10-K 1 v234629_10k.htm FORM 10-K Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Mark One

 
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2011

OR

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

For the transition period from ____________ to ____________

Commission File Number 000-51717

SOLAR ENERTECH CORP.
(Exact name of registrant as specified in its charter)

DELAWARE
 
98-0434357
State or other jurisdiction of incorporation or organization
 
(I.R.S. Employer Identification No.)
 
655 West Evelyn Avenue, Suite #2
 Mountain View, CA 94041
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code 650-688-5800
Securities registered under Section 12(b) of the Exchange Act:

Title of each class
 
Name of each exchange on which registered
None
 
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.001 Par Value
 (Title of class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     ¨  Yes     x  No

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     x   Yes     ¨   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 x  No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     ¨

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
 
x Smaller reporting company
        (Do not check if a small reporting company)

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

The aggregate market value of the common stock held by non-affiliates of the registrant, computed based on the closing sale price as of the last business day of the registrant’s second fiscal quarter, March 31, 2011, was approximately $10,614,813.

According to the records of the registrant's registrar and transfer agent, the number of shares of the registrant's common stock outstanding as of December 5, 2011 was 181,480,266.

 
 

 

TABLE OF CONTENTS
 
 
Page
PART I
 
   
Item 1.   Business
4
Item 1A. Risk Factors
8
Item 1B. Unresolved Staff Comments
20
Item 2.  Properties
20
Item 3.  Legal Proceedings
20
Item 4.  Submission of Matters to a Vote of Security Holders
20
   
PART II
 
   
Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
21
Item 6.  Selected Financial Data
23
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
24
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
33
Item 8.  Financial Statements and Supplementary Data
33
Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
63
Item 9A. Controls and Procedures
63
Item 9B. Other Information
64
   
PART III
 
   
Item 10.  Directors and Executive Officers and Corporate Governance
65
Item 11.  Executive Compensation
66
Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
69
Item 13.  Certain Relationship and Related Transactions, and Director Independence
71
Item 14.  Principal Accounting  Fees and Services
72
   
PART IV
 
   
Item 15.  Exhibits, Financial Statement Schedule
73
   
Signatures
76
   
EXHIBIT 21.1
 
   
EXHIBIT 31.1
 
   
EXHIBIT 31.2
 
   
EXHIBIT 32.1
 
   
EXHIBIT 32.2
 
   
XBRL Content
 

 
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, in particular in our Management’s Discussion and Analysis of Financial Condition and Results of Operations, which relate to our current expectations and views of future events. These statements relate to events that involve known and unknown risks, uncertainties and other factors, including those listed under the heading “Risks Related to Our Business”, “Risks Related to Doing Business in China” and “Risks Related To an Investment in Our Securities” in this document as well as other relevant risks detailed in our filings with the Securities and Exchange Commission (the “SEC”) which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. The information set forth in this report on Form 10-K should be read in light of such risks.

In some cases, these forward-looking statements can be identified by words or phrases such as “may”, “will”, “expect”, “anticipate”, “aim”, “estimate”, “intend”, “plan or planned”, “believe”, “potential”, “continue”, “is/are likely to”, “hope” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs.

These forward-looking statements include, among other things, statements relating to:

 
our expectations regarding the worldwide demand for electricity and the market for solar energy in certain countries;

 
our beliefs regarding the effects of environmental regulation, lack of infrastructure reliability and long-term fossil fuel supply constraints;

 
our beliefs regarding the inability of traditional fossil fuel-based generation technologies to meet the demand for electricity;

 
our beliefs regarding the importance of environmentally friendly power generation;

 
our expectations regarding research and development agreements and initiatives;

 
our expectations regarding governmental support and incentive programs for the deployment of solar energy;

 
our beliefs regarding the acceleration of adoption of solar technologies;

 
our beliefs regarding the competitiveness of photovoltaic (“PV”) products;

 
our expectations regarding the creation and development of our manufacturing capacity;

 
our expected benefits from manufacturing based on China’s favorable policies and cost-effective workforce;

 
our expectations with respect to revenue and sales and our ability to achieve profitability resulting from increases in production volumes;

 
our expectations with respect to our ability to secure raw materials in the future;

 
our future business development, results of operations and financial condition; and

 
competition from other manufacturers of PV products and conventional energy suppliers.

YOU SHOULD NOT PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING
STATEMENTS

The forward-looking statements made in this report on Form 10-K relate only to events or information as of the date on which the statements are made in this report on Form 10-K. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this report and the documents that we reference in this report, including documents referenced by incorporation, completely and with the understanding that our actual future results may be materially different from what we expect or hope.

 
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PART I

ITEM 1. BUSINESS

Our Business

Solar EnerTech Corp. was originally incorporated under the laws of the State of Nevada on July 7, 2004.  In April 2006, we changed our name to Solar EnerTech Corp. and in August 2008, we reincorporated to the State of Delaware through a merger whereby the predecessor Nevada entity merged with and into a Delaware wholly-owned subsidiary.  Solar EnerTech Corp. is a solar product manufacturer with its headquarters based in Mountain View, California, and with low-cost operations located in Shanghai, China.  Our principal products are monocrystalline silicon and polycrystalline silicon solar cells and solar modules. Solar cells convert sunlight to electricity through the photovoltaic effect, with multiple solar cells electrically interconnected and packaged into solar modules to form the building blocks for solar power generating systems. We primarily sell solar modules to solar panel installers who incorporate our modules into their power generating systems that are sold to end-customers located in Europe, Australia, North America and China.

We have established our manufacturing base in Shanghai, China to capitalize on the cost advantages offered in manufacturing of solar power products.  In our 67,107-square-foot manufacturing facility, we operate two 25 Megawatts (“MW”) solar cell production lines and a 50MW solar module production facility.  We believe that the choice of Shanghai, China for our manufacturing base provides us with convenient and timely access to key resources and conditions to support our growth and low-cost manufacturing operations.

Our Industry

Solar power has emerged as one of the most rapidly growing renewable energy sources. Through a process known as the photovoltaic (PV) effect, electricity is generated by solar cells that convert sunlight into electricity. In general, global solar cell production can be categorized by three different types of technologies, namely, monocrystalline silicon, polycrystalline silicon and thin film technologies. Crystalline silicon technology is currently the most commonly used.

Although selling prices for solar power products, including the average selling prices of our products, have generally stabilized at levels substantially below pre-crisis prices resulting from global recession, there is no assurance that such prices may not decline again. In addition, demand for solar power products is significantly affected by government incentives adopted to make solar power competitive with conventional fossil fuel power. The widespread implementation of such incentive policies, as has occurred in many countries in Europe, Asia Pacific and North America, has significantly stimulated demand, whereas reductions or limitations on such policies, as have recently been announced in Germany, Spain and South Korea, can reduce demand for such products. We have taken mitigating efforts to reduce this risk by developing customers in other emerging markets and in our established markets. We are currently expanding our niche market, which are customers who are often underserved by major manufacturers who prefer to sell solar product in large volumes.

We believe the following factors will continue to drive demand in the global solar power industry, in spite of recent downturn due to financial crisis in Europe:
 
 
environmental and other advantages of solar power;

 
long-term growth in demand for alternative sources of energy;

 
government incentives for solar power; and

 
decreasing costs of producing solar energy.

We believe the following are the key challenges presently facing the solar power industry:
 
 
higher cost of solar power compared with other sources of energy to consumers;

 
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difficulties in obtaining cost-effective financing for solar power projects;

 
continual reliance on government subsidies and incentives;

 
volatility of prices in the polysilicon and solar power product markets; and

 
need to promote awareness and acceptance of solar power usage.

Our Competitive Strengths
 
We believe that the following strengths enable us to compete successfully in the solar power industry:
 
 
our focus on niche, “emerging markets” and “emerging customers” in existing markets not typically covered by the major solar manufacturers;

 
our ability to provide high-quality products enables us to increase our sales and enhance our brand recognition;

 
our strategic locations provide us with convenient access to key resources and conditions to support our low-cost manufacturing operations; and

 
our modern production equipment enables us to enhance our productivity.

Our Strategy
 
In order to achieve our goal of becoming a leading supplier of solar power products, we intend to pursue the following principal strategies:
 
 
continuing to diversify our customer base with a focus on quality, service and competitive pricing, but with a focus on niche, “emerging markets” and “emerging customers” in existing markets not typically covered by the major solar manufacturers;

 
commercialize our new thin film product which we have developed together with AQT Solar, a company in California during the past two years;

 
continuing to enhance our research and development capability with a focus on improving our manufacturing processes to increase overall cell efficiency, reduce our average cost and improve the quality of our products;

 
establishing regional sales and support offices and warehouses in Central Europe and North America to expand our sales and marketing network and enhance our sales and marketing channels; and

 
establishing strategic alliances with medium and small installers, who also serve as distributors, and system integrators and securing silicon raw material supplies at competitive cost.

Our Challenges
 
We believe that the following are some of the major challenges, risks and uncertainties that may materially affect us:
 
 
we have a limited amount of cash to fund our operations and we may not be able to secure external financing when needed; and if available, financing may not be obtained on terms favorable to us or our stockholders;
 
 
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we may be adversely affected by volatile market and industry trends, in particular, the demand for our solar power products or the price at which we can charge may decline, which may reduce our sales and earnings;

 
a significant reduction in or discontinuation of government subsidies and economic incentives for installation of solar energy systems may have a material adverse effect on our results of operations;

 
our limited operating history makes it difficult to evaluate our results of operations and prospects;

 
notwithstanding our continuing efforts to further diversify our customer base, we derive, and expect to continue to derive, a significant portion of our sales from a limited number of customers. As a result, the loss of, or a significant reduction in orders from, any of these customers would significantly reduce our sales and harm our results of operations;

 
our failure to successfully execute our business expansion plans would have a material adverse effect on the growth of our sales and earnings;

 
we may not be able to obtain sufficient silicon raw materials in a timely manner, which could have a material adverse effect on our results of operations and financial condition;

 
volatility in the prices of silicon raw materials makes our procurement planning challenging and could have a material adverse effect on our results of operations and financial condition; and

 
fluctuations in exchange rates could adversely affect our results of operations because the currency we generally do business in is the RMB Yuan, our financial statements are expressed in U.S. dollars and a significant portion of our sales and expenses are denominated in foreign currencies.

Principal Products and Services

The essential component in all solar panel applications is the photovoltaic solar cell, which converts the sun’s visible light into electricity. Solar cells are then assembled in modules for specific applications. We manufacture PV solar cells, and we design and produce advanced PV modules for a variety of applications, such as standard panels for solar power stations, roof panels, solar arrays, and modules incorporated directly into exterior walls.

Marketing Strategy

The primary solar market is currently in Europe and Australia, where significant government incentive programs are helping fuel high demand for solar products. Our secondary market is the United States, where the State of California has launched an ambitious One Million Solar Roof incentive program for residences and businesses.

Sales Strategy

We manufacture high-quality and high-conversion-rate solar products with outstanding after-sale services. By keeping costs low, we expect to market our panels, to be trademarked as “SolarE”, at prices generally lower than many of our competitors.

Research and Development

We have established a joint Research and Development (“R&D”) laboratory with Shanghai University to facilitate improvements to our products. The main focus of this research laboratory is to:

 
Develop mass-production process for Copper Indium Gallium Selenide (“CIGS”) thin film technology we jointly developed with AQT Solar;

 
Develop environmentally-friendly high-conversion-rate manufacturing technology for chemical compound film PV cell; materials;

 
Research and develop key materials for new low-cost flexible-film PV cells and non-vacuum technology; and

 
Research and develop key technologies and fundamental theories for third-generation PV cells.

 
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Our management believes that the joint R&D laboratory will enable us to be at the forefront of PV research and development, and hopes to create a valuable comparative advantage over solar cell producers today, with the goal of enabling us to become an important solar-cell manufacturer.

Competition

The solar energy market is highly competitive. Outside China, our competitors include BP Solar, Kyocera Corporation, Mitsubishi Electric Corporation, Motech Industries Inc., Sharp Corporation, Q-Cells AG, Sanyo Electric Co., Ltd. and Sunpower Corporation. In China, the Company’s primary competitors are Suntech Power Holding’s Co., Ltd., Trina Solar Ltd., Baoding Tianwei Yingli New Energy Resources Co., Ltd. and Nanjing PV-Tech Co., Ltd, Canadian Solar Inc. and Solarfun Power Holdings Co., Ltd.

We compete primarily on the basis of the power efficiency, quality, performance and appearance of our products, price, post-sale service and brand image. Many of our competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial and marketing resources than us.

Intellectual Property

We are not, at present, the holder of any patents, trademarks or copyrights on our products. We intend to trademark the trade name “SolarE” in Asia, Europe and North America in the future and will, if we are successful in our conduct of research and development activities seek intellectual property protection for such products. Solar cells are in the public domain and our only protection in producing them is in the know-how or experience of our employees and management in producing our products.

The Market

Energy generated from PV cells continues to be researched and the resulting products deployed. PV technology is relatively a simple concept: harness the sun’s energy on a solid-state device and generate electricity. In many markets around the world – especially Japan, Germany, Spain and the U.S. – PV electricity has already become a favored energy choice, and within this established base, the technology of PV’s is poised to help transform the energy landscape within the next decade.

Photovoltaic Industry and the World

The photovoltaic industry has made huge improvements in solar cell efficiencies as well as having achieved significant cost reductions. The global photovoltaic industry is expanding rapidly:  In the last few years, most solar production has moved and continues to move to Europe and China. Countries like Germany and Spain have had government-incentive programs that have made solar systems more attractive. In the United States, Energy Policy Act (EPACT) enacted a 30% investment tax credit for solar, and in January 2006, California approved the largest solar program in the country's history that provides for long term subsidies in the form of rebates to encourage use of solar energy where possible. As the current administration in the United States pursues a “Green Economy”, we expect both federal and state incentives to play an important role in boosting the use of solar electricity in the near future.

The price of electricity produced from solar cells is still significantly more expensive than from fossil fuels, such as coal and oil, especially when environmental costs are not considered. The competitiveness of solar-generated electricity in grid-connected applications is largely a function of electricity rates, which are subject to regulations and taxes that vary from country to country across the world.

With the global solar boom in the past five years and with renewable energy laws being implemented as best-practice models often with attractive solar energy delivery compensation rules in many nations, solar companies have been expanding their activities in Europe, the U.S., with growing markets in Africa and Asia, numerous opportunities exist for competitors in the photovoltaic market.

Compared to other energy technologies, solar power’s benefits include:

 
Environmental Superiority. Solar power is one of the most benign electric generation resources. Solar cells and concentrated solar power (“CSP”) systems generate electricity without significant air or water emissions, habitat impact or waste generation;

 
Price Stability. Unlike fossil fuels, solar energy has no fuel price volatility or delivery risk. Although there is variability in the amount and timing of sunlight, it is predictable, and a properly configured system can be designed to be highly reliable while providing long-term, fixed price electricity;
 
 
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Location Flexibility. Unlike other renewable resources such as hydroelectric or wind power, solar power can be generated where it is needed. This limits the expense and energy losses associated with transmission and distribution of large, centralized power stations;

 
Peak Generation. Solar power is well-suited to match peak energy needs as maximum sunlight hours generally correspond to peak demand periods when electricity prices are at their highest;

 
System Modularity. Solar power products can be deployed in many sizes and configurations to meet the specific needs of the user; and

 
Reliability. With no moving parts or regular required maintenance, photovoltaic systems are among the most reliable forms of electricity generation.

Environmental Regulations

In our manufacturing process, we will use, generate and discharge toxic, volatile or otherwise hazardous chemicals and wastes in our manufacturing activities. We are subject to a variety of foreign, federal, state and local governmental laws and regulations related to the purchase, storage, use and disposal of hazardous materials. If we fail to comply with present or future environmental laws and regulations, we could be subject to fines, suspension of production or a cessation of operations. In addition, under some foreign, federal, state and local statutes and regulations, a governmental agency may seek recovery and response costs from operators of property where releases of hazardous substances have occurred or are ongoing, even if the operator was not responsible for the release or otherwise was not at fault.

Management believes that we have all environmental permits necessary to conduct our business and have obtained all necessary environmental permits for our facility in Shanghai. Management also believes that we have properly handled our hazardous materials and wastes and have appropriately remediated any contamination at any of our premises. We are not aware of any pending or threatened environmental investigation, proceeding or action by foreign, federal, state or local agencies, or third parties involving our current facilities. Any failure by us to control the use of or to restrict adequately the discharge of, hazardous substances could subject us to substantial financial liabilities, operational interruptions and adverse publicity, any of which could materially and adversely affect our business, results of operations and financial condition.

Principal Suppliers

We currently purchase silicon wafers, our key raw material, from the spot market. In 2011 and 2010, our five largest suppliers supplied in the aggregate approximately 81.5% and 87.5%, respectively, of our total silicon wafer material purchases by value.

Employees

As of September 30, 2011, we employed approximately 290 people, as follows: our California office currently has 2 employees and the manufacturing plant in Shanghai currently has 288 employees.

ITEM 1A. RISK FACTORS

Any investment in our common stock involves a high degree of risk.  Investors should carefully consider the risks described below and all of the information contained in this prospectus before deciding whether to purchase our common stock.  Our business, financial condition or results of operations could be materially adversely affected by these risks if any of them actually occur.  The trading price could decline due to any of these risks, and an investor may lose all or part of an investor’s investment.  Some of these factors have affected our financial condition and operating results in the past or are currently affecting our company. Our filings with the SEC also contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks we face described below. See “Special Note Regarding Forward-Looking Statements.” In assessing these risks, investors should also refer to the other information contained or incorporated by reference in this Annual Report on Form 10-K, including our September 30, 2011 consolidated financial statements and related notes.
 
 
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RISKS RELATED TO OUR BUSINESS AND OUR INDUSTRY

We have a limited amount of cash to fund our operations.  If we cannot obtain additional sources of cash, our growth prospects and future profitability may be materially adversely affected and we may not be able to continue as a going concern.

During the fourth quarter of fiscal year 2011, the gross margin was negative 2%, mainly because of the decrease in average selling price of solar modules from $1.91 per watt in the first quarter of 2011 to $1.05 per watt in the fourth quarter of fiscal year 2011, coupled with a decline in sales volume from 8.0 MW in the first quarter of 2011 to 2.2 MW in the fourth quarter of fiscal year 2011 due to a downturn in major European and Australian markets which has left module shipments well in excess of demand. Also, the devaluation of the Euro dollar against RMBnegatively affecting our return, usually 45-60 days after cargo was shipped. The Feed-in Tariff (FIT) policy cancellation caused high inventory and low sales orders, and the lower production volume resulted in a higher fixed cost per unit, driving down margins. We have already secured orders from two major customers amounting to 40 MW in volume and anticipate additional volume from other existing customers. Additionally, in May 2011, to finance projected operating requirements, we successfully entered into agreement of accounts receivable financing with Bank of China (“BOC”). Through the agreement, we believe we can get the financing we need to support our operations. Nonetheless, we may be unable to secure sufficient financing to support our operations, and our liquidity and financial position raises substantial doubt about our ability to continue as a going concern.

On March 19, 2010, we entered into an Exchange Agreement (the “Exchange Agreement”) with Capital Ventures International (“CVI”) whereby we issued a Series B-1 Convertible Note (the “Note”) to CVI with an original principal amount of $1,815,261, which is due on March 19, 2012 and bears interest at 6% per annum.  On May 11, 2011, we executed an amendment with CVI (“Amendment”) whereby CVI waives the following Trigger Events: (a) the migration of our listing from the OTCBB to the OTCQB, (b) the failure of us to timely pay the interest payment due on April 1, 2011 and (c) any other Trigger Event that may exist as of the date of this Amendment. According to the Amendment, Section 3(c) of the Exchange Agreement is amended to reduce the conversion price of the Note from $0.15 to $0.10 per common share, subject to further adjustment upon certain specified events as defined in the Exchange Agreement. As of September 30, 2011, the outstanding principal of the Note was $1,540,261, the carrying amount was $1,474,000 and the related interest was $23,294.

