Attached files

file filename
EX-31.1 - SOLAR ENERTECH CORPv171023_ex31-1.htm
EX-32.1 - SOLAR ENERTECH CORPv171023_ex32-1.htm
EX-31.2 - SOLAR ENERTECH CORPv171023_ex31-2.htm
EX-23.1 - SOLAR ENERTECH CORPv171023_ex23-1.htm
EX-21.1 - SOLAR ENERTECH CORPv171023_ex21-1.htm
EX-32.2 - SOLAR ENERTECH CORPv171023_ex32-2.htm

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, 2009
OR

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ____________ to ____________
Commission File Number 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.)
444 Castro Street, Suite #707, 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 o  No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.      o

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

o Large accelerated filer
  
o Accelerated filer
  
o 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).    o 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, 2009, was approximately $16,989,394.

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 January 6, 2010 was 111,406,696.

 
 

 

TABLE OF CONTENTS
 
   
Page
PART I
   
     
Item 1.  Business
 
4
Item 1A. Risk Factors
 
7
Item 1B. Unresolved Staff Comments
 
17
Item 2.  Properties
 
17
Item 3.  Legal Proceedings
 
17
Item 4.  Submission of Matters to a Vote of Security Holders
 
17
     
PART II
   
     
Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
18
Item 6.  Selected Financial Data
 
20
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
 
28
Item 8.  Financial Statements and Supplementary Data
 
28
Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
58
Item 9A(T). Controls and Procedures
 
58
Item 9B. Other Information
 
60
     
PART III
   
     
Item 10.  Directors and Executive Officers and Corporate Governance
 
61
Item 11.  Executive Compensation
 
63
Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
66
Item 13.  Certain Relationship and Related Transactions, and Director Independence
 
69
Item 14.  Principal Accountant  Fees and Services
 
69
     
PART IV
   
Item 15.  Exhibits and Financial Statement Schedules
 
71
     
Signatures
 
74
     
EXHIBIT 21.1
   
     
EXHIBIT 23.1
   
     
EXHIBIT 31.1
   
     
EXHIBIT 31.2
   
     
EXHIBIT 32.1
   
     
EXHIBIT 32.2
   
 
 
2

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This 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, that 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 the 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.

 
3

 

PART I

ITEM 1. BUSINESS

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.

The Company’s management in February 2008 decided that it was in the Company’s and its shareholders’ best interests to change the Company’s state of domicile from Nevada to Delaware (the “Reincorporation”).  On August 13, 2008, the Company, a Nevada entity at the time, entered into an Agreement and Plan of Merger with Solar EnerTech Corp., a Delaware corporation and wholly-owned subsidiary of the Nevada entity (the “Delaware Subsidiary”), whereby the Nevada entity merged with and into the Delaware Subsidiary in order to effect the Reincorporation. After the Reincorporation, the Nevada entity ceased to exist and the Company survived as a Delaware entity.

The Reincorporation was duly approved by both the Company’s Board of Directors and a majority of the Company’s stockholders at its annual meeting of stockholders held on May 5, 2008. On August 13, 2008, the Reincorporation was completed. The Reincorporation into Delaware did not result in any change to the Company’s business, management, employees, directors, capitalization, assets or liabilities.

On April 27, 2009, the Company entered into a Joint Venture Agreement (the “JV Agreement”) with Jiangsu Shunda Semiconductor Development Co., Ltd. (“Jiangsu Shunda”) to form a joint venture in the United States by forming a new company, to be known as Shunda-SolarE Technologies, Inc. (the “Joint Venture Company”), in order to jointly pursue opportunities in the United States solar market. After its formation, the Joint Venture Company’s name was later changed to SET-Solar Corp.

