Shegkai Innovations Lowers Revenue Guidance

On February 9,2012, Shengkai Innovations (VALV), a leading ceramic valve manufacturer in the People's Republic of China (PRC), announced results for its fiscal year 2012 second quarter and first six months ended December 31, 2011.

Revenue was approximately $10.3 million in second-quarter FY2012 compared with approximately $22.4 million in the second quarter of FY2011.

Revenue from the electric power segment was approximately $2.6 million compared with approximately $16.0 million in the second quarter of FY2011.

Revenue from the petrochemical and chemical segment increased 32.8% year-over-year to approximately $7.1 million.

Revenue from other industries, including the aluminum and metallurgy industries was approximately $0.6 million compared with approximately $1.1 million in the second quarter of FY2011.

I estimated correctly the revenue by segment on my article at January 9, 2012.

My revenue estimates for each industry group for the quarter ended December 31, 2011 are as follows: electric power industry $2 million, petrochemical and chemical industry $7 million and aluminum, metallurgy and others $1 million.

GAAP net income was approximately $1.8 million compared with approximately $14.9 million in the second quarter of FY2011. Based on a greater weighted average number of shares, diluted earnings per share were $0.05 compared with diluted earnings per share of $0.42 in the second quarter of FY2011. During the second quarter, the number of diluted shares was 36,363,979 compared with 35,579,888 diluted shares in the second quarter of FY2011.

Financial Condition

As of December 31, 2011, the company had cash and cash equivalents of approximately $69.0 million ($1.91 per share) and accounts receivable of approximately $6.5 million compared with approximately $59.9 million cash and cash equivalents and $12.6 million of accounts receivable as of June 30, 2011. Total current liabilities as of December 31, 2011, were approximately $4.7 million, compared with approximately $9.6 million as of June 30, 2011. Additionally, the company has no short-term or long-term debts.

Net cash flow provided by operating activities was approximately $7.7 million for the first six months of FY2012 compared with $10.1 million in the first six months of FY2011. The decrease was primarily attributable to the lower adjusted net income.

Business Outlook

In response to the business disruptions and changes in the application of ceramic in the valve industry, Shengkai management has decided to gradually phase out its less profitable domestic market segments including the electric power market and focus on expanding the company's presence in the more profitable domestic and foreign oil and chemical industries where ceramic valve products typically command higher prices than the domestic Chinese market. Successful penetration into the international oil and chemical markets, however, would require the company to obtain various industry-wide certifications, including but not limited to ISO14000 and OHSAS18000 and other firm-specific supplier qualifications, which will take time to go through various application procedures, efforts in new product development and investment in additional or different equipment.

There are less effective working days during the period between January and March due to various holidays such as the New Year and the Spring Festival. In addition, the increase in the average selling price of our products is impacting our domestic sales in the foreseeable future before the new pricing dynamics takes hold. In light of such developments, we expect the total revenue for the quarter ending March 31, 2012 to be approximately $5.5 million. We expect the company to continue to run with positive but significantly reduced cash flow from operations. Such decrease may persist until our marketing and sales efforts to some new customers and projects pay off, and the expansion in the international market picks up meaningfully.

My new revenue estimates for each industry group for the quarter ended March 31, 2012, are as follows: electric power industry $1 million, petrochemical and chemical industry $4 million and aluminum, metallurgy and others $0.5 million.

Conclusion

I still recommend buying this stock under its cash position of $1.91 as long as the company stays profitable. I am disappointed by the company's new revenue guidance but consider it remarkable that the company still expects to be profitable with the significantly reduced revenue expectation.

Disclosure: I am long VALV.