Pursuant to a joint research and development laboratory agreement with Shanghai University, there are approximately $3.2 million remaining of research and development commitment to be funded in full by December 15, 2014.  If we fail to make pre-approved funding payments, when requested, it is deemed to be a breach of the agreement. If we are unable to correct the breach within the requested time frame, Shanghai University could seek compensation up to an additional 15% of the total committed amount for approximately $0.7 million. As of September 30, 2011, we were not in breach as we had not received from Shanghai University any additional compensation requests for pre-approved funding payments.

On August 21, 2008, we acquired two million shares of common stock of 21-Century Silicon for $1.0 million in cash. We may also be obligated to acquire an additional two million common shares (at $0.50 per share) of 21-Century Silicon upon the first polysilicon shipment meeting the quality specifications determined solely by us. As of September 30, 2011, we had not yet acquired the additional two million shares as the product shipment had not occurred.

The Company conducts a substantial part of its operations under a wholly-owned subsidiary in Shanghai, China named Solar EnerTech (Shanghai) Co., Ltd.  The paid-in capital of Solar EnerTech (Shanghai) Co., Ltd as of June 30, 2011 was $32 million, with an outstanding remaining balance of $15.5 million to be funded by the Company.  The Board of Directors of the Company has decided not to fund the remaining balance of $15.5 million. On September 11, 2011, Solar EnerTech (Shanghai) Co., Ltd received approval from Shanghai Government to reduce the capital requirement to $32 million.

Our subsidiary in Yizheng Jiangsu Province was formed with a registered capital requirement of $33 million, of which $23.4 million was to be funded by October 16, 2011.  In order to fund the registered capital requirement, we will have to raise funds or otherwise obtain the approval of local authorities to extend the payment of registered capital for the subsidiary. On February 8, 2010, we acquired land use rights of a parcel of land at the price of approximately $0.7 million. As part of the right of land use, we are required to complete construction of the facility by February 8, 2012. The Board of Directors of the Company has decided not to continue to fund the investment in the Yizheng Jiangsu Province subsidiary. We received the approval on December 22, 2011 to write-off the registration of the Yizheng Jiangsu Province subsidiary.

As of September 30, 2011, we had a cash and cash equivalents balance of approximately $1.3 million. Operating cash outflows amounted to $3.0 million in the fiscal year ended September 30, 2011, mainly due to payments to our vendors based on contractual terms. There have been no significant changes in the payment terms of our major vendors in the fiscal year ended September 30, 2011 compared to the same period in the prior year. If we are unable to successfully generate enough revenues to cover our costs or secure additional financing, our liquidity and results of operations may be materially and adversely affected and may not continue as a going concern.

If we fail to comply with our covenants on our credit facility, our debt may be accelerated or future drawdown requests may not be honored.

Our credit facility with BOC contains provisions whereby BOC can demand repayment of outstanding debt if we do not comply with any of the covenants, including but not limited to, maintaining our creditworthiness, complying with all our contractual obligations as requested by BOC, fulfillment of other indebtedness (if any), maintaining our business license and continuing operations, ensuring our financial condition does not deteriorate, remaining solvent, and other conditions, as defined in the credit facility agreement. Since certain of the covenants are broadly constructed and subjective in nature, BOC may have the right to demand repayment of any outstanding debt as it may determine in its own discretion.
 
 
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We may be adversely affected by volatile market and industry trends and, in particular, the demand or pricing for our solar power products may decline, which may reduce our sales and earnings.

We are affected by solar power market and industry trends. Recently, many of our key markets, including Belgium, Germany, and Australia, experienced a period of economic contraction and significantly slower economic growth. In particular, from late 2009 through the end of fiscal year 2011, the credit crisis, weak consumer confidence and diminished consumer and business spending contributed to a significant slowdown in market demand for solar power products. Meanwhile, manufacturing capacity for solar power products increased during the same period. This resulted in prices for solar power products declining significantly. These same trends continue to cause prices for solar power products to decline.

In addition, many of our customers and end-users of our products depend on debt financing to fund the initial capital expenditure required to purchase our products. Due to the global credit crisis, our customers and end-users have experienced difficulty in obtaining financing or have experienced an increase in the cost of financing.  This may have affected their decision on whether to purchase our products and/or the timing of their purchases.  The global economy has begun recovering since the first half of 2009 and this resulted in an increased availability of financing for solar power projects.  Taken in conjunction with decreased average selling prices for solar power products, demand for solar power products has increased since the second half of 2009. However, if demand for solar power products declines again and the supply of solar power products continues to grow, the average selling price of our products will be materially and adversely affected.

Also, demand for solar power products is influenced by available supply and prices for other energy products, such as oil, coal and natural gas, as well as government regulations and policies concerning the electric utility industry. A decrease in oil prices, for example, may reduce demand for investment in alternative energy like solar. If these negative market and industry trends continue and the prices of our solar power products continue to decrease as a result, our business and results of operations may be materially and adversely affected.

A significant reduction in or discontinuation of government subsidies and economic incentives for installation of solar energy systems may have a material adverse effect on our results of operations.

A majority of our products sold are eventually incorporated into solar power systems. We believe that the near-term growth of the market for solar power systems depends substantially on government incentives because the cost of solar power continues to substantially exceed the cost of conventional power in many locations around the world. Various governments have used different policy initiatives to encourage or accelerate the development and adoption of solar power and other renewable energy sources. Countries in Europe, most notably Germany and Spain, certain countries in Asia, including China, Japan and South Korea, as well as Australia and the United States have adopted renewable energy policies. Examples of government-sponsored financial incentives include capital cost rebates, feed-in tariffs, tax credits, net metering and other incentives to end-users, distributors, system integrators and manufacturers of solar power products to promote the use of solar power in both on-grid and off-grid applications and reduced dependency on other forms of energy.  However, political changes in a particular country could result in significant reductions or eliminations of subsidies or economic incentives, and the effects of the recent global financial crisis may affect the fiscal ability of governments to offer certain types of incentives, such as tax credits.

A significant reduction in the scope or discontinuation of government incentive programs, especially those in our target overseas markets, such as Germany, Spain and South Korea could cause demand for our products and our sales to decline, and have a material adverse effect on our business, financial condition, results of operations and prospects. Governments may decide to reduce or eliminate these economic incentives for political, financial or other reasons. Reductions in, or eliminations of government subsidies and economic incentives before the solar power industry reaches a sufficient scale to be cost-effective in a non-subsidized marketplace could reduce demand for our products and adversely affect our business prospects and results of operations. A significant reduction in the scope or discontinuation of government incentive programs, especially those in the target markets of our major customers, could cause demand for our products and our sales to decline and have a material adverse effect on our business, financial condition, results of operations and prospects. We have taken mitigating efforts to reduce this risk by developing customers in other emerging markets and in our established markets. We are currently expanding our niche market, which are customers who are often underserved by major manufacturers who prefer to sell solar product in large volumes. Accordingly, we believe that demand will continue to grow rapidly in the long term as solar power becomes an increasingly important source of renewable energy.
 
 
10

 

We have a history of losses and cash outflow from operations which may continue if we do not continue to increase our sales and/or further reduce our costs.

While we have been able to increase sales since our inception, we have generated an operating loss in each financial period since inception. After various cost cutting efforts, our operational expenses have been reduced significantly. In order to improve our profitability, we will need to continue to generate new sales while controlling our costs. As we plan on continuing to invest to grow our business, we may not be able to successfully generate sufficient sales to reach profitability. Our ability to achieve profitability also depends on the growth rate of the photovoltaic portion of the market, the continued market acceptance of photovoltaic products, the competitiveness of our products as well as our ability to provide new products and services to meet the demands of our customers. If we fail to reduce the cash consumption from operations and to generate cash from these other sources on a timely basis, or if the cash requirements of our business change as the result of changes in terms from vendors or other causes, we could no longer have the cash resources required to run our business.

Our limited operating history makes it difficult to evaluate our results of operations and prospects.

We have only been operating since 2006 and have limited operating history. Our future success will require us to scale up our production capacity beyond our existing capacity and further expand our customer base. Although we have experienced sales growth in certain periods, we cannot assure you that our sales will increase at previous rates or at all, or that we will be able to operate profitably in future periods. Our limited operating history makes the prediction of future results of operations difficult, and therefore, past sales growth experienced by us should not be taken as indicative of the rate of sales growth, if any, that can be expected in the future. We believe that period to period comparisons of our operating results are not meaningful and that the results for any period should not be relied upon as an indication of future performance. You should consider our business and prospects in light of the risks, uncertainties, expenses and challenges that we will face as an early-stage company seeking to manufacture and sell new products in a volatile and challenging market.

Notwithstanding our continuing efforts to further diversify our customer base, we derive, and expect to continue to derive, a significant portion of our sales from a limited number of customers. As a result, the loss of, or a significant reduction in orders from, any of these customers would significantly reduce our sales and harm our results of operations.

We expect that our results of operations will, for the foreseeable future, continue to depend on the sale of our products to a relatively small number of customers. For the fiscal years ended September 30, 2011 and 2010, sales to three and two customers, respectively, exceeded 10% of our sales and accounted for approximately 73.0% and 66.6% respectively, of our sales. Consequently, any one of the following events may cause material fluctuations or declines in our sales and have a material adverse effect on our results of operations:

 
·
reduction, delay or cancellation of orders from one or more significant customers;

 
·
loss of one or more significant customers and failure to identify additional or replacement customers;

 
·
failure of any significant customers to make; and

 
·
timely payment for products.

We cannot assure you that these customers will continue to generate significant sales for us or that we will be able to maintain these customer relationships. We also cannot assure you that we will be successful in diversifying our number of customers, which diversification in itself may create additional financial risk.  In addition, our business is affected by competition in the market for products that many of our major customers sell, and any decline in the businesses of our customers could reduce the purchase of our products by these customers. The loss of sales to any of these customers could also have a material adverse effect on our business, prospects and results of operations.

Our failure to successfully execute our business expansion plans would have a material adverse effect on the growth of our sales and earnings.

Our future success depends, to a large extent, on our ability to expand our production capacity, increase vertical integration and continue technological development of cell efficiencies. If we are able to raise sufficient capital, we plan to increase our annual silicon solar cell and module production capacity from 50 MW to approximately 100 MW. If we are unable to do so, we will not be able to attain the production capacity and desired level of economies of scale in our operations or cut the marginal production cost to the level necessary to effectively maintain our pricing and other competitive advantages. The planned expansion requires substantial capital expenditures, significant engineering efforts, timely delivery of manufacturing equipment and dedicated management attention, and is subject to significant risks and uncertainties, including:

 
·
in order to finance our production capacity expansion, we will need to raise additional capitalthrough bank borrowings or the issuance of our equity or debt securities, which may not be available on reasonable terms or at all, and which could be dilutive to our existing stockholders;
 
 
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·
we will be required to obtain government approvals, permits or documents of similar nature with respect to any acquisitions or new expansion projects, and we cannot assure you that such approvals, permits or documents will be obtained in a timely manner or at all;

 
·
we may experience cost overruns, construction delays, equipment problems, including delays in manufacturing equipment deliveries or deliveries of equipment that does not meet our specifications, and other operating difficulties; and

 
·
we may not have sufficient management resources to properly oversee capacity expansion as currently planned.

Any of these or similar difficulties could significantly delay or otherwise constrain our ability to undertake our capacity expansion as currently planned, which in turn would limit our ability to increase sales, reduce marginal manufacturing costs or otherwise improve our prospects and profitability.

In addition, we may have limited access to financing to fund working capital requirements, or may have to adjust the terms of our contracts with our suppliers or customers to accommodate their requests, or our suppliers and customers may be unable to perform their obligations under our existing contracts with them.  For example, if we are required to prepay for raw materials or to buy equipment for our manufacturing facilities, we will need to maintain sufficient working capital for such payments and we may not be unable to obtain on reasonable terms to finance such payments or at all.  The occurrence of any of these events would affect our ability to achieve economies of scale and higher utilization rates, which may in turn hinder our ability to increase vertical integration and expand our production capacity as planned.

Volatility in the prices of raw materials makes our procurement planning challenging and could have a material adverse effect on our results of operations and financial condition.

We procure raw materials primarily through spot market purchases.  We expect that the prices of raw materials may become increasingly volatile, making our procurement planning challenging. For example, if we refrain from entering into more fixed-price, long-term supply contracts, we may miss opportunities to secure long-term supplies of raw materials at favorable prices if the price of raw materials increases significantly in the future.

On the other hand, if we enter into more fixed-price, long-term supply contracts, we may not be able to renegotiate or otherwise adjust the purchase prices under such long-term supply contracts if the price declines. If we fail to obtain silicon wafers, our key raw material from the spot market, due to the volatility of raw material prices, we may be unable to manufacture our products.  If we are able to manufacture our products, our products may be available at a higher cost or after a long delay in connection with our efforts to obtain silicon wafers. The inability to obtain silicon wafers could prevent us from delivering our products to potential customers and meeting their required quantities and prices that are profitable to us. The failure to obtain materials and components that meet quality, quantity and cost requirements in a timely manner could impair our ability to manufacture products or increase our expected costs, or could cause us to experience order cancellations and loss of market share. In each case, our business, financial condition and results of operations may be materially and adversely affected.

Our dependence on a limited number of suppliers for a substantial majority of raw materials, especially our silicon wafers, could prevent us from delivering our products in a timely manner to our customers in the required quantities, which could result in order cancellations, decreased sales and loss of market share.

In fiscal years 2011 and 2010, our five largest suppliers supplied in the aggregate approximately 81.5% and 87.5%, respectively, of our total silicon wafer material purchases by value. If we fail to develop or maintain our relationships with these or our other suppliers, we may be unable to manufacture our products, our products may only be available at a higher cost or after a long delay, or we could be prevented from delivering our products to our customers in the required quantities, at competitive prices and on acceptable terms of delivery. Problems of this kind could cause us to experience order cancellations, decreased sales and loss of market share. In general, the failure of a supplier to supply silicon wafer materials that meet our quality, quantity and cost requirements in a timely manner due to lack of supplies or other reasons could impair our ability to manufacture our products or could increase our costs, particularly if we are unable to obtain these materials and components from alternative sources in a timely manner or on commercially reasonable terms. Some of our suppliers have a limited operating history and limited financial resources, and the contracts we entered into with these suppliers do not clearly provide for remedies to us in the event any of these suppliers is not able to, or otherwise does not, deliver, in a timely manner or at all, any materials it is contractually obligated to deliver. Any disruption in the supply of silicon wafer materials to us may adversely affect our business, financial condition and results of operations.
 
 
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We face intense competition in solar power product markets. If we fail to adapt to changing market conditions and to compete successfully with existing or new competitors, our business prospects and results of operations would be materially and adversely affected.

The markets for solar cells and solar modules are intensely competitive.  As we build up our solar cell and solar module production capacity and increase the output of our products, we compete with manufacturers of solar cells and solar modules both outside as well as inside China.  Outside China, our competitors include BP Solar, Kyocera Corporation, Mitsubishi Electric Corporation, Motech Industries Inc., Sharp Corporation, Q-Cells AG, Sanyo Electric Co., Ltd. and Sunpower Corporation. In China, our primary competitors are Suntech Power Holding’s Co., Ltd., Trina Solar Ltd., Baoding Tianwei Yingli New Energy Resources Co., Ltd., Nanjing PV-Tech Co., Ltd, Canadian Solar Inc., JA Solar Holdings Co. Ltd. and Solarfun Power Holdings Co., Ltd.  We compete primarily on the basis of the power efficiency, quality, performance and appearance of our products, price, strength of supply chain and distribution network, after-sales service and brand image. Many of our competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial and marketing resources than we do.  They may also have existing relationships with suppliers of silicon wafers, which may give them an advantage in the event of a silicon shortage.

Moreover, we expect an increase in the number of competitors entering our markets over the next few years. The key barriers to entry into our industry at present consist of availability of financing and availability of experienced technicians and executives familiar with the industry. If these barriers disappear or become more easily surmountable, new competitors may successfully enter into our industry, resulting in loss of our market share and increased price competition, which could adversely affect our operating and net margins.

We also compete with alternative solar technologies. Some companies have spent significant resources in the research and development of proprietary solar technologies that may eventually produce photovoltaic products at costs similar to, or lower than, those of monocrystalline or polycrystalline wafers without compromising product quality. For example, some companies are developing or currently producing photovoltaic products based on thin film photovoltaic materials, which require significantly less polysilicon to produce than monocrystalline or polycrystalline solar power products. These alternative photovoltaic products may cost less than those based on monocrystalline or polycrystalline technologies while achieving the same level of conversion efficiency, and therefore, may decrease the demand for monocrystalline and polycrystalline wafers, which may adversely affect our business prospects and results of operations.

In addition, the solar power market in general also competes with other sources of renewable energy and conventional power generation. If prices for conventional and other renewable energy sources decline, or if these sources enjoy greater policy support than solar power, the solar power market could suffer and our business and results of operations may be adversely affected.

If solar power technology is not suitable for widespread adoption, or sufficient demand for solar power products do not develop or takes longer to develop than we anticipate, sufficient sales may not develop, which may have an adverse effect on our business and results of operations.

The solar power market is still at a young stage of development and the extent to which solar power products will be widely adopted is uncertain. Market data in the solar power industry is not as readily available as those in other more established industries where trends can be assessed more reliably from data gathered over a longer period of time. If solar power technology proves unsuitable for widespread adoption or if the demand for solar power products fails to develop sufficiently, we may not be able to grow our business or generate sufficient sales to become profitable or sustain profitability. In addition, demand for solar power products in targeted markets, including China, may not develop or may develop to a lesser extent than we anticipate. Many factors may affect the viability of widespread adoption of solar power technology and the demand for solar power products, including:

 
·
cost-effectiveness of solar power products compared to conventional and other non-solar energy sources and products;

 
·
performance and reliability of solar power products compared to conventional and other non-solar energy sources and products;

 
·
availability of government subsidies and incentives to support the development of the solar power industry;

 
·
success of other alternative energy generation technologies, such as wind power, hydroelectric power and biofuels;

 
·
fluctuations in economic and market conditions that affect the viability of conventional and non- solar alternative energy sources, such as increases or decreases in the prices of oil and other fossil fuels;

 
·
capital expenditures by end users of solar power products, which tend to decrease when economy slows down; and

 
·
deregulation of the electric power industry and broader energy industry.

 
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If solar power technology proves unsuitable for wide commercial adoption and application or if demand for solar power products fails to develop sufficiently, we may not be able to grow our business or generate sufficient sales to sustain our profitability.

Technological changes in the solar power industry could render our products uncompetitive or obsolete, which could reduce our market share and cause our sales and net income to decline.

The solar power industry is characterized by evolving technologies and standards. These technological evolutions and developments place increasing demands on the improvement of our products, such as solar cells with higher conversion efficiency and larger and thinner silicon wafers and solar cells. Other companies may develop production technologies enabling them to produce silicon wafers that could yield higher conversion efficiencies at a lower cost than our products. Some of our competitors are developing alternative and competing solar technologies that may require significantly less silicon than solar cells and modules, or no silicon at all. Technologies developed or adopted by others may prove more advantageous than ours for commercialization of solar power products and may render our products obsolete. As a result, we may need to invest significant resources in research and development to maintain our market position, keep pace with technological advances in the solar power industry and effectively compete in the future. Our failure to further refine and enhance our products or to keep pace with evolving technologies and industry standards could cause our products to become uncompetitive or obsolete, which could in turn reduce our market share and cause our sales to decrease and net loss to increase.

