiaries, are complied in accordance with generally accepted accounting principles in the United States of America. All significant inter-company accounts and transactions have been eliminated. The consolidated financial statements include 100% of assets, liabilities, and net income or loss of those wholly-owned subsidiaries.

The company owned the three subsidiaries since its reverse-merger on June 9, 2008. The detailed identities of the consolidating subsidiaries would have been as follows:

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

(c) Use of estimates

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

12

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(d) Economic and political risks

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

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

(e) Pledged deposits

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

(f) Plant and equipment

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

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

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

(g) Intangible assets

Intangible assets represent land use rights, patent rights and others in the PRC.  Land use rights are carried at cost and amortized on a straight-line basis over the period of rights of 50 years commencing from the date of acquisition of equitable interest. Patent rights are carried at cost and amortized on a straight-line basis over the period of rights of 10 years commencing from the date of acquisition of equitable interest.  Others are software costs which are carried at cost and amortized on a straight-line basis over the period of 6 years.

13

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

The Group periodically evaluates the carrying value of long-lived assets to be held and used, including intangible assets subject to amortization, when events and circumstances warrant such a review, pursuant to the guidelines established in ASC350. The carrying value of a long-lived asset is considered impaired when the anticipated undiscounted cash flow from such asset is separately identifiable and is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair market values are reduced for the cost to dispose.

During the reporting periods, there was no impairment loss.

(i) Inventories

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

(j) Cash and cash equivalents

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

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

14

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(k) Revenue recognition

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

- Persuasive evidence of an arrangement exists;

- Delivery has occurred or services have been rendered;

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

- Collection is reasonably assured.

Net revenue is recognized when customer takes delivery and acceptance of products, the price is fixed or determinable as stated on sales contract, and the collectability is reasonably assured.

(l) Costs of sales

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

(m) Research and development costs

The Company expensed all research and development costs as incurred.  Research and development expenses included in the general and administrative expenses for the six months ended December 31, 2009 and 2008 were $347,107 and $222,167 respectively.

(n) Retirement benefit plans

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

Retirement benefits in the form of contributions under defined contribution retirement plans to the relevant authorities are charged to the statements of income as incurred. The retirement benefit expenses included in and the general and administrative expenses for the six months ended December 31, 2009 and 2008 were $61,399 and $34,043 respectively.

15

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(o) Income tax

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

(p) Foreign currency translation

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

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

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

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

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

16

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(q) Cash and concentration of risk

Cash includes cash on hand and demand deposits in bank accounts maintained within PRC.  Total cash in the banks at December 31, 2009 and June 30, 2009 amounted to $37,158,707 and $38,982,722 respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to significant financial institution risks on its cash in bank accounts. Also see Note 3 for credit risk details.

(r) Statutory reserves

As stipulated by the PRC’s Company Law and as provided in the SK Ceramic Valves, and Shengkai’s Articles of Association, SK Ceramic Valves, and Shengkai’s net income after taxation can only be distributed as dividends after appropriation has been made for the following:

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

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

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

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

On December 31, 2003, Shengkai established a statutory surplus reserve as well as a statutory common welfare fund and commenced to appropriate 10% and 5%, respectively of the PRC net income after taxation to these reserves. The amounts included in the statutory reserves were surplus reserve of $7,081,706 and $4,693,020 respectively as of December 31, 2009 and June 30, 2009.

(s) Comprehensive income

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

17

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(t) Recently implemented standards

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

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

18

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(t) Recently implemented standards (Continued)

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

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

19

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(u) Recently issued standards

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

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

20

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

(u) Recently issued standards (Continued)

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

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

21

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

3.      CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS

Financial instruments which potentially expose the Group to concentrations of credit risk, consists of cash and accounts receivable as of December 31, 2009 and June 30, 2009. The Group performs ongoing evaluations of its cash position and credit evaluations to ensure sound collections and minimize credit losses exposure.

As of December 31, 2009 and June 30, 2009, almost all the Group’s bank deposits were conducted with banks in the PRC where there is currently no rule or regulation mandated on obligatory insurance of bank accounts. A minimal bank deposit was maintained with the bank in Hong Kong.

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

The maximum amount of loss exposure due to credit risk that the Group would bear if the counter parties of the financial instruments failed to perform represents the carrying amount of each financial asset in the balance sheet.

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

For the six months ended December 31, 2009 and 2008, there was no customer who accounts for 10% or more of the Group’s revenue.