Pursuant to the terms of the JV Agreement, Jiangsu Shunda owns 55% of the Joint Venture Company, the Company owns 35% of the Joint Venture Company and the remaining 10% of the Joint Venture Company is owned by the Joint Venture Company’s management.  The Joint Venture Company’s Board of Directors consist of five directors: three of the directors were nominated by Jiangsu Shunda and two of whom were nominated by the Company.  Furthermore, Mr. Yunda Ni, the President of Jiangsu Shunda, serves as the Joint Venture Company’s Chairman of the Board and Mr. Leo Shi Young, the Company’s Chief Executive Officer serves as the Joint Venture Company’s Vice Chairman of the Board.  Jiangsu Shunda is responsible for managing the Joint Venture Company in China and the Company is responsible for the managing the Joint Venture Company in the United States.  The JV Agreement is valid for 18 months. As of September 30, 2009, due to the foreign currency controls imposed by the PRC government, Jiangsu Shunda and the Company have not contributed any capital to the Joint Venture Company and no equity interest has been issued to either party.

The Company’s goal is to maximize its value through manufacturing and distribution of photovoltaic products globally. To date, the Company has established a 67,107-square-foot manufacturing facility in Shanghai, China. The Company currently has two 25MW solar cell production lines and a 50MW solar module production facility.

The Company has also established a Joint R&D Lab at Shanghai University to research and develop higher-efficiency cells and to put the results of that research to use in its manufacturing processes. Led by one of the industry’s top scientists, the Company expects its R&D program to help bring Solar EnerTech to the forefront of advanced solar technology research and production.

During fiscal year 2009, the Company has significantly improved its operational results. The Company restructured its management team, especially the sales team, and concentrated on leaner productions, our procurement process, improving efficiency, quality control and various cost cutting programs. Consequently, gross margin has significantly improved quarter by quarter and operational costs have been reduced. In January 2010, the Company modified the terms of its convertible notes, which were subsequently converted into shares of common stock of the Company. We believe that the successful completion of the debt restructuring, along with our existing cash resources and the cash expected to be generated from operations during fiscal year 2010 will be sufficient to meet our projected operating requirements through at least the next twelve months and enable us to continue as a going concern

The public may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Rooms by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The SEC’s Internet website is located at http://www.sec.gov.

 
4

 

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, the investment tax credits and production tax credit extensions were passed in October 2008.  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 a solar boom being expected globally in the near future and with renewable energy laws being implemented as best-practice models often with attractive solar energy delivery compensation rules as in Germany, solar companies are currently expanding their activities in Europe (e.g. Spain, Italy, France and Greece, and Holland). With growing markets in Southern Europe, Asia and the United States, 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;
 
 
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.

Company’s Strategy

The Company’s business strategy includes the acquisition, manufacturing and marketing of innovative PV cells and modules in order to provide superior solutions to its customers. In so doing, we believe it will generate substantial value for its stockholders while contributing to energy security and protection of ecosystems.

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. The Company manufactures PV solar cells, designs and produces 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.

 
5

 

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. The Company’s 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. With a newly set-up marketing and sales office in the United Sates, the Company is well-positioned to meet incremental market demand in the United States.

Sales Strategy

The Company manufactures high-quality and high-conversion-rate solar products with outstanding after-sale services. By keeping costs low, the Company expects to market its panels, to be trademarked as “SolarE”, at prices generally lower than many of our competitors.

Research & Development

The Company has established a joint Research and Development (“R&D”) laboratory with Shanghai University to facilitate improvements to the Company’s products. The main focus of this research laboratory is to:

 
(1)
Research and test theories of photovoltaics, thermo-physics, the physics of materials and chemistry;
 
 
(2)
Develop efficient and ultra-efficient PV cells with light/electricity conversion rate ranging from 20% to 35%;
 
 
(3)
Develop environmentally-friendly high-conversion-rate manufacturing technology for chemical compound film PV cell materials;
 
 
(4)
Develop highly-reliable, low-cost manufacturing technology and equipment for thin-film PV cells;
 
 
(5)
Research and develop key materials for new low-cost flexible-film PV cells and non-vacuum technology; and
 
 
(6)
Research and develop key technologies and fundamental theories for third-generation PV cells.