We face risks associated with the marketing, distribution and sale of PV products internationally, and if we are unable to effectively manage these risks, they could impair our ability to expand our business abroad.

We market PV products outside of China. The marketing, international distribution and sale of PV products exposes us to a number of risks, including:

 
·
fluctuations in currency exchange rates;

 
·
difficulty in engaging and retaining distributors who are knowledgeable about and, can function effectively in, overseas markets;

 
·
difficulty to get paid within the time period allowed for reimbursement of Value-added Tax imposed by the Chinese tax authorities;

 
·
difficulty and cost relating to compliance with the different commercial and legal requirements of the overseas markets in which we offer our anticipated products;

 
·
inability to obtain, maintain or enforce intellectual property rights; and

 
·
trade barriers such as export requirements, tariffs, taxes and other restrictions and expenses, which could increase the prices of our anticipated products and make us less competitive in some countries.

A significant portion of our sales and expenses are now denominated in foreign currencies. It has not been our recent practice to engage in the hedging of foreign currency transactions to mitigate foreign currency risk. For example, if the Euro depreciates against the RMB Yuan, the currency we use to purchase most of our raw materials, then our profits may be negatively impacted because a large amount of our sales are in Euros and US dollars. We are attempting to limit the impact of a declining Euro by quoting our prices in U.S. dollars, but this exposes us to the fluctuations between the RMB Yuan and the US dollar.  Therefore, fluctuations in the value of foreign currencies have and can continue to have a negative impact on the profitability of our global operations, which would seriously harm our business, results of operations, and financial condition.

We are subject to risks associated with currency fluctuations, and changes in the exchange rates of applicable currencies could impact our results of operations.

Historically, most of our revenues are primarily denominated in Euros and US dollars and greater than the majority of our operating expenses and costs of sales are denominated in the RMB Yuan, and we expect that this will remain true in the future. Because we report our results of operations in U.S. dollars, changes in the exchange rate between the RMB Yuan and the U.S. dollar and the Euro and the U.S. dollar could materially impact our reported results of operations and distort period to period comparisons. In particular, because of the difference in the amount of our consolidated revenues and expenses that are in U.S. dollars relative to RMB Yuan, a depreciation in the U.S. dollar relative to the RMB Yuan could result in a material increase in reported costs relative to revenues, and therefore could cause our profit margins and operating income to appear to decline materially, particularly relative to prior periods. The converse is true if the U.S. dollar were to appreciate relative to the RMB Yuan. Fluctuations in foreign currency exchange rates also impact the reporting of our receivables and payables in non-U.S. currencies. As a result of foreign currency fluctuations, it could be more difficult to detect underlying trends in our business and results of operations.
 
 
14

 

Existing regulations and policies and changes to these regulations and policies may present technical, regulatory and economic barriers to the purchase and use of solar power products, which may significantly reduce demand for our products.

The market for electricity generation products is heavily influenced by government regulations and policies concerning the electric utility industry, as well as policies adopted by electric utilities companies. These regulations and policies often relate to electricity pricing and technical interconnection of customer-owned electricity generation. In a number of countries, these regulations and policies are being modified and may continue to be modified. Customer purchases of, or further investment in the research and development of, alternative energy sources, including solar power technology, could be deterred by these regulations and policies, which could result in a significant reduction in the demand for our products. For example, without a regulatory mandated exception for solar power systems, utility customers are often charged interconnection or standby fees for putting distributed power generation on the electric utility grid. These fees could increase the cost of solar power and make it less desirable, thereby decreasing the demand for our products, harming our business, prospects, results of operations and financial condition.

In addition, we anticipate that solar power products and their installation will be subject to oversight and regulation in accordance with national and local regulations relating to building codes, safety, environmental protection, utility interconnection, and metering and related matters. Any new government regulations or utility policies pertaining to solar power products may result in significant additional expenses to the users of solar power products and, as a result, could eventually cause a significant reduction in demand for our products.

We require a significant amount of cash to fund our operations and business expansion; if we cannot obtain additional capital on terms satisfactory to us when we need it, our growth prospects and future profitability may be materially and adversely affected.

We require a significant amount of cash to fund our operations, including payments to suppliers of our raw materials. We will also need to raise funds for the expansion of our production capacity and other investing activities, as well as our research and development activities in order to remain competitive. Future acquisitions, expansions, market changes or other developments may cause us to require additional funds. Our ability to obtain external financing is subject to a number of uncertainties, including:

 
·
our future financial condition, results of operations and cash flows;

 
·
the state of global credit markets;

 
·
general market conditions for financing activities by companies in our industry; and

 
·
economic, political and other conditions in China and elsewhere.

If we are unable to obtain funding in a timely manner or on commercially acceptable terms, or at all, our growth prospects and future profitability may be materially and adversely affected.

Our research and development initiatives may fail to enhance manufacturing efficiency or quality of our products.

We are making efforts to improve our manufacturing processes and improve the conversion efficiency and quality of our products. We plan to focus our research and development efforts on improving each step of our production process, making us an industry leader in technological innovation. In addition, we undertake research and development to enhance the quality of our products. We cannot assure you that such efforts will improve the efficiency of manufacturing processes or yield products with expected quality. In addition, the failure to realize the intended benefits from our research and development initiatives could limit our ability to keep pace with rapid technological changes, which in turn would hurt our business and prospects.

Failure to achieve satisfactory production volumes of our products could result in a decline in sales.

The production of solar cells and solar modules involves complex processes. Deviations in the manufacturing process can cause a substantial decrease in output and, in some cases, disrupt production significantly or result in no output. We have from time to time experienced lower-than-anticipated manufacturing output during the ramp-up of production lines. This often occurs during the introduction of new products, the installation of new equipment or the implementation of new process technologies. As we bring additional lines or facilities into production, we may operate at less than intended capacity during the ramp-up period. This would result in higher marginal production costs and lower than expected output, which could have a material adverse effect on our results of operations.
 
 
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Because a majority of our products are sold with warranties extending for 25 years, problems with product quality or product performance may cause us to incur warranty expenses. If these expenses are significant, they could have a material adverse affect on our business and results of operations.

Our standard solar modules are typically sold with a two-year warranty for defects in materials and workmanship and a ten-year and twenty-five-year warranty against declines of more than 10.0% and 20.0%, respectively, of the initial minimum power generation capacity at the time of delivery.  Due to the long warranty period, we bear the risk of extensive warranty claims long after we have shipped the product and recognized the sale. Because our products are new to the market, we are not able to evaluate their performance for the entire warranty period before we offer them for sale. If our products fail to perform as expected and we experience a significant increase in warranty claims, we may incur significant repair and replacement costs associated with such claims. In addition, product defects could cause significant damage to our market reputation and reduce our product sales and market share, and our failure to maintain the consistency and quality throughout our production process could result in substandard quality or performance of our products. If we deliver our products with defects, or if there is a perception that our products are of substandard quality, we may incur substantially increased costs associated with returns or replacements of our products, our credibility and market reputation could be harmed and our sales and market share may be adversely affected.

Our operations are subject to natural disasters, adverse weather conditions, operating hazards and labor disputes.

We may experience earthquakes, floods, snowstorms, typhoon, power outages, labor disputes or similar events beyond our control that would affect our operations. Our manufacturing processes involve the use of hazardous equipment, and we also use, store and generate volatile and otherwise dangerous chemicals and wastes during our manufacturing processes, which are potentially destructive and dangerous if not properly handled or in the event of uncontrollable or catastrophic circumstances, including operating hazards, fires and explosions, natural disasters, adverse weather conditions and major equipment failures, for which we cannot obtain insurance at a reasonable cost or at all.

Our CEO and a significant stockholder collectively hold a controlling interest in us, they have significant influence over our management and their interests may not be aligned with our interests or the interests of our other stockholders.

As of September 30, 2011, our director, president and chief executive officer, Leo Shi Young, beneficially owns 15,284,286 shares of our common stock, or approximately 8%, of our common stock. As of September 30, 2010, The Quercus Trust, which nominated David Anthony to our Board of Directors, beneficially owns 125,734,189 shares of our common stock, or approximately 56%, of our common stock. Therefore, our CEO and the Quercus Trust have substantial control over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors, dividend policy and other significant corporate actions. They may take actions that are not in the best interest of our company or our securities holders. For example, this concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our stockholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our common stock. On the other hand, if our chief executive officer and the Quercus Trust are in favor of any of these actions, these actions may be taken even if they are opposed by our other stockholders, including you and those who invest in our common stock.

We have limited insurance coverage and may incur losses resulting from product liability claims, business interruption or natural disasters.

We are exposed to risks associated with product liability claims in the event that the use of our products results in property damage or personal injury. Since our products are ultimately incorporated into electricity generating systems, it is possible that users could be injured or killed by devices that use our products, whether as a result of product malfunctions, defects, improper installations or other causes. Due to our limited operating history, we are unable to predict whether product liability claims will be brought against us in the future or to predict the impact of any resulting adverse publicity on our business. The successful assertion of product liability claims against us could result in potentially significant monetary damages and require us to make significant payments. We carry limited product liability insurance and may not have adequate resources to satisfy a judgment in the event of a successful claim against us. In addition, we do not carry any business interruption insurance. As the insurance industry in China is still in its early stage of development, even if we decide to take out business interruption coverage, such insurance available in China offers limited coverage compared with that offered in many other countries. Any business interruption or natural disaster could result in substantial losses and diversion of our resources and materially and adversely affect our business, financial condition and results of operations.
 
 
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Our lack of sufficient patent protection in and outside of China may undermine our competitive position and subject us to intellectual property disputes with third parties, both of which may have a material adverse effect on our business, results of operations and financial condition.

We have developed various production process related know-how and technologies in the production of our products. Such know-how and technologies play a critical role in our quality assurance and cost reduction. In addition, we have implemented a number of research and development programs with a view to developing techniques and processes that will improve production efficiency and product quality. Our intellectual property and proprietary rights arising out of these research and development programs will be crucial in maintaining our competitive edge in the solar power industry.  However, we have not sought to protect our intellectual property and proprietary knowledge by applying for patents for them. We use contractual arrangements with employees and trade secret protections to protect our intellectual property and proprietary rights. Nevertheless, contractual arrangements afford only limited protection and the actions we may take to protect our intellectual property and proprietary rights may not be adequate.

In addition, others may obtain knowledge of our know-how and technologies through independent development. Our failure to protect our production process, related know-how and technologies and/or our intellectual property and proprietary rights may undermine our competitive position. Third parties may infringe or misappropriate our proprietary technologies or other intellectual property and proprietary rights. Policing unauthorized use of proprietary technology can be difficult and expensive. Litigation, which can be costly and divert management attention and other resources away from our business, may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of our proprietary rights. We cannot assure you that the outcome of such potential litigation will be in our favor. An adverse determination in any such litigation will impair our intellectual property and proprietary rights and may harm our business, prospects and reputation.

We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely to us, could cause us to pay significant damage awards.

Our success also depends largely on our ability to use and develop our technology and know-how without infringing the intellectual property rights of third parties. The validity and scope of claims relating to photovoltaic technology patents involve complex scientific, legal and factual questions and analysis and, therefore, may be highly uncertain. We may be subject to litigation involving claims of patent infringement or violation of intellectual property rights of third parties. The defense and prosecution of intellectual property suits and related legal and administrative proceedings can be both costly and time consuming and may significantly divert the efforts and resources of our technical and management personnel. An adverse determination in any such litigation or proceedings to which we may become a party could subject us to significant liability to third parties, require us to seek licenses from third parties, to pay ongoing royalties, or to redesign our anticipated products or subject us to injunctions prohibiting the manufacture and sale of our anticipated products or the use of our technologies. Protracted litigation could also result in our customers or potential customers deferring or limiting their purchase or use of our anticipated products until resolution of such litigation.

Our business depends substantially on the continuing efforts of our president and chief executive officer and key technical personnel, as well as our ability to maintain a skilled labor force. Our business may be materially and adversely affected if we lose their services.

Our future success depends to a significant extent on Leo Shi Young, our president and chief executive officer. We do not maintain key man life insurance on our executive officers. If Mr. Young becomes unable or unwilling to continue in his present position, we may not be able to replace him readily. In that case our business could be severely disrupted, and we may incur substantial expenses to recruit and retain new officers.  Furthermore, recruiting and retaining capable personnel, particularly experienced engineers and technicians familiar with our products and manufacturing processes, is vital to maintain the quality of our products and improve our production methods. There is substantial competition for qualified technical personnel, and we cannot assure you that we will be able to attract or retain qualified technical personnel. If we are unable to attract and retain qualified employees, key technical personnel and our executive officers, our business may be materially and adversely affected.

Compliance with environmental, safe production and construction regulations can be costly, while non-compliance with such regulations may result in adverse publicity and potentially significant monetary damages, fines and suspension of our business operations.

We use, store and generate volatile and otherwise dangerous chemicals and wastes during our manufacturing processes, and are subject to a variety of government regulations related to the use, storage and disposal of such hazardous chemicals and waste. We are required to comply with all People’s Republic of China (“PRC”), national and local environmental protection regulations. Under such regulations, we are prohibited from commencing commercial operations of our manufacturing facilities until we have obtained the relevant approvals from PRC environmental protection authorities. In addition, the PRC government may issue more stringent environmental protection, safe production and construction regulations in the future and the costs of compliance with new regulations could be substantial. If we fail to comply with the future environmental, safe production and construction laws and regulations, we may be required to pay fines, suspend construction or production, or cease operations. Moreover, any failure by us to control the use of, or to adequately restrict the discharge of, dangerous substances could subject us to potentially significant monetary damages and fines or the suspension of our business operations.
 
 
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RISKS RELATED TO DOING BUSINESS IN CHINA

Adverse changes in political and economic policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our anticipated products and materially and adversely affect our competitive position.

All of our business operations are conducted in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including:

 
·
the amount of government involvement;

 
·
the level of development;

 
·
the growth rate;

 
·
the control of foreign exchange; and

 
·
the allocation of resources.

While the Chinese economy has grown significantly in the past 20 years, the growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources, some of which benefit us and some of which may have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.

The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the PRC government has reduced state ownership of productive assets, a substantial portion of the productive assets in China is still owned by the PRC government. The continued control of these assets and other aspects of the national economy by the PRC government could materially and adversely affect our business. The PRC government also exercises significant control over Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Efforts by the PRC government to slow the pace of growth of the Chinese economy could result in decreased capital expenditure by solar energy users, which in turn could reduce demand for our anticipated products.

Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of renewable energy investments and expenditures in China, which in turn could lead to a reduction in the demand for our anticipated products and consequently have a material adverse effect on our businesses.

Uncertainties with respect to the Chinese legal system could have a material adverse effect on us.

We conduct substantially all of our business through a subsidiary in China. This subsidiary is generally subject to laws and regulations applicable to foreign investment in China and, in particular, laws applicable to wholly foreign-owned enterprises. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since these laws and regulations are relatively new and the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us or our management.

We conduct a substantial portion of our operations in China and the majority of our assets are located in China. In addition, all of our executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or in China against us or upon our executive officers, including with respect to matters arising under United States federal securities laws or applicable state securities laws. Moreover, there is uncertainty that the courts of China would enforce judgments of United States courts against us or our directors and officers based on the civil liability provisions of the securities laws of the United States or any state, or entertain an original action brought in China based upon the securities laws of the United States or any state.
 
 
18

 

Restrictions on currency exchange may limit our ability to receive and use our sales effectively.

Foreign exchange transactions by our Shanghai subsidiary under the capital account continue to be subject to significant foreign exchange controls and require the approval of PRC governmental authorities, including the State Administration of Foreign Exchange (SAFE).  We will need to fund our Shanghai subsidiary by means of capital contributions.  We cannot assure you that we will be able to obtain government approvals on a timely basis, if at all, with respect to future capital contributions by the U.S. Company to our Shanghai subsidiary. If we fail to receive such approvals, our ability to use the proceeds we have received from our fund raising to capitalize our PRC operations may be negatively affected, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

RISKS RELATED TO AN INVESTMENT IN OUR SECURITIES

Our stock price is volatile. There is no guarantee that our shares will appreciate in value or that our shareholders will be able to sell their shares at a price that is greater than the price they paid for them.

The trading price of our common stock has been and continues to be subject to fluctuations. The stock price may fluctuate in response to a number of events and factors, such as quarterly variations in operating results, the operating and stock performance of other companies that investors may deem comparable and news reports relating to trends in the marketplace, among other factors. Significant volatility in the market price of our common stock may arise due to factors such as:

 
·
our developing business;

 
·
a continued negative cash flow;

 
·
relatively low price per share;

 
·
relatively low public float;

 
·
variations in quarterly operating results;

 
·
general trends in the industries in which we do business;

 
·
the number of holders of our common stock; and

 
·
the interest of securities dealers in maintaining a market for our common stock.

We cannot guarantee that the shares our shareholders purchase will appreciate in value or that our shareholders will be able to sell the shares at a price equal to or greater than what they paid for them.

If we do not file our quarterly or annual reports with the SEC, we may be de-listed from the OTCQB.

OTCQB is the middle tier of the OTC market. OTCQB companies report to the SEC or a U.S. banking regulator, making it easy for investors to identify companies that are current in their reporting obligations. There are no financial or qualitative standards to be in this tier. OTCQB securities may also be quoted on the FINRA BB. The OTCQB allows investors to easily identify reporting companies traded in the OTC market regardless of where they are quoted.

Under OTCQB rules relating to the timely filing of periodic reports with the SEC, if we fail to file a periodic report (Forms 10-Q or 10-K) by the due date of such report, may be removed from the OTCQB and our common stock may only be able to be traded on the OTC Pink.  The OTC Pink is the bottom tier of the OTC market – a speculative trading marketplace that helps broker-dealers get the best prices for investors. Accordingly, our securities may become worthless and we may be forced to curtail or abandon our business plan.

We are subject to the penny stock rules and these rules may adversely affect trading in our common stock.

Our common stock is a “low-priced” security under rules promulgated under the Securities Exchange Act of 1934. In accordance with these rules, broker-dealers participating in transactions in low-priced securities must first deliver a risk disclosure document which describes the risks associated with such stocks, the broker-dealer duties in selling the stock, the customer’s rights and remedies and certain market and other information. Furthermore, the broker-dealer must make a suitability determination approving the customer for low-priced stock transactions based on the customer’s financial situation, investment experience and objectives. Broker-dealers must also disclose these restrictions in writing to the customer, obtain specific written consent from the customer, and provide monthly account statements to the customer. The effect of these restrictions probably decreases the willingness of broker-dealers to make a market in our common stock, decreases liquidity of our common stock and increases transaction costs for sales and purchases of our common stock as compared to other securities.
 
 
19

 

Trading of our common stock is limited.

Trading of our common stock is on the Over-the-Counter Quotation Board, or “OTCQB” This has adversely effected the liquidity of our securities, not only in terms of the number of securities that can be bought and sold at a given price, but also through delays in the timing of transactions and reduction in security analysts' and the media's coverage of us. This may result in lower prices for our common stock than might otherwise be obtained and could also result in a larger spread between the bid and asked prices for our common stock.

We have raised substantial amounts of capital in private placements and if we inadvertently failed to comply with the applicable securities laws, ensuing rescission rights or lawsuits would severely damage our financial position.

Some securities offered in our private placements were not registered under the Securities Act of 1933, as amended, or any state “blue sky” law in reliance upon exemptions from such registration requirements. Such exemptions are highly technical in nature and if we inadvertently failed to comply with the requirements or any of such exemptions, investors would have the right to rescind their purchase of our securities or sue for damages. If one or more investors were to successfully seek such rescission or prevail in any such suit, we would face severe financial demands that could materially and adversely affect our financial position. Financings that may be available to us under current market conditions frequently involve sales at prices below the prices at which our common stock currently is reported on the OTC Bulletin Board, as well as the issuance of warrants or convertible securities at a discount to market price.