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

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

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

4.      PLEDGED DEPOSITS

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

22

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

5.      OTHER RECEIVABLES

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

6.      INVENTORIES

Inventories comprise the followings:

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

23

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

7.      PLANT AND EQUIPMENT, NET

	December 31, 2009			June 30, 2009
At cost
Buildings	$	2,053,260		$	2,050,980
Machinery and equipment		3,078,651			3,056,646
Office equipment		171,974			166,748
Motor vehicles		484,861			416,163
	$	5,788,746		$	5,690,537
Less: accumulated depreciation		(1,042,228	)		(832,085	)
	$	4,746,518		$	4,858,452
Construction in progress		7,678,594			314,817
		12,425,112			5,173,269

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

Construction in progress represents direct costs of construction incurred. Capitalization of these costs ceases and the construction in progress is transferred to plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. No depreciation is provided until it is completed and ready for intended use.  Capital commitments in respect of these projects are $19,032,056 at December 31, 2009.

24

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

8. INTANGIBLE ASSETS, NET

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

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

9. OTHER PAYABLES

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

25

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

10.   PREFERRED STOCK AND WARRANTS

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

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

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

The Warrants were issued at an exercise price of $3.52 per share. The exercise price can adjust for dilutive events.  The Warrants are immediately exercisable. However, if after exercise the holder would become a holder of greater than 9.9% of common stock they cannot exercise without filing a waiver with the company.  The waiver is required to be filed 61 days prior to exercise and by filing the waiver the restriction is removed. (Since the company is required to accept the waiver this restriction is not considered significant in valuing the warrant.) The Warrants expire 5 years from the date of issuance. The Warrants are freely transferable upon registration. The Warrants are subject to the same Registration Rights Agreement as that of the Preferred Stock. If a registration statement providing for the resale of the Common Stock issued upon exercise of the Warrant is not declared effective after 180 days after the issuance date, the Warrants can be cashless exercised. Also, the Warrants have Buy-in Rights similar to those of the Preferred Stock.

The gross proceeds of the transaction were $15 million. The proceeds from the transaction were allocated to the Series A preferred stock, warrants and beneficial conversion feature based on the relative fair value of the securities. The Company evaluated whether a relative fair value approach or residual fair value approach was more appropriate given the terms and accounting treatment related to the financial instruments involved. Given that the Warrants will not be classified as a liability, the relative fair value method was used. The Warrants were first valued using the Black-Scholes valuation model. The Company valued the Warrants at issuance at $1.84 per warrant with the following assumptions:  common stock fair market value of $2.55, expected life of 5 year, volatility of 100% and an interest rate of 4.5%.

26

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

10.  PREFERRED STOCK AND WARRANTS (Continued)

The Company recognized a beneficial conversion feature discount on the Series A preferred stock at its intrinsic value, which was the fair value of the common stock at the commitment date for the Series A preferred stock investment, less the effective conversion price but limited to the $15 million of proceeds received from the sale. The Company recognized the $7.8 million beneficial conversion feature in the equity as a transfer from retained earnings to additional paid in capital as dividends in the accompanying consolidated financial statements on the date of issuance of the Series A preferred shares since the Series A preferred shares were convertible at the issuance date.

On July 18, 2008 the Company sold 1,971,842 shares of Series A Preferred Stock and various stock purchase warrants for cash consideration totaling $5 million dollars (the “July 2008 Financing”). The exercise price, expiration date and number of share eligible to be purchased with the warrants are summarized in the following table:

Series of warrant	Number of shares		Exercise price		Contractual term
Series A		2,366,211	$	3.52	5.0 years

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

The Warrants were issued at an exercise price of $3.52 per share. The exercise price can adjust for dilutive events.  The Warrants are immediately exercisable. However, if after exercise the holder would become a holder of greater than 9.9% of common stock they cannot exercise without filing a waiver with the company.  The waiver is required to be filed 61 days prior to exercise and by filing the waiver the restriction is removed. (Since the company is required to accept the waiver this restriction is not considered significant in valuing the warrant.) The Warrants expire 5 years from the date of issuance. The Warrants are freely transferable upon registration. The Warrants are subject to the same Registration Rights Agreement as that of the Preferred Stock. If a registration statement providing for the resale of the Common Stock issued upon exercise of the Warrant is not declared effective after 180 days after the issuance date, the Warrants can be cashless exercised. Also, the Warrants have Buy-in Rights similar to those of the Preferred Stock.