ITEM 1B.  UNRESOLVED STAFF COMMENTS

None

ITEM 2. PROPERTIES

All of our properties are leased and we do not own any real property.

We lease a 45,601 square foot manufacturing and research facility in Shanghai’s Jinqiao Modern Science and Technology Park. The lease expires on February 19, 2014. The termination clause in the agreement requires a notice of three months. Monthly costs are $24,000. We added 21,506 square feet to our existing facility with monthly rent of $12,000. The lease expires in August 2012.

We also have an operating lease for 3,365 square foot of office space in Shanghai.  The monthly rent for this space is $11,000. The lease expires on December 31, 2012 and can be renewed with a three-month advance notice.

On February 8, 2010, we acquired land use rights for a parcel of land at the price of approximately $0.7 million. This piece of land is 68,025 square meters and is located in Yizheng, Jiangsu Province of China, and it was to be used to house our second manufacturing facility. As part of the right of land use, we are required to complete construction of the facility by February 8, 2012. The Board of Directors of the Company has decided not to continue to fund the investment in the Yizheng Jiangsu Province subsidiary. We received the approval on December 22, 2011 to write-off the registration of the Yizheng Jiangsu Province subsidiary.

Finally, we lease 678 square feet of office space on a month-to-month basis in Mountain View, in Northern California’s Silicon Valley, to handle our United States operations.

We consider these facilities adequate to meet our current needs.

ITEM 3. LEGAL PROCEEDINGS

We are involved in various claims and actions arising in the ordinary course of business.  In the opinion of management, based on consultation with legal counsel, the ultimate disposition of these matters will not have a material adverse effect on us.  We believe appropriate accruals have been made for the disposition of these matters.  We establish an accrual for a liability when it is both probable that the liability has been incurred and the amount of the loss can be reasonably estimated.  These accruals are reviewed quarterly and adjusted to reflect the impact of negotiations, settlements and payments, rulings, advice of legal counsel, and other information and events pertaining to a particular case.  Legal expenses related to defense, negotiations, settlements, rulings, and advice of outside legal counsel are expensed as incurred. As of the date of this report, we have no involvement with any claims.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.
 
 
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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

On May 11, 2011, we migrated our listing from Over-The-Counter Bulletin Board (“OTCBB”) to Over-The-Counter Quote Board (“OTCQB”), which is operated by OTC Markets Group Inc. under the symbol “SOEN”. The following table shows, for the periods indicated, the high and low closing prices of common stock.

 
   
Year Ended September 30,
   
Year Ended September 30,
 
   
2011
   
2010
 
   
High
   
Low
   
High
   
Low
 
                         
First Quarter
  $ 0.12     $ 0.07     $ 0.30     $ 0.24  
Second Quarter
  $ 0.14     $ 0.09     $ 0.32     $ 0.19  
Third Quarter
  $ 0.13     $ 0.06     $ 0.21     $ 0.12  
Fourth Quarter
  $ 0.08     $ 0.03     $ 0.17     $ 0.11  

As of November 30, 2011, there were 59 stockholders of record of the common stock (which does not include the number of persons or entities holding stock in nominee or street name through various brokerage firms).

Dividends

We have neither declared nor paid any cash dividends on our capital stock and do not anticipate paying cash dividends in the foreseeable future. Our current policy is to retain any earnings in order to finance the expansion of our operations. Our Board of Directors will determine future declaration and payment of dividends, if any, in light of the then-current conditions they deem relevant and in accordance with applicable corporate law.

Authorized Shares

On May 5, 2008, the Company’s stockholders approved an increase of the Company’s authorized capital stock from 200 million common shares with a par value of $0.001 to 400 million common shares with a par value of $0.001. The increase in the Company’s authorized capital was affected in conjunction with the Company’s reincorporation into the State of Delaware.

Amended and Restated 2007 Equity Incentive Plan

On September 24, 2007, our Board of Directors approved the adoption of the 2007 Equity Incentive Plan (the “2007 Plan”). The 2007 Plan provides for the issuance of a maximum of 10 million shares of common stock in connection with awards under the 2007 Plan. Such awards may include stock options, restricted stock purchase rights, restricted stock bonuses and restricted stock unit awards. The 2007 Plan may be administered by the Company’s Board of Directors or a committee duly appointed by the Board of Directors and has a term of 10 years. Participation in the 2007 Plan is limited to employees, directors and consultants of the Company and its subsidiaries and other affiliates. Options granted under the 2007 Plan must have an exercise price per share not less than the fair market value of the Company’s common stock on the date of grant. Options granted under the 2007 Plan may not have a term exceeding 10 years. Awards will vest upon conditions established by the Board of Directors or it’s duly appointed Committee. Subject to the requirements and limitations of section 409A of the Internal Revenue Code of 1986, as amended, in the event of a Change in Control (as defined in the 2007 Plan), the Board of Directors may provide for the acceleration of the exercisability or vesting and/settlement of any award, the Board of Directors may provide for a cash-out of awards or the Acquirer (as defined in the 2007 Plan) may either assume or continue the Company’s rights and obligations under any awards.

On February 5, 2008, the Board of Directors adopted the Amended and Restated 2007 Equity Incentive Plan (the “Amended 2007 Plan”), which increases the number of shares authorized for issuance from 10 million to 15 million shares of common stock and was to be effective upon approval of the Company’s stockholders and upon the Company’s reincorporation into the State of Delaware.

On May 5, 2008, at the Company’s Annual Meeting of Stockholders, the Company’s stockholders approved the Amended 2007 Plan. On August 13, 2008, the Company reincorporated into the State of Delaware.
 
 
21

 

On May 9, 2008, the Compensation Committee of the Board of Directors of the Company authorized the repricing of all outstanding options issued to current employees, directors, officers and consultants prior to February 5, 2008 under the 2007 Plan to $0.62, determined in accordance with the 2007 Plan as the closing price for shares of Common Stock on the Over-the-Counter Bulletin Board on the date of the repricing.

As of September 30, 2011, the Board of Directors has granted options to purchase 5,190,000 shares of our common stock to our employees, director and consultants pursuant to the Amended 2007 Plan.

2008 Restricted Stock Plan

On August 19, 2008, Mr. Leo Young, our Chief Executive Officer, entered into a Stock Option Cancellation and Share Contribution Agreement with Jean Blanchard, a former officer, to provide for (i) the cancellation of a stock option agreement by and between Mr. Young and Ms. Blanchard dated on or about March 1, 2006 and (ii) the contribution to the Company by Ms. Blanchard of the remaining 25,250,000 shares of common stock underlying the cancelled Option Agreement.

On the same day, an Independent Committee of the Company’s Board adopted the 2008 Restricted Stock Plan (the “2008 Plan”) providing for the issuance of 25,250,000 shares of restricted common stock to be granted to the Company’s employees pursuant to forms of restricted stock agreements.

The 2008 Plan provides for the issuance of a maximum of 25,250,000 shares of restricted stock in connection with awards under the 2008 Plan.  The 2008 Plan is administered by the Company’s Compensation Committee, a subcommittee of our Board of Directors, and has a term of 10 years. Participation is limited to employees, directors and consultants of the Company and its subsidiaries and other affiliates.  During any period in which shares acquired pursuant to the 2008 Plan remain subject to vesting conditions, the participant shall have all of the rights of a stockholder of the Company holding shares of stock, including the right to vote such shares and to receive all dividends and other distributions paid with respect to such shares.  If a participant terminates his or her service for any reason (other than death or disability), or the participant’s service is terminated by the Company for cause, then the participant shall forfeit to the Company any shares acquired by the participant which remain subject to vesting Conditions as of the date of the participant’s termination of service. If a participant’s service is terminated by the Company without cause, or due to the death or disability of the participant, then the vesting of any restricted stock award shall be accelerated in full as of the effective date of the participant’s termination of service.

On July 2, 2011, the Company issued 8,600,000 shares of restricted common stock to the Company’s employees pursuant to the Company’s 2008 Restricted Stock Plan, with such awards to be evidenced by and subject to the terms and conditions of the form of restricted stock agreement previously adopted by the Company, except that the vesting of such restricted stock awards shall be over three years, with one-third of such shares vested upon the one year anniversary of the date of grant, and the balance to vest in equal monthly installments thereafter.  The issuance of the shares of  restricted stock was not registered under the Securities Act in reliance on the exemption from registration provided under Regulation S, as promulgated under the Securities Act. Shares of  restricted stock were issued only to non-U.S. persons in offshore transactions who met the conditions under Regulation S.

Out of the 8,600,000 shares of restricted common stock issued, the Company issued 1,000,000 shares of restricted common stock to Yihong Yao, the Company’s Chief Financial Officer, pursuant to the Company’s 2008 Restricted Stock Plan, with such awards to be evidenced by and subject to the terms and conditions of the form of restricted stock agreement previously adopted by the Company, except that the vesting of such restricted stock awards shall be over three years, with one-third of such shares vested upon the one year anniversary of the date of grant, and the balance to vest in equal monthly installments thereafter.
 
 
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Equity Compensation Plan Information

Plan Category
 
Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights (a)
   
Weighted-average
exercise price of
outstanding options,
warrants and rights (b)
   
Number of securities
remaining available for future
issuance under equity
compensation plans
(excluding securities reflected
in column a) (c)
 
Equity compensation plans approved by security holders
    5,190,000 (1)   $ 0.18       9,810,000  
Equity compensation plans not approved by security holders
        $        

(1) Represents options to purchase common stock issued pursuant to the terms of 2007 Plan, as amended and restated.
a — Our common stock is currently quoted by the Over-The-Counter Quote Board under the symbol “SOEN”.
b — We have approximately 59 record holders on November 30, 2011.
c — No cash dividend has been declared.

Rules Governing Low-Price Stocks that May Affect Our Stockholders’ Ability to Resell Shares of Our Common Stock

Our stock trades under the symbol “SOEN” on OTC Markets Group Inc’s OTCQB.

Quotations on the OTCQB reflect inter-dealer prices, without retail mark-up, markdown or commission and may not reflect actual transactions. Our common stock may be subject to certain rules adopted by the SEC that regulate broker-dealer practices in connection with transactions in “penny stocks”. Penny stocks generally are securities with a price of less than $5.00, other than securities registered on certain national exchanges or quoted on the NASDAQ system, provided that the exchange or system provides current price and volume information with respect to transaction in such securities. The additional sales practice and disclosure requirements imposed upon broker-dealers may discourage broker-dealers from effecting transactions in our shares which could severely limit the market liquidity of the shares and impede the sale of our shares in the secondary market.

The penny stock rules require broker-dealers, prior to a transaction in a penny stock not otherwise exempt from the rules, to make a special suitability determination for the purchaser to receive the purchaser’s written consent to the transaction prior to sale, to deliver standardized risk disclosure documents prepared by the SEC that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer must also provide the customer with current bid and offer quotations for the penny stock. In addition, the penny stock regulations require the broker-dealer to deliver, prior to any transaction involving a penny stock, a disclosure schedule prepared by the SEC relating to the penny stock market, unless the broker-dealer or the transaction is otherwise exempt. A broker-dealer is also required to disclose commissions payable to the broker-dealer and the registered representative and current quotations for the securities. Finally, a broker-dealer is required to send monthly statements disclosing recent price information with respect to the penny stock held in a customer’s account and information with respect to the limited market in penny stocks.

Recent Sales of Unregistered Securities

On October 1, 2011, we issued 784,304 shares of our common stock as accrued interest to the holder of our Series B-1 convertible note. These shares were exempt from any registration requirement under the Securities Act pursuant to Section 3(a)(9) of the Securities Act and Rule 144 promulgated under the Securities Act.
 
In October, 2011, 800,000 shares of our restricted stock were cancelled due to employees’ resignation.

ITEM 6.  SELECTED FINANCIAL DATA

As a Smaller Reporting Company as defined by Rule 12b-2 of the Exchange Act and in item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item 6.
 
 
23

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. In some cases, readers can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue.” These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those stated herein. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in Item 1A, “Risks Related to Our Business,” “Risks Related to Doing Business in China” and “Risks Related to an Investment in Our Securities” as well as in Item 1, “Business” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of  Operations” in this Annual Report on Form 10-K. You should carefully review these risks and also review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q that we will file. You are cautioned not to place undue reliance on these forward-looking statements, and we expressly assume no obligations to update the forward-looking statements in this report that occur after the date hereof.

Company Description and Overview

Solar EnerTech Corp. is a solar product manufacturer with its headquarters based in Mountain View, California, and with low-cost operations located in Shanghai, China.  Our principal products are monocrystalline silicon and polycrystalline silicon solar cells and solar modules. Solar cells convert sunlight to electricity through the photovoltaic effect, with multiple solar cells electrically interconnected and packaged into solar modules to form the building blocks for solar power generating systems. We primarily sell solar modules to solar panel installers who incorporate our modules into their power generating systems that are sold to end-customers located in Europe, Australia, North America and China.

We have established our manufacturing base in Shanghai, China to capitalize on the cost advantages offered in manufacturing of solar power products.  In our 67,107-square-foot manufacturing facility we operate two 25 MW solar cell production lines and a 50 MW solar module production facility.  We believe that the choice of Shanghai, China for our manufacturing base provides us with convenient and timely access to key resources and conditions to support our growth and low-cost manufacturing operations.

Our solar cells and modules are sold under the brand name “SolarE”.  Our total sales for the fiscal year ended September 30, 2011 was $42.7 million and our end users are mainly in Europe and Australia.  In anticipation of entering the US market, we have established a headquarter office which also serves as marketing, purchasing and distribution office in Mountain View, California. Our goal is to become a worldwide supplier of PV cells and modules.

We purchase our key raw materials, silicon wafers, from the spot market.  We do not have a long term contract with any silicon supplier.

We have been able to increase sales since our inception in 2006. Although our efforts to reach profitability have been adversely affected by the global recession, the credit market contraction and a volatile polysilicon market, during fiscal year 2010 and the first quarter of fiscal year 2011 we had significantly improved our gross margin as a result of declines in raw materials costs and the efficiencies gained from greater capacity utilization at our facilities. However, during the fiscal year 2011, the gross margin was negative 2%, mainly because of the decrease in average selling price of solar modules and decline in sales volume.

In December 2006, we entered into a joint venture with Shanghai University to operate a research facility to study various aspects of advanced PV technology. Our joint venture with Shanghai University is for shared investment in research and development on fundamental and applied technologies in the fields of semi-conductive photovoltaic theory, materials, cells and modules. The agreement calls for Shanghai University to provide equipment, personnel and facilities for joint laboratories. It is our responsibility to provide funding, personnel and facilities for conducting research and testing. Research and development achievements from this joint research and development agreement will be available for use by both parties. We are entitled to the intellectual property rights, including copyrights and patents, obtained as a result of this research. The research and development we will undertake pursuant to this agreement includes the following:

 
·
develop mass-production process for CIGS thin film technology which we jointly developed with AQT Solar;

 
·
develop efficient and ultra-efficient PV cells with light/electricity conversion rates ranging from 20% to 35%;

 
·
develop environmentally friendly high conversion rate manufacturing technology of chemical compound film PV cell materials;

 
·
research and develop key materials for new low-cost flexible-film PV cells and non-vacuum technology; and
 
 
24

 

 
·
research and develop key technologies and fundamental theories for third-generation PV cells.

On January 7, 2010 (the “Conversion Date”), we entered into a Series A and Series B Notes Conversion Agreement (the “Conversion Agreement”) with the holders of Notes representing at least seventy-five percent of the aggregate principal amounts outstanding under the Notes to restructure the terms of the Notes. On January 7, 2010, as part of the Conversion Agreement, approximately $9.8 million of convertible notes outstanding were successfully converted into shares of our common stock. On January 19, 2010, a holder of approximately $1.8 million of our formerly outstanding Series B Notes and Series B Warrants disputed the effectiveness of the Conversion Agreement and the Warrant Amendment.  Accordingly, such holder did not tender its Series B Notes for conversion. After negotiations with such holder, on March 19, 2010, we entered into an Exchange Agreement with the holder Capital Ventures International (“CVI”) (“Exchange Agreement”), whereby we issued the Series B-1 Note with a principal amount of $1.8 million (the “Series B-1 Note”) due on March 19, 2012 and an interest at 6% per annum, which extended the original maturity date by 24 months, in exchange for the Series B Notes.

On May 11, 2011, we executed an amendment with CVI (“Amendment”) whereby CVI waives the following Trigger Events: (a) the migration of our listing from the OTCBB to the OTCQB, (b) the failure of us to timely pay the interest payment due on April 1, 2011 and (c) any other Trigger Event that may exist as of the date of this Amendment. According to the Amendment, Section 3(c) of the Exchange Agreement was amended to reduce the conversion price of the Note from $0.15 to $0.10 per common shares, subject to further adjustment upon certain specified events as defined in the Exchange Agreement. As of September 30, 2011, the outstanding principal of the Note was $1,540,261, the carrying amount was $1,474,000 and the related interest was $23,294.

On May 5, 2011, we entered into a credit facility arrangement with BOC, in which we can draw up to the cumulative amount of accounts receivable outstanding from our key customer. If we are unable to successfully generate enough revenues to cover our costs or secure additional financing, our liquidity and results of operations may be materially and adversely affected. As of September 30, 2011, we had short term loans outstanding of approximately $0.3 million. Other than as discussed in this report, we know of no trends, events or uncertainties that are reasonably likely to impact our future liquidity. 

On July 6, 2011, our Board of Directors approved the appointment of Child, Van Wagoner & Bradshaw, PLLC as our new auditor replacing Ernst & Young Hua Ming (“E&Y China”). The resignation of E&Y China on May 17, 2011 was not related to any disagreements with our management on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of E&Y China would have caused it to make reference thereto in any reports on our financial statements for the past two fiscal years.

Environmental, Health and Safety Regulations

In our manufacturing process, we will use, generate and discharge toxic, volatile or otherwise hazardous chemicals and wastes in our manufacturing activities. We are subject to a variety of foreign, federal, state and local governmental laws and regulations related to the purchase, storage, use and disposal of hazardous materials. If we fail to comply with present or future environmental laws and regulations, we could be subject to fines, suspension of production or a cessation of operations. In addition, under some foreign, federal, state and local statutes and regulations, a governmental agency may seek recovery and response costs from operators of property where releases of hazardous substances have occurred or are ongoing, even if the operator was not responsible for the release or otherwise was not at fault.

Management believes that we have all environmental permits necessary to conduct our business and have obtained all necessary environmental permits for our facility in Shanghai. Management also believes that we have properly handled our hazardous materials and wastes and have appropriately remediated any contamination at any of our premises. We are not aware of any pending or threatened environmental investigation, proceeding or action by foreign, federal, state or local agencies, or third parties involving our current facilities. Any failure by us to control the use of or to restrict adequately the discharge of, hazardous substances could subject us to substantial financial liabilities, operational interruptions and adverse publicity, any of which could materially and adversely affect our business, results of operations and financial condition.

Solar Energy Industry

We believe that economic and national security issues, technological advances, environmental regulations seeking to limit emissions by fossil fuel, air pollution regulations restricting the release of greenhouse gasses, aging electricity transmission infrastructure and depletion and limited supply of fossil fuels, has made reliance on traditional sources of fuel for generating electricity less attractive. Government policies, in the form of both regulation and incentives, have accelerated the adoption of solar technologies by businesses and consumers. For example, in the U.S., the Energy Policy Act (EPACT) enacted a 30% investment tax credit for solar, and in January 2006, California approved the largest solar program in the country's history that provides for long term subsidies in the form of rebates to encourage use of solar energy where possible.
 
 
25

 

Government Subsidies and Incentives

Various subsidies and tax incentive programs exist at the federal and state level to encourage the adoption of solar power including capital cost rebates, performance-based incentives, feed-in tariffs, tax credits and net metering. Capital cost rebates provide funds to customers based on the cost or size of a customer's solar power system. Performance-based incentives provide funding to a customer based on the energy produced by their solar system. Under a feed-in tariff subsidy, the government sets prices that regulated utilities are required to pay for renewable electricity generated by end-users. The prices are set above market rates and may be differentiated based on system size or application. Feed-in tariffs pay customers for solar power system generation based on kilowatt-hours produced, at a rate generally guaranteed for a period of time. Tax credits reduce a customer's taxes at the time the taxes are due. Under net metering programs, a customer can generate more energy than used, during which periods the electricity meter will spin backwards. During these periods, the customer "lends" electricity to the grid, retrieving an equal amount of power at a later time. Net time metering programs enable end-users to sell excess solar electricity to their local utility in exchange for a credit against their utility bills. Net metering programs are usually combined with rebates, and do not provide cash payments if delivered solar electricity exceeds their utility bills. In addition, several states have adopted renewable portfolio standards, which mandate that a certain portion of electricity delivered to customers come from a set of eligible renewable energy resources. Under a renewable portfolio standard, the government requires regulated utilities to supply a portion of their total electricity in the form of renewable electricity. Some programs further specify that a portion of the renewable energy quota must be from solar electricity.

Despite the benefits of solar power, there are also certain risks and challenges faced by solar power. Solar power is heavily dependent on government subsidies to promote acceptance by mass markets. We believe that the near-term growth in the solar energy industry depends significantly on the availability and size of these government subsidies and on the ability of the industry to reduce the cost of generating solar electricity. The market for solar energy products is, and will continue to be, heavily dependent on public policies that support growth of solar energy. There can be no assurances that such policies will continue. Decrease in the level of rebates, incentives or other governmental support for solar energy would have an adverse affect on our ability to sell our products.

Results of Operations

Comparison of the Fiscal Years Ended September 30, 2011 and 2010

Revenues, Cost of Sales and Gross Margin

   
Year Ended September 30, 2011
   
Year Ended September 30, 2010
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Sales
  $ 42,694,000       100.0 %   $ 70,029,000       100.0 %   $ (27,335,000 )     (39.0 )%
Cost of sales
    (43,720,000 )     (102.4 )%     (64,820,000 )     (92.6 )%     21,100,000       (32.6 )%
Gross loss
  $ (1,026,000 )     (2.4 )%   $ 5,209,000       7.4 %   $ (6,235,000 )     (119.7 )%

For the fiscal year ended September 30, 2011, the Company reported total revenue of $42.7 million, representing a decrease of $27.3 million or 39.0% compared to $70.0 million of revenue in the same period of fiscal year 2010. For the year ended September 30, 2011, we recorded $42.7 million in revenue which comprised of $42.0 million in solar module sales and $0.7 million in solar cell sales compared to $70.0 million of revenue in the same period of the prior year which comprised of $62.3 million in solar module sales, $5.1 million in solar cell sales and $2.6 million in resale of raw materials. The decrease in revenue resulted from a decrease in solar module shipments from 34.9 MW in fiscal year 2010 to 24.3 MW in fiscal year 2011 and a 6% decrease in average selling prices for solar modules from $1.8 per watt in fiscal year 2010 to $1.7 per watt in fiscal year 2011. In addition, the decline in sales was mainly due to a downturn in major European and Australian markets which has left module supply well in excess of demand.

For the fiscal year ended September 30, 2011, we incurred a negative gross margin of $1.0 million compared to a positive gross margin of $5.2 million in fiscal year 2010. The decrease in gross profit margin was primarily due to a decrease in average selling price for solar modules, lower production volume for the fiscal year ended September 30, 2011 (resulting in higher fixed production cost per unit), and lower sales volume which caused the total margin to decrease.

Selling, general and administrative

   
Year Ended September 30, 2011
   
Year Ended September 30, 2010
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Selling, general and administrative
  $ 6,813,000       16.0 %   $ 9,565,000       13.7 %   $ (2,752,000 )     (28.8 )%
 
 
26

 

For the fiscal year ended September 30, 2011, we incurred selling, general and administrative expense of $6.8 million, representing a decrease of $2.8 million or 28.8% from $9.6 million in the same period of fiscal year 2010. Selling, general and administrative expense as a percentage of net sales for the fiscal year ended September 30, 2011 increased to 16.0% from 13.7% for fiscal year 2010. The decrease in the selling, general and administrative expenses was primarily due to decreases in shipping and handling costs of $2.2 million resulted from lower revenue in fiscal year 2011 and a decrease of $0.5 million in stock-based compensation expenses related to employee options and restricted stock from $2.8 million for the fiscal year ended September 30, 2010 to $2.3 million for the fiscal year ended September 30, 2011.

Research and development

   
Year Ended September 30, 2011
   
Year Ended September 30, 2010
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Research and development
  $ 361,000       0.8 %   $ 347,000       0.5 %   $ 14,000       4.0 %

Research and development expenses in the fiscal years ended September 30, 2011 and 2010 were $0.4 million and $0.3 million, respectively. Research and development expenses as a percentage of net sales for the fiscal year ended September 30, 2011 increased to 0.8% from 0.5% for the fiscal year ended September 30, 2010 due to lower revenue for the fiscal year ended September 30, 2011 compared to revenue for the fiscal year ended September 30, 2010.

In accordance with our joint research and development laboratory agreement with Shanghai University, dated December 15, 2006 (amended on November 12, 2010) expiring on December 15, 2016, we committed to fund the establishment of laboratories and completion of research and development activities at no less than RMB 30 million ($4.5 million) cumulatively within eight years (extended from five years). The funding requirements are based on specific milestones agreed upon by Shanghai University and us. Shanghai University needs to obtain pre-approval from us before incurring expenditures on the program. We paid $13,000 in funding to Shanghai University during the year ended September 30, 2011. As of September 30, 2011, there are approximately $3.2 million remaining to be funded in full by December 15, 2014.

Loss on debt extinguishment

   
Year Ended September 30, 2011
   
Year Ended September 30, 2010
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Loss (gain) on debt extinguishment
  $ -       0.1 %   $ 18,540,000       26.5 %   $ (18,540,000 )     (100.0 )%

We had no cumulative loss on debt extinguishment for the fiscal year ended September 30, 2011.

For the fiscal year ended September 30, 2010, we incurred a loss on debt extinguishment of $18.5 million as a result of the Conversion Agreement and the Exchange Agreement dated January 7, 2010.

Reversal of payroll related tax accrual

   
Year Ended September 30, 2011
   
Year Ended September 30, 2010
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Reversal of payroll related tax accrual
  $ (5,817,000 )     (13.6 )%   $ -       0.0 %   $ (5,817,000 )     0.0 %

The reversal of payroll related tax accrual was $5.8 million and $0 million during the fiscal years ended September 30, 2011 and 2010, respectively. The $5.8 million reversal of payroll related tax accrual in the fiscal year ended September 30, 2011 represented $4.8 million of compensation expense related to our obligation to withhold tax upon exercise of stock options by Mr. Young in the fiscal year 2006 and the related interest and penalties, and $1.0 million of indemnification provided by us to Mr. Young  for any liabilities he may incur as a result of previous stock options granted to him by Ms. Blanchard, a former officer, in conjunction with the purchase of Infotech on August 19, 2008.

Both our obligation to withhold tax upon the exercise of stock options by Mr. Young and the indemnification have a three year statute of limitation. The statute of limitation expired as of December 31, 2010. As a result, we have released the $5.8 million in the fiscal year ended September 30, 2011.
 
 
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Other income (expense)

    
Year Ended September 30, 2011
   
Year Ended September 30, 2010
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Interest income
  $ 5,000       0.0 %   $ 7,000       0.0 %   $ (2,000 )     (28.6 )%
Interest expense
    (304,000 )     (0.7 )%     (5,446,000 )     (7.8 )%     5,142,000       (94.4 )%
Gain on change in fair market value of compound embedded derivative
    393,000       0.9 %     1,235,000       1.8 %     (842,000 )     (68.2 )%
Gain on change in fair market value of warrant liability
    902,000       2.1 %     4,511,000       6.4 %     (3,609,000 )     (80.0 )%
Impairment loss on investment
    -       0.0 %     (1,000,000 )     (1.4 )%     1,000,000       (100.0 )%
Other expense
    (302,000 )     (0.7 )%     (1,078,000 )     (1.5 )%     776,000       (72.0 )%
Total other income (expense)
  $ 694,000       1.6 %   $ (1,771,000 )     (2.5 )%   $ 2,465,000       (139.2 )%

For the fiscal year ended September 30, 2011, total other income was $0.7 million, representing an increase of $2.5 million, or 139.2%, compared to total other expense of $1.8 million for the same period of the prior year. Other income as a percentage of sales for the fiscal year ended September 30, 2011 was 1.6% compared to other expense as a percentage of sales of 2.5% for the same period in the prior year.  In the fiscal year ended September 30, 2011, we recorded a gain on change in fair market value of compound embedded derivative of $0.4 million and a gain on change in fair market value of warrant liability of $0.9 million compared to a gain on change in fair market value of compound embedded derivative of $1.2 million and a gain on change in fair market value of warrant liability of $4.5 million during the fiscal year ended September 30, 2010. The lower conversion price of the compound embedded derivative and warrant in the fiscal year ended September 30, 2011 compared to that in the fiscal year ended September 30, 2010, resulted in greater decreases in the fair value of the compound embedded derivative and warrant liability and higher gains on change in fair market value of the compound embedded derivative and warrant liability. We incurred interest expenses of $0.3 million and $5.4 million in the fiscal years ended September 30, 2011 and 2010, respectively, primarily related to the amortization of the discount on the convertible notes and deferred financing cost, and 6% interest charges on Series A and Series B notes, which was converted to our common stock on January 7, 2010 and 6% interest charges on Series B-1 Convertible Notes. Other expense of $0.3 million for the fiscal year ended September 30, 2011 and other expense of $1.1 million for the fiscal year ended September 30, 2010 were primarily related to foreign exchange gain (loss).

The $1.0 million in impairment loss on investment for fiscal year ended September 30, 2010 was related to the write-down of our investment in 21-Century Silicon, which we consider unrecoverable.  No write-down of investment was recorded for the fiscal year ended September 30, 2011.

Liquidity and Capital Resources

   
Year Ended September 30,
       
   
2011
   
2010
   
Change
 
                   
Cash and cash equivalents
  $ 1,324,000     $ 6,578,000     $ (5,254,000 )
 
   
Year Ended September 30,
       
   
2011
   
2010
   
Change
 
                   
Net cash provided by (used in):
                 
Operating activities
  $ (2,979,000 )   $ 4,277,000     $ (7,256,000 )
Investing activities
    (1,728,000 )     (770,000 )     (958,000 )
Financing activities
    (1,040,000 )     1,312,000       (2,352,000 )
Effect of exchange rate changes on cash and cash equivalents
    493,000       40,000       453,000  
Net increase (decrease) in cash and cash equivalents
  $ (5,254,000 )   $ 4,859,000     $ (10,113,000 )

 As of September 30, 2011 and 2010, we had cash and cash equivalents of $1.3 million and $6.6 million, respectively. We will require a significant amount of cash to fund our operations. Changes in our operating plans, an increase in our inventory, increased expenses, or other events, may cause us to seek additional equity or debt financing in the future. In order to continue as a going concern, we will need to continue to generate new sales while controlling our costs.  If we are unable to successfully generate enough sales to cover our costs, our liquidity and results of operations may be materially and adversely affected and we may not continue as a going concern.
 
 
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Our liquidity is impacted to a large extent based on both the nature of the products we sell and also the geographical location of our customers, as our payment terms on sale vary greatly depending on both factors. With respect to the products we sell, while in the past we have engaged in transactions where we have resold our raw materials due to our overstock of materials relative to our then limited production capacity, as our production capacity has increased over the years, our sales now consist primarily of solar modules to solar panel installers in Europe and Australia who incorporate our modules into their power generating systems that are sold to end-customers. Payment terms for the sale of our modules are generally longer than payment terms where we resell our raw materials in China and as a result, our payment terms have lengthened relative to prior years. In addition, with respect to the geographic location of our customers, the payment terms for the sale of our solar modules are generally longer for our customers in the United States than for our customers in Europe and Australia. While our current sales to customers in the United States are limited, if we are able to increase our sales in the U.S. market or in other markets that may have longer payment terms, our payment terms may lengthen. Payment terms for our solar module sales generally range from 0 to 60 days. In some cases, these terms are extended up to 200 days for certain qualifying customers of whom we applied rigorous credit requirements. If we have more sales of products or in geographies with longer payment terms, the longer payment terms will impact the timing of our cash flows.

Net cash used in operating activities was $3.0 million for the fiscal year ended September 30, 2011, representing an increase of $7.3 million, compared to net cash provided by operating activities of $4.3 million for the fiscal year ended September 30, 2010. Cash flow from operating activities reflected a net loss of $1.6 million adjusted for non-cash items, including depreciation of property and equipment, stock-based compensation, reversal of payroll related tax accruals, gain on debt extinguishment, amortization of note discount and deferred financing cost, the change in the fair market value of the compound derivative liabilities and warrants liabilities, and payment of interest by issuance of shares. The increase of $7.3 million in net cash used in operating activities from the fiscal year ended September 30, 2010 to the fiscal year ended September 30, 2011 was mainly attributable to more cash out flow for purchase of raw materials in the fiscal year ended September 30, 2011 compared to the same period in 2010. The payment terms granted by our major vendors ranged from 0 to 60 days. There were no material changes in the payment terms granted by our major vendors in the fiscal year ended September 30, 2011 compared to the same period in the prior year. The net loss excluding non-cash expenses for the fiscal year ended September 30, 2011 decreased compared to the same period in 2010, coupled with lower balances in accounts payable as of September 30, 2011 compared to September 30, 2010.

Net cash used in investing activities were $1.7 million and $0.8 million in fiscal years 2011 and 2010, respectively. The increase of $1.0 million in net cash used in investing activities was primarily due to higher property and equipment acquisitions during fiscal year 2011 compared to the fiscal year 2010.

Net cash used in and provided by financing activities were $1.0 million in fiscal year 2011 and $1.3 million in fiscal year 2010, respectively because of draw downs from our credit facility with Industrial Bank Co., Ltd (“IBC”) and Bank of China (“BOC”).

Our consolidated balance sheet, statements of operations and cash flows have been prepared on the assumption that the Company will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business.

On March 19, 2010, we entered into an Exchange Agreement (the “Exchange Agreement”) with Capital Ventures International (“CVI”) whereby we issued a Series B-1 Convertible Note (the “Note”) to CVI with an original principal amount of $1,815,261, which is due on March 19, 2012 and bears interest at 6% per annum. On May 11, 2011, we executed an amendment with CVI (“Amendment”) whereby CVI waives the following Trigger Events: (a) the migration of our listing from the OTCBB to the OTCQB, (b) the failure of us to timely pay the interest payment due on April 1, 2011 and (c) any other Trigger Event that may exist as of the date of this Amendment. According to the Amendment, Section 3(c) of the Exchange Agreement is amended to reduce the conversion price of the Note from $0.15 to $0.10 per common share, subject to further adjustment upon certain specified events as defined in the Exchange Agreement. As of September 30, 2011, the outstanding principal of the Note was $1,540,261, the carrying amount was $1,474,000 and the related interest was $23,294.  

On March 25, 2010, we entered into a one year contract with China Export & Credit Insurance Corporation (“CECIC”) to insure the collectability of outstanding accounts receivable of our key customers. We pay a fee based on a fixed percentage of the accounts receivable outstanding and expense this fee when it is incurred. In addition, on March 30, 2010, we entered into a one year revolving credit facility arrangement with IBC that is secured by the accounts receivable balances of our key customers insured by CECIC above. On March 25, 2011, we renewed our contract with CECIC for another one year to insure the collectability of outstanding accounts receivable of one of our customers for up to $3.5 million. On May 5, 2011, we terminated the credit facility arrangement with IBC and on the same day, we entered into a revolving credit facility arrangement with Bank of China (“BOC”), which is also secured by the accounts receivable balances of our key customers insured by CECIC above. If the insured customer fails to repay the amounts outstanding due to us, the insurance proceeds will be remitted directly to BOC instead of us.  The interest rate of the credit facility is variable and ranged from 3.78% to 5.30% during the fiscal year ended September 30, 2011. The amount drawn down as of September 30, 2011 was $273,000 and there have been no insurance claims submitted to CECIC. We paid the short term loan of $273,000 to BOC on October 9, 2011.The credit facility contains certain non-financial ratios related covenants, including maintaining creditworthiness, complying with all contractual obligations as requested by BOC, fulfillment of other indebtedness (if any), maintaining its business license and continuing operations, ensuring its financial condition does not deteriorate, remaining solvent, and other conditions, as defined in the credit facility agreement. We complied with these covenants as September 30, 2011. If we fail to comply with our covenants on our credit facility, our debt may be accelerated or future drawdown requests may not be honored.

 
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As of September 30, 2011, we had cash and cash equivalents balance of approximately $1.3 million. If we experience a material shortfall versus our operating plans, we have a range of actions we can take to remediate the cash shortage, including but not limited to raising additional funds through debt financing, securing a credit facility, entering into secured or unsecured bank loans, or undertaking equity offerings such as a rights offering to existing shareholders. However, due to the conditions of capital and credit markets, we cannot be sure that external financing will be available when needed or that, if available, financing will be obtained on terms favorable to us or our stockholders. If we are unable to successfully generate enough revenues to cover our costs or secure additional financing, our liquidity and results of operations may be materially and adversely affected.

Off-Balance Sheet Arrangements

Future minimum payments under all non-cancelable lease obligations and payments under our agreement with Shanghai University are as follows as of September 30, 2011:

         
Payments Due by Period
 
   
Total
   
Less than 1
year
   
1 to 3 years
   
4 to 5 year
   
More than 5
years
 
                               
Operating lease
  $ 1,073,000     $ 627,000     $ 446,000     $ -     $ -  
Research and development commitment
    3,240,000       -       3,240,000       -       -  
                                         
Total contractual obligations
  $ 4,313,000     $ 548,000     $ 3,686,000     $ -     $ -  

Pursuant to a joint research and development laboratory agreement with Shanghai University, dated December 15, 2006 and expiring on December 15, 2016, we are committed to funding the establishment of laboratories and completion of research and development activities. On November 12, 2010, we amended the agreement with Shanghai University and extended the commitment from five years to eight years, and consequently the agreement will end on December 15, 2014. Based on the amendment, we committed to fund no less than RMB 30 million ($4.5 million) cumulatively across the eight years. The funding requirements are based on specific milestones agreed upon by Shanghai University and us. As of September 30, 2011, there are approximately $3.2 million remaining to be funded in full by December 15, 2014.

We intend to increase research and development spending as we grow our business. The payment to Shanghai University was to be used to fund program expenses and equipment purchase. Shanghai University needs to obtain the pre-approval from us before incurring expenditures on the program. If we fail to make pre-approved funding payments, when requested, we will be deemed to be in breach of the agreement. If we are unable to correct the breach within the requested time frame, Shanghai University could seek compensation up to an additional 15% of the total committed amount for approximately $0.7 million. As of September 30, 2011, we are not in breach as we have not received any additional compensation requests for pre-approved funding payment from Shanghai University.