27

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

10.   PREFERRED STOCK AND WARRANTS (Continued)

The gross proceeds of the transaction were $5 million. The proceeds from the transaction were allocated to the Series A preferred stock, warrants and beneficial conversion feature based on the relative fair value of the securities. The Company evaluated whether a relative fair value approach or residual fair value approach was more appropriate given the terms and accounting treatment related to the financial instruments involved. Given that the Warrants will not be classified as a liability, the relative fair value method was used. The Warrants were first valued using the Black-Scholes valuation model. The Company valued the Warrants at issuance at $1.84 per warrant with the following assumptions:  common stock fair market value of $2.55, expected life of 5 year, volatility of 100% and an interest rate of 4.5%.

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

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

11.  CAPITALIZATION

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

28

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

12. INCOME TAXES

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

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

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

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

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

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

29

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

13. EARNINGS PER SHARE

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

	For the six months ended December 31,					For the three months ended December 31,
	2009		2008			2009		2008
Earnings:
Net income for the year	$	8,193,526	$	5,658,878		$	4,145,079		2,532,561
Non-Cash Dividends on convertible preferred stock		-		(2,560,186	)		-		-
Earnings for the purpose of basic earnings per share	$	8,193,526	$	3,098,692		$	4,145,079	$	2,532,561
Effect of dilutive potential common stock		-		-			-		-
Earnings for the purpose of dilutive earnings per share	$	8,193,526	$	3,098,692		$	4,145,079	$	2,532,561
Number of shares:
Weighted average number of common stock for the purpose of basic earnings per share		22,382,719		22,112,500			22,570,742		22,112,500
Effect of dilutive potential common stock
-Conversion of  Series A convertible		-		-			-		-
preferred stock		7,187,368		7,887,368			7,187,368		7,887,368
-Conversion of A Warrant		1,353,569		-			2,241,339		-
Weighted average number of common stock for the purpose of dilutive earnings per share		30,923,656		29,999,868			31,999,449		29,999,868
Earnings per share:
Basic earnings per share	$	0.366	$	0.140		$	0.184	$	0.115
Dilutive earnings per share	$	0.265	$	0.103		$	0.130	$	0.084

30

SHENGKAI INNOVATIONS, INC.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED DECEMBER 31, 2009 AND 2008

(Stated in US Dollars)(Unaudited)

14. FAIR VALUE OF FINANCIAL INSTRUMENTS

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

15. COMMITMENTS AND CONTINGENCY

A new manufacturing facility and a headquarters’ building are under construction on a plot of land in Tianjin, China which was obtained in October, 2008. Certain construction contracts including the main superstructure were executed. The total amount of executed contracts was $26,710,649 (RMB182,626,051) of which $7,678,593 (RMB52,500,079) was paid as at December 31, 2009. The balance of $19,032,056 (RMB130,125,972) will be settled within one year.

16. SEGMENT INFORMATION

The Group is principally engaged in one segment of the manufacturing and selling of ceramic valve in the PRC. Nearly all revenues are generated in the PRC and nearly all identifiable assets of the Group are located in the PRC. Accordingly, no segmental analysis is presented.

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

Cautionary Notice Regarding Forward-Looking Statements
 

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

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

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

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

· legislative and regulatory changes that affect our business;

· the availability of funds and working capital;

· the actions and initiatives of current and potential competitors;

· investor sentiment; and

· our reputation.

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

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

Overview

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

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

32

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of the financial condition and results of operation of the Company for the three months and six months ended December 31, 2009 and 2008 should be read in conjunction with the financial statements and the notes to those statements that are included elsewhere in this registration statement. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors, Cautionary Notice Regarding Forward-Looking Statements and Business sections in this registration statement. We use terms such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions to identify forward-looking statements.

General

Shengkai, the entity through which we run our operations, is a prominent ceramic valve manufacturer. We have more than 15 years of experience and possess a unique method for creating ceramic valves.

We believe that Shengkai is the one of the few ceramic valve manufacturers in the world with research, development, engineering, and production capacity for structural ceramics. Shengkai’s product categories include a broad range of valves in all industries that are sold throughout China, to North America, and other countries in the Asia-Pacific region. Having over 300 customers, Shengkai became a supplier of the CPCC in 2005 and a member of the PetroChina supply network in 2006, after a six-year application process.