On August 21, 2008, we entered into an equity purchase agreement in which we acquired two million shares of common stock of 21-Century Silicon for $1.0 million in cash. However, 21-Century Silicon’s production facilities and technical development were significantly below expected standards and was in a working capital deficit. Therefore, we considered the above findings as indicators that a significant adverse effect on the fair value of our investment in 21-Century Silicon had occurred. Accordingly, an impairment loss of $1.0 million was recorded to fully write-down the carrying amount of the investment as of September 30, 2010. See “Note 3 — Summary of Significant Accounting Policies – Investments” in the Notes to Consolidated Financial Statements of this Form 10-K.

On September 22, 2008, the registered capital of Solar EnerTech (Shanghai) Co., Ltd was increased from $25 million to $47.5 million, which was approved by our Board of Directors and authorized by Shanghai Municipal Government (the “Shanghai Government”). The paid-in capital as of September 30, 2011 was $32 million. The Board of Directors of the Company has decided not to fund the remaining balance of $15.5 million. On September 11, 2011, Solar EnerTech (Shanghai) Co., Ltd received approval from Shanghai Government to reduce the capital requirement to $32 million.

On January 15, 2010, we incorporated a wholly-owned subsidiary in Yizheng, Jiangsu Province of China to supplement our existing production facilities to meet increased sales demands.  The subsidiary was formed with a registered capital requirement of $33 million, of which $23.4 million was to be funded by October 16, 2011.  The Board of Directors of the Company has decided not to continue to fund the investment in the Yizheng Jiangsu Province subsidiary. We received the approval on December 22, 2011 to write-off the registration of the Yizheng Jiangsu Province subsidiary.

 
30

 

Critical Accounting Policies

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods.

Our management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex. We have identified the following accounting policies, described below, as the most important to an understanding of our current financial condition and results of operations.

Inventories

Inventories are stated at the lower of cost or market. Cost is determined by the weighted-average method. Market is defined principally as net realizable value. Raw material cost is based on purchase costs while work-in-progress and finished goods are comprised of direct materials, direct labor and an allocation of manufacturing overhead costs. Inventory in-transit is included in finished goods and consists of products shipped but not recognized as revenue because it does not meet the revenue recognition criteria. Provisions are made for excess, slow moving and obsolete inventory as well as inventory whose carrying value is in excess of net realizable value.

Impairment of Long Lived Assets

We review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. When such factors and circumstances exist, management compares the projected undiscounted future cash flows associated with the future use and disposal of the related asset or group of assets to their respective carrying values. Impairment, if any, is measured as the excess of the carrying value over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. No loss on property and equipment impairment was recorded during fiscal years ended September 30, 2011 and 2010.

Investment

Investment in an entity where we own less than twenty percent of the voting stock of the entity and do not exercise significant influence over operating and financial policies of the entity are accounted for using the cost method. Investment in the entity where we own twenty percent or more, but not in excess of fifty percent of the voting stock of the entity or less than twenty percent and exercises significant influence over operating and financial policies of the entity are accounted for using the equity method. We have a policy in place to review our investments at least annually and to evaluate the carrying value of the investments in these companies. The cost method investment is subject to impairment assessment if there are identified events or changes in circumstance that may have a significant adverse effect on the fair value of the investment. If we believe that the carrying value of an investment is in excess of estimated fair value, it is our policy to record an impairment charge to adjust the carrying value to the estimated fair value, if the impairment is considered other-than-temporary.

On August 21, 2008, we entered into an equity purchase agreement in which we acquired two million shares of common stock of 21-Century Silicon for $1.0 million in cash. See “Note 3 – Summary of Significant Accounting Policies – Investments” in the Notes to Consolidated Financial Statements of this Form 10-K.

Warranty Cost

We provide product warranties and accrue for estimated future warranty costs in the period in which revenue is recognized. Our standard solar modules are typically sold with a two-year warranty for defects in materials and workmanship and a ten-year and twenty five-year warranty against declines of more than 10.0% and 20.0%, respectively, of the initial minimum power generation capacity at the time of delivery. We therefore maintain warranty reserves to cover potential liabilities that could arise from our warranty obligations and accrue the estimated costs of warranties based primarily on management’s best estimate. In estimating warranty costs, we applied 460 – Guarantees, specifically paragraphs, 460-10-25-5 to 460-10-25-7 of the FASB Accounting Standards Codification. This guidance requires that we make a reasonable estimate of the amount of a warranty obligation. It also provides that in the case of an entity that has no experience of its own, reference to the experience of other entities in the same business may be appropriate. Because we began to commercialize our products in fiscal year 2007, there is insufficient experience and historical data that can be used to reasonably estimate the expected failure rate of our solar modules. Thus, we consider warranty cost provisions of other China-based manufacturers that produce photovoltaic products that are comparable in engineering design, raw material input and functionality to our products, and sold to a similar target and class of customer with similar warranty coverage. In determining whether such peer information can be used, we also consider the years of experience that these manufacturers have in the industry. Because our industry is relatively young as compared to other traditional manufacturing industries, the selected peer companies that we consider have less than ten years in manufacturing and selling history. In addition, they have a manufacturing base in China, offer photovoltaic products with comparable engineering design, raw material input, functionality and similar warranty coverage, and sell in markets, including the geographic areas and class of customer, where we compete.  Based on the analysis applied, we accrue warranty at 1% of sales. We have not experienced any material warranty claims to date in connection with declines of the power generation capacity of our solar modules and will prospectively revise the actual rate to the extent that actual warranty costs differ from the estimates. 
 
 
31

 

Income Taxes

We account for income taxes under the liability method per the provisions of FASB ASC 740, “Income Taxes”, formerly referenced as SFAS No. 109, “Accounting for Income Taxes”.

Under the provisions of FASB ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between their financial statement carrying values and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Valuation Allowance

Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust its valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.

Unrecognized Tax Benefits

Effective on October 1, 2007, we adopted the provisions related to uncertain tax positions under FASB ASC 740, “Income Taxes”, formerly referenced as FIN 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109”. Under FASB ASC 740, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority based solely on the technical merits of the associated tax position. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. We also elected the accounting policy that requires interest and penalties to be recognized as a component of tax expense. We classify the unrecognized tax benefits that are expected to result in payment or receipt of cash within one year as current liabilities, otherwise, the unrecognized tax benefits will be classified as non-current liabilities.

Fair Value of Warrants

Our management used the binomial valuation model to value the warrants issued in conjunction with convertible notes entered into in March 2007. The model uses inputs such as implied term, suboptimal exercise factor, volatility, dividend yield and risk free interest rate. Selection of these inputs involves management’s judgment and may impact estimated value. Management selected the binomial model to value these warrants as opposed to the Black-Scholes-Merton model primarily because management believes the binomial model produces a more reliable value for these instruments because it uses an additional valuation input factor, the suboptimal exercise factor, which accounts for expected holder exercise behavior which management believes is a reasonable assumption with respect to the holders of these warrants.

Stock-Based Compensation

On January 1, 2006, Solar EnerTech began recording compensation expense associated with stock options and other forms of employee equity compensation in accordance with FASB ASC 718, “Compensation – Stock Compensation”.

We estimate the fair value of stock options granted using the Black-Scholes-Merton option-pricing formula and a single option approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The following assumptions are used in the Black-Scholes-Merton option pricing model:

Expected Term — Our expected term represents the period that our stock-based awards are expected to be outstanding.

 
32

 

Expected Volatility — Our expected volatilities are based on historical volatility of our stock, adjusted where determined by management for unusual and non-representative stock price activity not expected to recur. Due to the limited trading history, we also considered volatility data of guidance companies.

Expected Dividend —The Black-Scholes-Merton valuation model calls for a single expected dividend yield as an input. We currently pay no dividends and do not expect to pay dividends in the foreseeable future.

Risk-Free Interest Rate— We base the risk-free interest rate on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term.

Estimated Forfeitures— When estimating forfeitures, we take into consideration the historical option forfeitures over the expected term.

Revenue Recognition

We recognize revenues from product sales in accordance with guidance in FASB ASC 605, “Revenue Recognition”, which states that revenue is realized or realizable and earned when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the price to the buyer is fixed or determinable; and collectability is reasonably assured. Where a revenue transaction does not meet any of these criteria it is deferred and recognized once all such criteria have been met. In instances where final acceptance of the product, system, or solution is specified by the customer, revenue is deferred until all acceptance criteria have been met.

On a transaction by transaction basis, the Company determines if the revenue should be recorded on a gross or net basis based on criteria discussed in the Revenue Recognition topic of the FASB Subtopic 605-405, “Reporting Revenue Gross as a Principal versus Net as an Agent”. The Company considers the following factors to determine the gross versus net presentation: if the Company (i) acts as principal in the transaction; (ii) takes title to the products; (iii) has risks and rewards of ownership, such as the risk of loss for collection, delivery or return; and (iv) acts as an agent or broker (including performing services, in substance, as an agent or broker) with compensation on a commission or fee basis.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are carried at net realizable value. We record our allowance for doubtful accounts based upon its assessment of various factors. We consider historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, and other factors that may affect customers’ ability to pay.

Recent Accounting Pronouncements

For recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated condensed financial statements, see “Note 3 – Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements included in this Form 10-K.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a Smaller Reporting Company as defined by Rule 12b-2 of the Exchange Act and in item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this Item 7A.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Item 15 (a) for an index to the Consolidated Financial Statements and Supplementary Financial Information, which are attached hereto and incorporated by reference herein.

 
33

 

Report of Independent Registered Public Accounting Firm
 
The Board of Directors and Shareholders of
Solar EnerTech Corp.

We have audited the accompanying consolidated balance sheet of Solar EnerTech Corp. (the Company) as of September 30, 2011, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive loss, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States of America). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Solar EnerTech Corp. as of September 30, 2011, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
 
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has an accumulated deficit and has suffered recurring losses from operations. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
/s/ Child, Van Wagoner & Bradshaw, PLLC
Salt Lake City, Utah
December 27, 2011

 
34

 
 
Report of Independent Registered Public Accounting Firm


The Board of Directors and Shareholders
Solar EnerTech Corp.


We have audited the accompanying consolidated balance sheets of Solar Enertech Corp. (the "Company") as of September 30, 2010 and 2009, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended September 30, 2010. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting.  Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Solar Enertech Corp. at September 30, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of the two years in the period ended September 30, 2010, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, the Company's recurring losses from operations raise substantial doubt about its ability to continue as a going concern. Management's plans as to these matters also are described in Note 2. The fiscal 2010 consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Ernst & Young Hua Ming
 Shanghai, Peoples Republic of China
 December 17, 2010
 
 
35

 
 
Solar EnerTech Corp.
Consolidated Balance Sheets
 
   
September 30,
 
   
2011
   
2010
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 1,324,000     $ 6,578,000  
Accounts receivable, net of allowance for doubtful accounts of
               
   $454,000 and $42,000 at September 30, 2011 and September 30, 2010, respectively
    7,715,000       6,546,000  
Advance payments and other
    703,000       1,274,000  
Inventories, net
    2,189,000       4,083,000  
VAT receivable
    535,000       870,000  
Other receivable
    807,000       690,000  
Total current assets
    13,273,000       20,041,000  
Property and equipment, net
    8,523,000       8,874,000  
Other assets
    -       735,000  
Deposits
    81,000       102,000  
Total assets
  $ 21,877,000     $ 29,752,000  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
 
               
Accounts payable
  $ 7,035,000     $ 7,895,000  
Customer advance payment
    1,599,000       2,032,000  
Accrued expenses
    2,023,000       2,596,000  
Accounts payable and accrued liabilities, related parties
    -       5,817,000  
Short-term loans
    273,000       1,312,000  
Convertible notes, net of discount
    1,474,000       -  
Derivative liabilities
    3,000       -  
Total current liabilities
    12,407,000       19,652,000  
Convertible notes, net of discount
    -       1,531,000  
Derivative liabilities
    -       422,000  
Warrant liabilities
    -       902,000  
Total liabilities
    12,407,000       22,507,000  
                 
STOCKHOLDERS' EQUITY:
               
Common stock - 400,000,000 shares authorized at $0.001 par value, 181,495,962
               
   and 170,338,954 shares issued and outstanding at September 30, 2011 and
               
   September 30, 2010, respectively
    181,000       170,000  
Additional paid in capital
    100,422,000       97,656,000  
Accumulated other comprehensive income
    3,893,000       2,755,000  
Accumulated deficit
    (95,026,000 )     (93,336,000 )
Total stockholders' equity
    9,470,000       7,245,000  
Total liabilities and stockholders' equity
  $ 21,877,000     $ 29,752,000  
 
The accompanying notes are an integral part of these consolidated financial statements.

 
36

 

Solar EnerTech Corp.
Consolidated Statements of Operations

   
Year Ended September 30,
 
   
2011
   
2010
 
             
             
Sales
  $ 42,694,000     $ 70,029,000  
Cost of sales
    (43,720,000 )     (64,820,000 )
     Gross profit (loss)
    (1,026,000 )     5,209,000  
                 
Operating expenses:
               
Selling, general and administrative
    6,813,000       9,565,000  
Research and development
    361,000       347,000  
Loss on debt extinguishment
    -       18,540,000  
Reversal of payroll related tax accrual
    (5,817,000 )     -  
   Total operating expenses
    1,357,000       28,452,000  
                 
   Operating loss
    (2,383,000 )     (23,243,000 )
                 
Other income (expense):
               
Interest income
    5,000       7,000  
Interest expense
    (304,000 )     (5,446,000 )
Gain on change in fair market value of compound embedded derivative
    393,000       1,235,000  
Gain on change in fair market value of warrant liability
    902,000       4,511,000  
Impairment loss on investment
    -       (1,000,000 )
Other expense
    (302,000 )     (1,078,000 )
Loss before income tax expense
    (1,689,000 )     (25,014,000 )
Income tax expense
    (1,000 )     -  
   Net loss
  $ (1,690,000 )   $ (25,014,000 )
                 
                 
Net loss per share - basic
    (0.01 )   $ (0.18 )
Net loss per share - diluted
  $ (0.01 )   $ (0.18 )
                 
Weighted average shares outstanding - basic
    162,633,557       135,557,265  
Weighted average shares outstanding - diluted
    162,633,557       135,557,265  

The accompanying notes are an integral part of these consolidated financial statements.

 
37

 

Solar EnerTech Corp.
Consolidated Statements of Stockholders’ Equity
 
   
Common Stock
   
Additional
Paid-
   
Accumulated
Other Comprehensive
   
Accumulated
   
Total
Stockholders'
   
Total Comprehensive
 
   
Number
   
Amount
    In Capital     Income     Deficit     Equity     Loss  
                                           
Balance at September 30, 2009
    111,406,696     $ 111,000     $ 75,389,000     $ 2,456,000     $ (68,322,000 )   $ 9,634,000     $ (65,866,000 )
Stock-based compensation
    -       -       2,705,000       -       -       2,705,000       -  
Issuance of common stock to Board of Director and non-employees
    800,000       1,000       211,000       -       -       212,000       -  
Issuance of stock for warrants
    450,878       -       157,000       -       -       157,000       -  
Issuance of stock for convertible notes
    67,681,380       68,000       19,184,000       -       -       19,252,000       -  
Cancellation of unvested restricted stock
    (10,000,000 )     (10,000 )     10,000       -       -       -       -  
Currency translation adjustment
    -       -       -       299,000       -       299,000       299,000  
Net loss for the year ended September 30, 2010
    -       -       -       -       (25,014,000 )     (25,014,000 )     (25,014,000 )
Balance at September 30, 2010
    170,338,954     $ 170,000     $ 97,656,000     $ 2,755,000     $ (93,336,000 )   $ 7,245,000     $ (90,581,000 )
Stock-based compensation
    -       -       2,442,000       -       -       2,442,000       -  
Issuance of stock for convertible notes
    2,812,008       2,000       324,000       -       -       326,000       -  
Restricted Shares Granted
    8,600,000       9,000                               9,000       -  
Cancellation of unvested restricted stock
    (255,000 )     -       -       -       -       -       -  
Currency translation adjustment
    -       -       -       1,138,000       -       1,138,000       1,138,000  
Net loss for the year ended September 30, 2011
    -       -       -       -       (1,690,000 )     (1,690,000 )     (1,690,000 )
Balance at September 30, 2011
    181,495,962     $ 181,000     $ 100,422,000     $ 3,893,000     $ (95,026,000 )   $ 9,470,000     $ (91,133,000 )
 
The accompanying notes are an integral part of these consolidated financial statements.

 
38

 
 
Solar EnerTech Corp.
Consolidated Statements of Cash Flows
 
   
Year Ended September 30,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net loss
  $ (1,690,000 )   $ (25,014,000 )
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
               
Depreciation of property and equipment
    2,553,000       2,408,000  
Loss (gain) on disposal of property and equipment
    (5,000 )     51,000  
Stock-based compensation
    2,442,000       2,916,000  
Accounts payable and accrued liabilities, related parties
    (5,817,000 )     171,000  
Amortization of other assets
    768,000       11,000  
Loss on debt extinguishment
    -       18,540,000  
Impairment loss on investment
    -       1,000,000  
Payment of interest by issuance of shares
    126,000       237,000  
Amortization of note discount and deferred financing cost
    126,000       5,177,000  
Gain on change in fair market value of compound embedded derivative
    (393,000 )     (1,235,000 )
Gain on change in fair market value of warrant liability
    (902,000 )     (4,511,000 )
Changes in operating assets and liabilities:
               
Accounts receivable, net
    (760,000 )     1,057,000  
Advance payments and other
    634,000       (54,000 )
Inventories, net
    2,104,000       2,000  
VAT receivable
    371,000       (523,000 )
Other receivable
    (98,000 )     (263,000 )
Accounts payable, accrued liabilities and customer advance payment
    (2,438,000 )     4,320,000  
Deposits
    -       (13,000 )
Net cash provided by (used in) operating activities
    (2,979,000 )     4,277,000  
                 
Cash flows from investing activities:
               
Acquisition of property and equipment
    (1,766,000 )     (779,000 )
Proceeds from sales of property and equipment
    38,000       9,000  
Net cash used in investing activities
    (1,728,000 )     (770,000 )
                 
Cash flows from financing activities:
               
Borrowing under short-term loans
    5,317,000       2,842,000  
Short-term loans repayment
    (6,357,000 )     (1,530,000 )
Net cash provided by (used in) financing activities
    (1,040,000 )     1,312,000  
                 
Effect of exchange rate on cash and cash equivalents
    493,000       40,000  
Net increase (decrease) in cash and cash equivalents
    (5,254,000 )     4,859,000  
Cash and cash equivalents, beginning of period
    6,578,000       1,719,000  
Cash and cash equivalents, end of period
  $ 1,324,000     $ 6,578,000  
                 
Cash paid:
               
Interest
  $ 78,000     $ 7,000  
Supplemental disclosure of non-cash activities:
               
Extinguishment of convertible notes by issuance of common stock
  $ (200,000 )   $ (5,779,000 )
Extinguishment of convertible notes by issuance of Series B-1 Note
    -       (1,815,000 )
Issuance of Series B-1 Note
    -       1,535,000  
Acquisition of other assets
    -       746,000  

The accompanying notes are an integral part of these consolidated financial statements

 
39

 

SOLAR ENERTECH CORP.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011

NOTE 1 — ORGANIZATION AND NATURE OF OPERATIONS

Solar EnerTech Corp. was originally incorporated under the laws of the State of Nevada on July 7, 2004 as Safer Residence Corporation and was reincorporated to the State of Delaware on August 13, 2008 (“Solar EnerTech” or the “Company”).  The Company engaged in a variety of businesses until March 2006, when the Company began its current operations as a photovoltaic (“PV”) solar energy cell (“PV Cell”) manufacturer. The Company’s management decided that, to facilitate a change in business that was focused on the PV Cell industry, it was appropriate to change the Company’s name. A plan of merger between Safer Residence Corporation and Solar EnerTech Corp., a wholly-owned inactive subsidiary of Safer Residence Corporation, was approved on March 27, 2006, under which the Company was to be renamed “Solar EnerTech Corp.” On April 7, 2006, the Company changed its name to Solar EnerTech Corp.  On August 13, 2008, the Company reincorporated to the State of Delaware.

The Company conducts a substantial part of its operations under a wholly-owned subsidiary in Shanghai, China named Solar EnerTech (Shanghai) Co., Ltd.

On April 27, 2009, the Company entered into a Joint Venture Agreement with Jiangsu Shunda Semiconductor Development Co., Ltd. to form a joint venture in the United States by forming a new company, to be known as Shunda-SolarE Technologies, Inc., in order to jointly pursue opportunities in the United States solar market. The Agreement was valid for 18 months and expired on October 27, 2010. After its formation, the joint venture company’s name was later changed to SET-Solar Corp. Since the agreement expired on October 27, 2010, SET-Solar Corp. became an independent company and transactions with SET-Solar Corp after that date are not considered as related party transactions.

On January 15, 2010, the Company incorporated a wholly-owned subsidiary in Yizheng, Jiangsu Province of China to supplement its existing production facilities to meet increased sales demands.  On February 8, 2010, the Company acquired land use rights of a 68,025 square meter parcel of land located in Yizheng, Jiangsu Province of China, which was to be used to house the Company’s second manufacturing facility. The Board of Directors of the Company has decided not to continue to fund the investment in the Yizheng Jiangsu Province subsidiary. The Company received the approval on December 22, 2011 to write-off the registration of the Yizheng Jiangsu Province subsidiary.

NOTE 2 — GOING CONCERN
 
The Company has incurred significant net losses during each period from inception through September 30, 2011 and has an accumulated deficit of approximately $95.0 million at September 30, 2011. The conditions described raise substantial doubt about the Company’s ability to continue as a going concern. The Company’s consolidated financial statements have been prepared on the assumption that it will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business.

While the Company believes in the viability of its strategy to increase sales volume and in its ability to raise additional funds, there can be no assurances to that effect.  The ability of the Company to continue as a going concern is dependent upon the Company’s ability to further implement its business plan and generate sufficient revenues.
 
During 2011, the Company intends to raise financing for the purpose of funding operating expenses and working capital. In addition, the Company engaged in various cost cutting programs and renegotiated most of the contacts to reduce operating expenses.  However, there can be no assurance that the raising of future equity will be successful and that the Company’s anticipated financing will be available in the future, at terms satisfactory to the Company. Failure to achieve the equity and financing at satisfactory terms and amounts could have a material adverse effect on the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
 
40

 

NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation and Basis of Accounting

Prior to August 19, 2008, the Company operated its business in the People’s Republic of China through Solar EnerTech (HK) Corporation, Limited (“Solar EnerTech HK”) and Solar EnerTech (Shanghai) Co., Ltd (“Infotech Shanghai” and together with Solar EnerTech HK, “Infotech”). While the Company did not own Infotech, the Company’s financial statements have included the results of the financials of each of Solar EnerTech HK and Infotech Shanghai since these entities were wholly-controlled variable interest entities of the Company through an Agency Agreement dated April 10, 2006 by and between the Company and Infotech (the “Agency Agreement”). Under the Agency Agreement the Company engaged Infotech to undertake all activities necessary to build a solar technology business in China, including the acquisition of manufacturing facilities and equipment, employees and inventory. The Agency Agreement continued through April 10, 2008 and then on a month to month basis thereafter until terminated by either party.

To permanently consolidate Infotech with the Company through legal ownership, the Company acquired Infotech at a nominal amount on August 19, 2008 through a series of agreements. In connection with executing these agreements, the Company terminated the original agency relationship with Infotech.

The Company had previously consolidated the financial statements of Infotech with its financial statements pursuant to FASB ASC 810-10 “Consolidations”, formerly referenced as FASB Interpretation No. 46(R),  due to the agency relationship between the Company and Infotech and, notwithstanding the termination of the Agency Agreement, the Company continues to consolidate the financial statements of Infotech with its financial statements since Infotech became a wholly-owned subsidiary of the Company as a result of the acquisition.
 
The Company’s consolidated financial statements include the accounts of Solar EnerTech Corp. and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. These consolidated financial statements have been prepared in U.S. dollars and in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”).

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents
 
Cash and cash equivalents are defined as cash on hand, demand deposits and short-term, highly liquid investments that are readily convertible to known amounts of cash within ninety days of deposit.

Currency and Foreign Exchange
 
The Company’s functional currency is the Renminbi as substantially all of the Company’s operations are in China. The Company’s reporting currency is the U.S. dollar.

Transactions and balances originally denominated in U.S. dollars are presented at their original amounts. Transactions and balances in other currencies are converted into U.S. dollars in accordance with FASB ASC 830, “Foreign Currency Matters,” formerly referenced as SFAS No. 52,   “Foreign Currency Translation”, and are included in determining net income or loss.

For foreign operations with the local currency as the functional currency, assets and liabilities are translated from the local currencies into U.S. dollars at the exchange rate prevailing at the balance sheet date. Revenues and expenses are translated at weighted average exchange rates for the period to approximate translation at the exchange rates prevailing at the dates those elements are recognized in the consolidated financial statements. Translation adjustments resulting from the process of translating the local currency consolidated financial statements into U.S. dollars are included in determining comprehensive loss.

Property and Equipment

The Company’s property and equipment are stated at cost net of accumulated depreciation. Depreciation is provided using the straight-line method over the related estimated useful lives, as follows:

   
Useful Life (Years)
Office equipment
 
3 to 5
Machinery
 
10
Production equipment
 
5
Automobiles
 
5
Furniture
 
5
Leasehold improvement
 
the shorter of the lease term or  5 years

 
41

 

Expenditures for maintenance and repairs that do not improve or extend the lives of the related assets are expensed to operations. Major repairs that improve or extend the lives of the related assets are capitalized.

Inventories

Inventories are stated at the lower of cost or market. Cost is determined by the weighted-average method. Market is defined principally as net realizable value. Raw material cost is based on purchase costs while work-in-progress and finished goods are comprised of direct materials, direct labor and an allocation of manufacturing overhead costs. Inventory in-transit is included in finished goods and consists of products shipped but not recognized as revenue because it does not meet the revenue recognition criteria. Provisions are made for excess, slow moving and obsolete inventory as well as inventory whose carrying value is in excess of net realizable value.

Warranty Cost

The Company provides product warranties and accrues for estimated future warranty costs in the period in which revenue is recognized. The Company’s standard solar modules are typically sold with a two-year warranty for defects in materials and workmanship and a ten-year and twenty five-year warranty against declines of more than 10.0% and 20.0%, respectively, of the initial minimum power generation capacity at the time of delivery. The Company therefore maintains warranty reserves to cover potential liabilities that could arise from its warranty obligations and accrues the estimated costs of warranties based primarily on management’s best estimate. In estimating warranty costs, the Company applied Accounting Standards Codification Topic 460 (“ASC 460”) – Guarantees, specifically paragraphs 460-10-25-5 to 460-10-25-7 of the FASB Accounting Standards Codification. This guidance requires that the Company make a reasonable estimate of the amount of a warranty obligation. It also provides that in the case of an entity that has no experience of its own, reference to the experience of other entities in the same business may be appropriate. Because the Company began to commercialize its products in fiscal year 2007, there is insufficient experience and historical data that can be used to reasonably estimate the expected failure rate of its solar modules. Thus, the Company considers warranty cost provisions of other China-based manufacturers that produce photovoltaic products that are comparable in engineering design, raw material input and functionality to the Company’s products, and sold to a similar target and class of customer with similar warranty coverage. In determining whether such peer information can be used, the Company also considers the years of experience that these manufacturers have in the industry. Because the Company’s industry is relatively young as compared to other traditional manufacturing industries, the selected peer companies that the Company considers have less than ten years in manufacturing and selling history. In addition, they have a manufacturing base in China, offer photovoltaic products with comparable engineering design, raw material input, functionality and similar warranty coverage, and sell in markets, including the geographic areas and class of customer, where the Company competes. Based on the analysis applied, the Company accrues warranty at 1% of sales. The Company has not experienced any material warranty claims to date in connection with declines of the power generation capacity of its solar modules and will prospectively revise its actual rate to the extent that actual warranty costs differ from the estimates. As of September 30, 2011 and 2010, the Company’s warranty liability was $1,532,000 and $1,125,000, respectively. The Company’s warranty costs for the fiscal years ended September 30, 2011 and 2010 were $407,000 and $595,000, respectively. The Company did not make any warranty payments during the fiscal years ended September 30, 2011 and 2010.

Other Assets

The Company acquired land use rights to a parcel of land from the government in the People’s Republic of China (“PRC”). All land in the PRC is owned by the PRC government and cannot be sold to any individual or entity. The government in the PRC, according to relevant PRC law, may sell the right to use the land for a specified period of time. Thus, the Company’s land purchase in the PRC is considered to be leased land and recorded as other assets at cost less accumulated amortization. Amortization is provided over the term of the land use right agreements on a straight-line basis, which is for 46.5 years from February 8, 2010 through August 31, 2056.

Impairment of Long Lived Assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. When such factors and circumstances exist, management compares the projected undiscounted future cash flows associated with the future use and disposal of the related asset or group of assets to their respective carrying values. Impairment, if any, is measured as the excess of the carrying value over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. No loss on property and equipment impairment was recorded during the fiscal years ended September 30, 2011 and 2010.

Investments

Investments in an entity where the Company owns less than twenty percent of the voting stock of the entity and does not exercise significant influence over operating and financial policies of the entity are accounted for using the cost method. Investments in the entity where the Company owns twenty percent or more but not in excess of fifty percent of the voting stock of the entity or less than twenty percent and exercises significant influence over operating and financial policies of the entity are accounted for using the equity method. The Company has a policy in place to review its investments at least annually, to evaluate the carrying value of the investments in these companies. The cost method investment is subject to impairment assessment if there are identified events or changes in circumstance that may have a significant adverse affect on the fair value of the investment. If the Company believes that the carrying value of an investment is in excess of estimated fair value, it is the Company’s policy to record an impairment charge to adjust the carrying value to the estimated fair value, if the impairment is considered other-than-temporary.

 
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On August 21, 2008, the Company entered into an equity purchase agreement in which it acquired two million shares of common stock of 21-Century Silicon, Inc., a polysilicon manufacturer based in Dallas, Texas (“21-Century Silicon”), for $1.0 million in cash. The two million shares of common stock represented approximately 7.8% of 21-Century Silicon’s outstanding equity. In connection with the equity purchase agreement, the Company also signed a memorandum of understanding with 21-Century Silicon for a four-year supply framework agreement for polysilicon shipments.  The first polysilicon shipment from 21-Century Silicon was initially expected in March 2009, but was subsequently delayed to March 2010. On March 5, 2009, the Emerging Technology Fund, created by the State of Texas, invested $3.5 million in 21-Century Silicon to expedite production and commercialization of research. The Company’s ownership of 21-Century Silicon became 5.5% as a result of the dilution. This first polysilicon shipment that was to be delivered in March 2010 was further delayed without a specified date given by 21-Century Silicon. As a result of the continued delays in shipment, in July 2010, members of the Company’s executive team, including the CEO, visited 21-Century Silicon and conducted reviews of the production facility and technical development.  The review indicated that 21-Century Silicon’s production facility and technical development were significantly below expected standards. Based on the findings from this visit, the timing of the first polysilicon shipment is unknown and it is unknown whether it will even occur. In addition, management of 21-Century Silicon expressed the need for more funding to sustain operations. Moreover, 21-Century Silicon could not provide the Company with updated financial information concerning 21-Century Silicon’s working capital condition and future cash flows.  The Company considered the above findings were indicators that a significant adverse effect on the fair value of the Company’s investment in 21-Century Silicon had occurred. Accordingly, an impairment loss of $1.0 million was recorded in the Consolidated Statements of Operations for the fiscal year ended September 30, 2010 to fully write-down the carrying amount of the investment. The Company may also be obligated to acquire an additional two million shares of 21-Century Silicon upon the first polysilicon shipment meeting the quality specifications determined solely by the Company. As of September 30, 2011, the Company has not yet acquired the additional two million common shares (at $0.50 per share) as the product shipment has not occurred.  On October 7, 2010, the X-Change Corporation announced that it has acquired 21-Century Silicon, Inc. The terms of the acquisition are anticipated to involve a change in control of the 21-Century Silicon and the appointment of new directors. The X-Change Corporation is anticipated to issue 20 million shares of its unregistered, restricted common stock to the shareholders of 21-Century Silicon in exchange for 100% of the issued and outstanding stock of 21-Century Silicon. As of the date of this report, the X-Change Corporation has not issued its shares to the Company.

Income Taxes

The Company accounts for income taxes under the liability method per the provisions of Accounting Standards Codification Topic 740 (“ASC 740”), “Income Taxes”.

Under the provisions of ASC 740, deferred tax assets and liabilities are determined based on the differences between their financial statement carrying values and their respective tax bases using enacted tax rates that will be in effect in the period in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
 
Valuation Allowance

Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, the Company considers all available evidence including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. In the event that the Company changes its determination as to the amount of deferred tax assets that can be realized, the Company will adjust its valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.
 
Unrecognized Tax Benefits
 
Effective on October 1, 2007, the Company adopted the provisions related to uncertain tax positions under ASC 740, “Income Taxes”, formerly referenced as FIN 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109”.  Under ASC 740, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority based on the technical merits of the associated tax position.  An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. The Company also elected the accounting policy that requires interest and penalties to be recognized as a component of tax expense. The Company classifies the unrecognized tax benefits that are expected to be effectively settled within one year as current liabilities, otherwise, the unrecognized tax benefits will be classified as non-current liabilities.

 
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Fair Value of Warrants

The Company’s management used the binomial valuation model to value the warrants issued in conjunction with convertible notes entered into in March 2007. The model uses inputs such as implied term, suboptimal exercise factor, volatility, dividend yield and risk free interest rate. Selection of these inputs involves management’s judgment and may impact estimated value. Management selected the binomial model to value these warrants as opposed to the Black-Scholes-Merton model primarily because management believes the binomial model produces a more reliable value for these instruments because it uses an additional valuation input factor, the suboptimal exercise factor, which accounts for expected holder exercise behavior which management believes is a reasonable assumption with respect to the holders of these warrants.

Stock-Based Compensation

On January 1, 2006, Solar EnerTech began recording compensation expense associated with stock options and other forms of employee equity compensation in accordance with FASB ASC 718, “Compensation – Stock Compensation”, formerly referenced as SFAS 123R, “Share-Based Payment”.
  
The Company estimates the fair value of stock options granted using the Black-Scholes-Merton option-pricing formula and a single option approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The following assumptions are used in the Black-Scholes-Merton option pricing model:

Expected Term — The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding.

Expected Volatility — The Company’s expected volatilities are based on historical volatility of the Company’s stock, adjusted where determined by management for unusual and non-representative stock price activity not expected to recur. Due to the limited trading history, the Company also considered volatility data of guidance companies.

Expected Dividend — The Black-Scholes-Merton valuation model calls for a single expected dividend yield as an input. The Company currently pays no dividends and does not expect to pay dividends in the foreseeable future.

Risk-Free Interest Rate — The Company bases the risk-free interest rate on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term.

Estimated Forfeitures — When estimating forfeitures, the Company takes into consideration the historical option forfeitures over the expected term.

Revenue Recognition

The Company recognizes revenues from product sales in accordance with guidance provided in FASB ASC 605, “Revenue Recognition”, which states that revenue is realized or realizable and earned when all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the price to the buyer is fixed or determinable; and collectability is reasonably assured. Where a revenue transaction does not meet any of these criteria it is deferred and recognized once all such criteria have been met. In instances where final acceptance of the product, system, or solution is specified by the customer, revenue is deferred until all acceptance criteria have been met.

On a transaction by transaction basis, the Company determines if the revenue should be recorded on a gross or net basis based on criteria discussed in the Revenue Recognition topic of the FASB Subtopic 605-405, “Reporting Revenue Gross as a Principal versus Net as an Agent”. The Company considers the following factors to determine the gross versus net presentation: if the Company (i) acts as principal in the transaction; (ii) takes title to the products; (iii) has risks and rewards of ownership, such as the risk of loss for collection, delivery or return; and (iv) acts as an agent or broker (including performing services, in substance, as an agent or broker) with compensation on a commission or fee basis.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are carried at net realizable value. The Company records allowance for doubtful accounts based upon its assessment of various factors. The Company considers historical experience, the age of the accounts receivable balances, credit quality of our customers, current economic conditions, and other factors that may affect customers’ ability to pay.

 
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Shipping and Handling Costs

The Company incurred shipping and handling costs of $448,000 and $1,761,000 for the fiscal years ended September 30, 2011 and 2010, respectively, which are included in selling expenses. Shipping and handling costs include costs incurred with third-party carriers to transport products to customers.

Research and Development Cost

Expenditures for research activities relating to product development are charged to expense as incurred. Research and development cost for the fiscal years ended September 30, 2011 and 2010 were $361,000 and $347,000, respectively.

Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity of the Company during a period from transactions and other events and circumstances excluding transactions resulting from investments by owners and distributions to owners.  Comprehensive income (loss) is reported in the consolidated statements of shareholder’s equity.  Accumulated other comprehensive income (loss) of the Company consists of cumulative foreign currency translation adjustments.

Segment Information

The Company identifies its operating segments based on its business activities. The Company operates within a single operating segment - the manufacture of solar energy cells and modules in China. The Company’s manufacturing operations and fixed assets are all based in China. The solar energy cells and modules are distributed to customers, located in Europe, Australia, North America and China.

During the fiscal years ended September 30, 2011 and 2010, the Company had three and two customers, respectively that accounted for more than 10% of net sales.

Recent Accounting Pronouncements

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820) (“ASU 2011-04”). The amendments to this update provide a uniform framework for applying the principles of fair value measurement and include (i) amendments that clarify the Board’s intent about the application of existing fair value measurement and disclosure requirements and (ii) amendments that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. These amendments do not require additional fair value measurements. The Company will adopt ASU 2011-04 in the second quarter of fiscal year 2012. The Company does not believe the adoption of ASU 2011-04 will have a material impact on the Company’s consolidated financial statements.
 
In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2001-05 amends Topic 220, “Comprehensive Income”, to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income, nor does it change the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects. This ASU is effective for the Company’s financial statements for annual and interim periods beginning on or after December 15, 2011, and must be applied retrospectively. The Company will adopt ASU 2011-05 in the first quarter of fiscal year 2012. The adoption of ASU 2011-05 is not expected to have a material impact on the Company’s consolidated financial statements.

NOTE 4 — FINANCIAL INSTRUMENTS

The Company’s assets that are potentially subject to significant concentration of credit risk are primarily cash and cash equivalents, advance payments to suppliers and accounts receivable.

The Company maintains cash deposits with financial institutions, which from time to time may exceed federally insured limits. The Company has not experienced any losses in connection with these deposits and believes it is not exposed to any significant credit risk from cash. At September 30, 2011 and 2010, the Company had approximately $82,000 and $82,000, respectively in excess of insured limits.