Results of Operations

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

Revenue

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

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

Gross Profit

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

33

Selling Expenses

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

General and Administrative Expenses

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

Interest expense

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

Income Tax Expenses

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

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

Revenue

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

34

Gross Profit

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

Selling Expenses

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

General and Administrative Expenses

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

Interest expense

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

Income Tax Expenses

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

Liquidity and Capital Resources

Cash and Cash Equivalents

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

Net cash provided by operating activities

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

35

Net cash used in investing activities

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

Net cash used in financing activities

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

Capital Expenditures

In October 2008, we successfully won a bid on a land use right over a plot of land approximately 43,566.3 square meters in size. The land is located in Tianjin, China and the bid price is RMB12.6 million (approximately $1.8 million). The formal contract was signed with the government on Jan 23, 2009, pursuant to which the Company shall pay the bid price in full by March 25, 2009. The land was purchased with plans to construct corporate headquarters and to build a new manufacturing facility to expand our production capacity.  Expenditures made under related construction contracts totaled $26,710,649 (RMB182,626,051), of which $7,678,593 (RMB52,500,079) was paid as of December 31, 2009. The balance of $19,032,056 (RMB130,125,972) will be settled within one year. In order to complete such expansion of production capacity, we would need to substantially increase our capital expenditures.

Trends

We are not aware of any trends, events or uncertainties that have or are reasonably likely to have a material impact on our short-term or long-term liquidity.

Inflation

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

Contractual Obligations

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

The following table summarizes our contractual obligations as of December 31, 2009, and the effect these obligations are expected to have on our liquidity and cash flows in future periods.

	Totals		Less Than 1 Year		1 to 3 Years		Thereafter
Capital expenditures (1)	$	19,032,056	$	19,032,056	$	-

(1) Capital expenditure is commitment for the construction of a new manufacturing facility. See Note 15 - Commitment and Contingency in the notes to the financial statements, included elsewhere in this report. The Company entered into certain construction contracts for building a new manufacturing facility and a headquarters’ building. The total amount of executed contracts was $26,710,649, of which $7,678,593 was paid as at of December 31, 2009. The construction of both the manufacturing facility and the headquarters’ building is estimated to be completed during this fiscal year.

36

Off Balance Sheet Arrangements

None.

Critical Accounting Policies and Estimates

The financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made. However, actual results could differ materially from those estimates (See Note 2 in the Notes to Financial Statements).

Revenue recognition

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

Intangible assets

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

Foreign currency translation

The accompanying financial statements are presented in United States dollars. The functional currency of Shengkai is the Renminbi (RMB). The financial statements are translated into United States dollars from RMB at year-end exchange rates as to assets and liabilities and average exchange rates as to revenues and expenses. Capital accounts are translated at their historical exchange rates when the capital transactions occurred.

New Financial Accounting Pronouncements

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

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

37

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

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

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

N/A.
 

Item 4. Controls and Procedures.

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

Pursuant to Rule 13a-15(b) under the Exchange Act, the Company carried out an evaluation with the participation of the Company’s management, including Wang Chen, the Company’s Chief Executive Officer (“CEO”), of the effectiveness of the Company’s disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the three months ended December 31, 2009. Based upon that evaluation, the Company’s CEO concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s CEO, as appropriate, to allow timely decisions regarding required disclosure.

38

Changes in internal controls

Our management, with the participation of our Chief Executive Officer, performed an evaluation as to whether any change in our internal controls over financial reporting occurred during the quarter ended December 31, 2009.  Based on that evaluation, our Chief Executive Officer concluded that no change occurred in the Company's internal controls over financial reporting during the quarter ended December 31, 2009 that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

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

Item 1A. Risk Factors.

N/A.

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

None.

Item 3. Defaults Upon Senior Securities.

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

Item 4.  Submission of Matters to a Vote of Securities Holders.

None.

Item 5.  Other Information.

None.

Item 6.  Exhibits.

(a) Exhibits

31.1 Certification Required Under Section 302 of Sarbanes-Oxley Act of 2002.

32.1 Certification Required Under Section 906 of Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

	SHENGKAI INNOVATIONS, INC.
Date: February 10, 2010	By:	/s/Wang Chen
		Name:  Wang Chen
		Title:   Chief Executive Officer and Director (principal executive officer, principal financial officer, and principal accounting officer )

40

EX-31.1

Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF THE

SARBANES-OXLEY ACT OF 2002

I, Wang Chen, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Shengkai Innovations, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

	/s/Wang Chen
Date: February 10, 2010
	Wang Chen
	Chief Executive Officer
	(principal executive officer, principal financial officer, and principal accounting officer )

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Shengkai Innovations, Inc. (the “Company”) on Form 10-Q for the period ended December 31, 2009, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Wang Chen, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

The foregoing certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. section 1350 and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

Date: February 10, 2010
	/s/Wang Chen
	Wang Chen
	Chief Executive Officer
	(principal executive officer, principal financial officer, and principal accounting officer )