Other financial instruments that potentially subject the Company to concentration of credit risk consist principally of accounts receivable.  Concentrations of credit risk with respect to accounts receivable are limited because a number of geographically diverse customers make up the Company’s customer base, thus spreading the trade credit risk.  The Company controls credit risk through credit approvals, credit limits and monitoring procedures.  The Company performs credit evaluations for all new customers but generally does not require collateral to support customer receivables. All of the Company’s customers have gone through a very strict credit approval process. The Company diligently monitors the customers’ financial position. Payment terms for our solar module sales generally range from 0 to 60 days. In some cases, these terms are extended up to 200 days for certain qualifying customers of whom the Company applied rigorous credit requirements. The Company has also purchased insurance from the China Export & Credit Insurance Company to insure the collectability of the outstanding accounts receivable balances of a key customer. During the fiscal years ended September 30, 2011 and 2010, the Company had three and two customers, respectively that accounted for more than 10% of net sales.

 
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Foreign exchange risk and translation

The Company may be subject to significant currency risk due to the fluctuations of exchange rates between the Chinese Renminbi, Euro and the United States dollar.

The local currency is the functional currency for the China subsidiary.  Assets and liabilities are translated at end of period exchange rates while revenues and expenses are translated at the average exchange rates in effect during the period.  Equity is translated at historical rates and the resulting cumulative translation adjustments, to the extent not included in net income, are included as a component of accumulated other comprehensive income (loss) until the translation adjustments are realized. Included in accumulated other comprehensive income was foreign currency translation adjustment gains of $1.1 million and $0.3 million for the fiscal years ended September 30, 2011 and 2010, respectively.   Foreign currency transaction gains and losses are included in earnings. For the fiscal years ended September 30, 2011 and 2010, the Company recorded foreign exchange losses of $0.3 million and $1.1 million, respectively.

NOTE 5 — ACCOUNTS RECEIVABLE, NET OF ALLOWANCE FOR DOUBTFUL ACCOUNTS

At September 30, 2011 and 2010, the accounts receivable, net of allowance for doubtful accounts consists of:

   
September 30, 2011
   
September 30, 2010
 
Accounts receivable, gross
  $ 8,170,000     $ 6,588,000  
Allowance for doubtful accounts
    (454,000 )     (42,000 )
Accounts receivable, net
  $ 7,716,000     $ 6,546,000  

The following table summarizes the activities of the allowance for doubtful accounts as of September 30, 2011 and 2010:

   
Allowance for doubtful
accounts
 
As of September 30, 2009
  $ 117,000  
Addition
    -  
Write-down
    (75,000 )
As of September 30, 2010
  $ 42,000  
Addition
    432,000  
Write-down
    (20,000 )
As of September 30, 2011
  $ 454,000  

NOTE 6 — ADVANCE PAYMENTS AND OTHER

At September 30, 2011 and 2010, advance payments and other consist of:

   
September 30, 2011
   
September 30, 2010
 
Prepayment for raw materials
  $ 310,000     $ 673,000  
Prepayment for equipment
    -       402,000  
Others
    393,000       199,000  
Total advance payments and other
  $ 703,000     $ 1,274,000  

 
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NOTE 7 — INVENTORIES

At September 30, 2011 and 2010, inventories consist of:

   
September 30, 2011
   
September 30, 2010
 
Raw materials
  $ 1,268,000     $ 2,667,000  
Finished goods
    2,415,000       1,618,000  
Inventories, gross
  $ 3,683,000     $ 4,285,000  
Inventory Provision
    (1,494,000 )     (202,000 )
Inventories, net
  $ 2,189,000     $ 4,083,000  

The inventory provision is an inventory allowance for aged or obsolete inventory items as well as inventory whose carrying value is in excess of net realizable value.

NOTE 8 — PROPERTY AND EQUIPMENT

The Company depreciates its assets over their estimated useful lives. A summary of property and equipment at September 30, 2011 and 2010 is as follows:

   
September 30, 2011
   
September 30, 2010
 
Production equipment
  $ 9,782,000     $ 8,130,000  
Leasehold improvements
    3,950,000       3,709,000  
Automobiles
    318,000       366,000  
Office equipment
    411,000       348,000  
Machinery
    3,121,000       2,916,000  
Furniture
    71,000       40,000  
Total property and equipment
    17,653,000       15,509,000  
Less:  accumulated depreciation
    (9,130,000 )     (6,635,000 )
Total property and equipment, net
  $ 8,523,000     $ 8,874,000  
 
NOTE 9 — OTHER ASSETS

Other assets at September 30, 2011 and 2010 mainly consist of the following:

   
September 30, 2011
   
September 30, 2010
 
             
Land use rights
           
Cost
  $ -     $ 746,000  
Less: Accumulated amortization
    -       (11,000 )
Total other assets
  $ -     $ 735,000  
 
On February 8, 2010, the Company acquired land use rights of a 68,025 square meter parcel of land located in Yizheng, Jiangsu Province of China, which was to be used to house the Company’s second manufacturing facility. For each of the next five years, annual amortization expense of the land use rights will be approximately $17,000 with an estimated useful life of 46.5 years.

As part of the acquisition of the land use right, we are required to complete construction of the facility by February 8, 2012. The Board of Directors of the Company has decided not to continue to fund the investment in the Yizheng Jiangsu Province subsidiary. The Company received the approval on December 22, 2011 to write-off the registration of the Yizheng Jiangsu Province subsidiary.

In September 2011, the Company wrote off the land use rights and received a partial refund. The remaining refund of approximately $31,000 is estimated to be received in January 2012.

 
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NOTE 10 — SHORT TERM LOANS

At September 30, 2011 and 2010, short-term loans consist of:

   
September 30, 2011
   
September 30, 2010
 
             
Short-term loans
  $ 273,000     $ 1,312,000  
 
On March 25, 2010, the Company entered into a one year contract with China Export & Credit Insurance Corporation (“CECIC”) to insure the collectability of outstanding accounts receivable for two of the Company’s key customers. The Company pays a fee based on a fixed percentage of the accounts receivable outstanding and expenses this fee when it is incurred. In addition, on March 30, 2010, the Company entered into a one year revolving credit facility arrangement with Industrial Bank Co., Ltd. (“IBC”) that was secured by the accounts receivable balances of the two key customers insured by CECIC above. The cost of the insurance on accounts receivable is recorded as selling, general and administrative costs in the Consolidated Statements of Operations of the Company. On May 5, 2011, the Company terminated the credit facility arrangement with IBC and on the same day, the Company entered into a revolving credit facility arrangement with Bank of China (“BOC”), which is also secured by the accounts receivable balances of our key customers insured by CECIC above.

If the insured customer fails to repay the amounts outstanding due to the Company, the insurance proceeds will be remitted directly to BOC instead of the Company.  The amount drawn down as of September 30, 2011 was $273,000. The Company paid the short term loan of $273,000 to BOC on October 9, 2011. There have been no insurance claims submitted to CECIC. There are no commitment fees associated with the unused portion of the credit facility. The interest rate of the credit facility is variable and ranged from 3.78% to 5.30% during the fiscal year ended September 30, 2011. The weighted average interest rate on this credit facility during the fiscal year ended September 30, 2011 was 4.42% per annum.  

NOTE 11 — INCOME TAXES

The Company has no taxable income and no provision for federal and state income taxes is required for 2011 and 2010, except certain state minimum tax.

Accounting income (loss) before income taxes consists of:

   
Year Ended September 30,
 
   
2011
   
2010
 
             
United States
  $ 3,781,000       (23,280,000 )
The PRC
    (5,470,000 )     (1,734,000 )
Total
    (1,689,000 )     (25,014,000 )
 
The Company conducts its business in the United States and in various foreign locations and generally is subject to the respective local countries’ statutory tax rates.

 
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A reconciliation of the statutory federal rate and the Company’s effective tax rate for the fiscal years ended September 30, 2011 and 2010 are as follows:

   
Year Ended September 30,
 
   
2011
   
2010
 
U.S. federal taxes (benefit)
           
At statutory rate
    34 %     34 %
Gain (loss) on derivative/warrant and other permanents
    41 %     (24 )%
Stock-based compensation
    (50 )%     (4 )%
Difference between statutory rate and foreign effective rate
    (58 )%     (4 )%
Change in Valuation allowance
    39 %     (4 )%
Deferred tax expenses
    (6 )%     2 %
Total
    0 %     0 %
 
Significant components of the Company’s deferred tax assets and liabilities as of September 30, 2011 and 2010 are as follows:
 
   
Year Ended September 30,
 
   
2011
   
2010
 
Deferred tax assets:
           
Net operating loss carryforwards
  $ 5,475,000     $ 4,978,000  
Stock-based compensation
    798,000       565,000  
Allowances and reserve
    1,967,000       3,272,000  
Depreciation and amortization
    223,000       281,000  
Total deferred tax assets
    8,463,000       9,096,000  
Less valuation allowance
    (8,463,000 )     (9,096,000 )
Net deferred tax assets
  $ -     $ -  
 
As of September 30, 2011 and 2010, the Company had United States federal net operating loss carry forwards of approximately $7.3 million and $6.7 million, respectively. These net operating loss carry forwards will expire at various dates beginning in 2026 if not utilized. In addition, the Company had U.S. state net operating loss carry forwards of approximately $4.1 million and $3.8 million as of September 30, 2011 and 2010, respectively, and these losses will begin to expire at various dates beginning in 2020 if not utilized. In addition, the Company had foreign net operating loss carry forwards of approximately $13.7 million and $9.4 million as of September 30, 2011 and 2010, respectively. These net operating loss carryforwards will begin to expire in 2013 if not utilized.  The Company has no tax credit carry forwards.

As of September 30, 2011, due to the history of losses the Company has generated, the Company believes that it is more-likely-than-not that the deferred tax assets will not be realized. Therefore, the Company has a full valuation allowance on the Company’s deferred tax assets of $8.5 million. Utilization of the U.S. federal and state net operating loss carry forwards may be subject to substantial annual limitation due to certain limitations resulting from ownership changes provided by U.S. federal and state tax laws. The annual limitation may result in the expiration of net operating losses carryforwards and credits before utilization.

Under the New Income Tax Law in PRC, dividends paid by PRC enterprises out of profits earned post-2007 to non-PRC tax resident investors are subject to PRC withholding tax of 10%. A lower withholding tax rate may be applied based on applicable tax treaties with certain countries. The Company has no accumulated earnings in PRC as of September 30, 2011.
 
Under the Enterprise Income Tax (“EIT”) Law, a “resident enterprise” which may include an enterprise established outside of the PRC with management located in the PRC, will be subject to the PRC income tax. If the PRC tax authorities subsequently determine that the Company and its subsidiaries registered outside the PRC should be deemed a resident enterprise, the Company and its subsidiaries registered outside the PRC will be subject to the PRC income tax at a rate of 25%. The Company will continue to monitor its tax status with regard to the PRC tax resident enterprise regulation.

The Company continues to enjoy the 50% reduction in the regular income tax rate of 25% until December 31, 2012 under the transitional rules of new EIT law and was approved by the tax authority.

 
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There are no ongoing examinations by taxing authorities at this time. The Company’s tax years starting from 2006 to 2010 remain open in various tax jurisdictions. The Company has not recorded any unrecognized tax benefits; and does not anticipate any significant changes within the next 12 months.

NOTE 12 — CONVERTIBLE NOTES

On March 7, 2007, Solar EnerTech entered into a securities purchase agreement to issue $17.3 million of secured convertible notes (the “Notes”) and detachable stock purchase warrants the “Series A and Series B Warrants”). Accordingly, during the quarter ended March 31, 2007, Solar EnerTech sold units consisting of:

 
·
$5.0 million in principal amount of Series A Convertible Notes and warrants to purchase 7,246,377 shares (exercise price of $1.21 per share) of its common stock;

 
·
$3.3 million in principal amount of Series B Convertible Notes and warrants to purchase 5,789,474 shares (exercise price of $0.90 per share) of its common stock ; and

 
·
$9.0 million in principal amount of Series B Convertible Notes and warrants to purchase 15,789,474 shares (exercise price of $0.90 per share) of its common stock.

These Notes bear interest at 6% per annum and are due in 2010. Under their original terms, the principal amount of the Series A Convertible Notes may be converted at the initial rate of $0.69 per share for a total of 7,246,377 shares of common stock (which amount does not include shares of common stock that may be issued for the payment of interest). Under their original terms, the principal amount of the Series B Convertible Notes may be converted at the initial rate of $0.57 per share for a total of 21,578,948 shares of common stock (which amount does not include shares of common stock that may be issued for the payment of interest).
 
The Company evaluated the Notes for derivative accounting considerations under FASB ASC 815 and determined that the notes contained two embedded derivative features, the conversion option and a redemption privilege accruing to the holder if certain conditions exist (the “compound embedded derivative” or “CED”). The compound embedded derivative is measured at fair value both initially and in subsequent periods. Changes in fair value of the compound embedded derivative are recorded in the account “gain (loss) on fair market value of compound embedded derivative” in the accompanying consolidated statements of operations.

In connection with the issuance of the Notes and Series A and Series B Warrants, the Company engaged an exclusive advisor and placement agent (the “Advisor”) and issued warrants to the Advisor to purchase an aggregate of 1,510,528 shares at an exercise price of $0.57 per share and 507,247 shares at an exercise price of $0.69 per share, of the Company’s common stock (the “Advisor Warrants”). In addition to the issuance of the warrants, the Company paid $1,038,000 in commissions, an advisory fee of $173,000, and other fees and expenses of $84,025.

The Series A and Series B Warrants (including the Advisor Warrants) were classified as a liability, as required by FASB ASC 480, “Distinguishing Liabilities from Equity”, formerly referenced as SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”, due to the terms of the warrant agreement which contains a cash redemption provision in the event of a fundamental transaction. The warrants are measured at fair value both initially and in subsequent periods. Changes in fair value of the warrants are recorded in the account “gain (loss) on fair market value of warrant liability” in the accompanying consolidated statements of operations.

In conjunction with the March 2007 financing, the Company recorded a total deferred financing cost of $2.5 million, of which $1.3 million represented cash payment and $1.2 million represented the fair market value of the Advisor Warrants. The deferred financing cost is amortized over the three year life of the notes using a method that approximates the effective interest rate method. The Advisor Warrants were recorded as a liability and adjusted to fair value in each subsequent period.

On January 7, 2010 (the “Conversion Date”), the Company entered into a Series A and Series B Notes Conversion Agreement (the “Conversion Agreement”) with the holders of Notes representing at least seventy-five percent of the aggregate principal amounts outstanding under the Notes to restructure the terms of the Notes. As of the Conversion Date, approximately $9.8 million of the Series A and B Convertible Notes were effectively converted into 64,959,227 shares of the Company’s common stock along with 1,035,791 shares of the Company’s common stock as settlement of the accrued interest on the Series A and B Convertible Notes, and the remaining $1.8 million of the Series B Notes were exchanged into another convertible note as further discussed below. In connection with the Conversion Agreement, on January 7, 2010, the Company entered into an Amendment (the “Warrant Amendment”) to the Series A, Series B and Series C Warrants with the holders of at least a majority of the common stock underlying each of its outstanding Series A Warrants, Series B Warrants and Series C Warrants (collectively the “PIPE Warrants”). The Warrant Amendment reduced the exercise price for all of the PIPE Warrants from $1.21, $0.90 and $1.00, respectively, to $0.15, removed certain maximum ownership provisions and removed anti-dilution provisions for lower-priced security issuances.

 
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The Conversion Agreement resulted in modifications or exchanges of the Notes and PIPE Warrants, which should be accounted for pursuant to FASB ASC 405-20, “Liabilities” and FASB ASC 470-50, "Debt/Modifications and Extinguishment" formerly referenced as EITF Consensus for Issue No. 96-19, "Debtor's Accounting for a Modification (or Exchange) of Convertible Debt Instruments". The combination of the adjustment to conversion price and the automatic conversion of the Notes effectively resulted in the settlement of the Notes through the issuance of shares of the Company’s common stock and amendment of the PIPE Warrants’ terms. Since the Company is relieved of its obligation for the Notes, the transaction is accounted for as an extinguishment of the Notes upon issuance of ordinary shares and modification of the PIPE Warrants’ terms. The loss on extinguishment associated with the Conversion Agreement amounted to approximately $17.2 million.

On January 19, 2010, a holder of approximately $1.8 million of the Company’s formerly outstanding Series B Notes and Series B Warrants (hereinafter referred to as the “Holder”) of the Company’s common stock disputed the effectiveness of the Conversion Agreement and the Warrant Amendment.  Accordingly, the Holder did not tender its Series B Notes for conversion. After negotiations with the Holder, on March 19, 2010, the Company entered into an Exchange Agreement with the Holder (the “Exchange Agreement”), whereby the Company issued the Series B-1 Note with a principal amount of $1.8 million (the “Series B-1 Note”) to the Holder along with 283,498 shares of the Company’s common stock as settlement of the accrued interest on the Holder’s Series B Notes and 666,666 shares of the Company’s common stock as settlement of the outstanding dispute regarding the effectiveness of the Company’s Conversion Agreement and the Warrant Amendment.  The Company did not capitalize any financing costs associated with the issuance of the Series B-1 Note.  As of September 30, 2011, the Company has an outstanding convertible note with a principal balance of $1,540,261 consisting of the Series B-1 Note, which was recorded at a carrying amount of $1,474,000. The Series B-1 Note bears interest at 6% per annum and is due on March 19, 2012. During the fiscal year ended September 30, 2011, the Company issued 784,768 shares of its common stock to settle the accrued interest on the Series B-1 Note. 

The Exchange Agreement resulted in modifications or exchanges of the Holder’s rights under its former Series B Note, which was accounted for pursuant to FASB ASC 470-50, "Debt/Modifications and Extinguishment" formerly referenced as EITF Consensus for Issue No. 96-19, "Debtor's Accounting for a Modification (or Exchange) of Convertible Debt Instruments", and FASB ASC 470-50, "Debt/Modifications and Extinguishment" formerly referenced as EITF Consensus for Issue No.06-06, "Debtor's Accounting for a Modification (or Exchange) of Convertible Debt Instruments". The loss on debt extinguishment associated with the Exchange Agreement amounted to approximately $1.3 million.

The costs associated with the Conversion Agreement were directly derived from the execution of the Company’s plan in improving its liquidity and business sustainability. The related loss on debt extinguishment was a cost that was integral to the continuing operations of the business which is different in nature to the continuing interest payments and change in fair value of the compound embedded derivative and warrant liability. Accordingly, the loss on debt extinguishment is included in operating expenses in the accompanying consolidated statements of operations.

The Company evaluated the Series B-1 Note for derivative accounting considerations under FASB ASC 815 and determined that the Series B-1 Note contained two embedded derivative features, the conversion option and a redemption privilege accruing to the holder if certain conditions exist (the “compound embedded derivative”). The compound embedded derivative is measured at fair value both initially and in subsequent periods. Changes in fair value of the compound embedded derivative are recorded in the account “gain (loss) on fair market value of compound embedded derivative” in the accompanying consolidated statements of operations.

On March 19, 2010, the Company entered into an Exchange Agreement (the “Exchange Agreement”) with Capital Ventures International (“CVI”) whereby the Company issued a Series B-1 Convertible Note (the “Note”) to CVI with an original principal amount of $1,815,261, which is due on March 19, 2012 and bears interest at 6% per annum. On May 11, 2011, the Company executed an amendment with CVI (“Amendment”) whereby CVI waives the following Trigger Events: (a) the migration of the Company’s listing from the OTCBB to the OTCQB, (b) the failure of the Company to timely pay the interest payment due on April 1, 2011 and (c) any other Trigger Event that may exist as of the date of this Amendment. According to the Amendment, Section 3(c) of the Exchange Agreement is amended to reduce the conversion price of the Note from $0.15 to $0.10 per common share, subject to further adjustment upon certain specified events as defined in the Exchange Agreement. As of September 30, 2011, the outstanding principal of the Note was $1,540,261, the carrying amount was $1,474,000 and the related interest was $23,294.

 
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The loss on debt extinguishment is computed as follows:
 
   
Fiscal Years Ended September 30,