Management believes that the joint R&D laboratory will enable the Company 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 the Company to become an important solar-cell manufacturer.

Competition

The solar energy market is highly competitive. Outside China, the Company’s 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.

The Company competes primarily on the basis of the power efficiency, quality, performance and appearance of its products, price, strength of its supply chain and distribution network, after-sales service and brand image. Many of the Company’s competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial and marketing resources than the Company.

Intellectual Property

The Company is not, at present, the holder of any patents, trademarks or copyrights on its products. The Company intends to trademark the trade name “SolarE” in Asia, Europe and North America in the future and will, if it is successful in its conduct of research and development activities seek intellectual property protection for such products. Solar cells are in the public domain and the Company’s only protection in producing them is in the know-how or experience of its employees and management in producing its products.
 
 
6

 

Environmental Regulations

In its manufacturing process, the Company will use, generate and discharge toxic, volatile or otherwise hazardous chemicals and wastes in its manufacturing activities. The Company is 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 the Company fails to comply with present or future environmental laws and regulations, it 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 the Company has all environmental permits necessary to conduct its business and has obtained all necessary environmental permits for its facility in Shanghai. Management also believes that the Company has properly handled its hazardous materials and wastes and has appropriately remediated any contamination at any of its premises. The Company is 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 the Company to control the use of or to restrict adequately the discharge of, hazardous substances could subject the Company to substantial financial liabilities, operational interruptions and adverse publicity, any of which could materially and adversely affect its business, results of operations and financial condition.

Principal suppliers

We currently purchase silicon wafer, our key raw material, from the spot market.

Employees

As of September 30, 2009, the Company employed approximately 328 people, as follows: the Company’s California office currently has 3 employees and the manufacturing plant in Shanghai currently has 325 employees.

ITEM 1A. RISK FACTORS

RISKS RELATED TO OUR BUSINESS

Investors should carefully consider the risks described below before deciding whether to invest in our common stock. The risks described below are not the only ones we face. Additional risks not presently known to us or that we currently believe are immaterial may also impair our business operations and financial results. If any of the following risks actually occurs, our business, financial condition or results of operations could be adversely affected. In such case, the trading price of our common stock could decline and you could lose all or part of your investment. 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, 2009 consolidated financial statements and related notes.

Our limited operating history may not serve as an adequate basis to judge our future prospects and results of operations.

We were originally incorporated in the State of Nevada in July 2004 and began our current operations in March 2006. On August 13, 2008, we reincorporated to the State of Delaware. We have a limited operating history. As such, our historical operating results may not provide a meaningful basis for evaluating our business, financial performance and future prospects. Accordingly, you should not rely on our results of operations for any prior periods as an indication of our future performance.

We require a significant amount of cash to fund our future capital expenditure requirements and working capital needs. If we cannot obtain additional sources of liquidity when we need it, our growth prospects and future profitability may be materially adversely affected and we may not be able to continue as a going concern.

We generated a net loss of $14.2 million for the fiscal year ended September 30, 2009. During the same period in fiscal year 2008, we had negative gross margin due to high manufacturing cost associated with our low production volume. In order to improve our profitability, we will need to continue to generate new sales while controlling our costs. As we plan on continuing the growth of our business while implementing cost control measures, we may not be able to successfully generate enough revenues to return to profitability. Failure to increase our revenues and control costs as we pursue our planned growth would harm our profitability and would likely negatively affect the market price of our stock.

 
7

 

If the world-wide financial crisis intensifies, potential disruptions in the capital and credit markets may adversely affect the Company, including adversely affecting the availability and cost of short-term funds for the Company’s liquidity requirements and the Company’s ability to meet its long-term commitments, which in turn could adversely affect the Company’s results of operations, cash flows and financial condition.

The Company relies on its limited cash reserves to fund short-term liquidity needs if internal funds are not available from the Company’s operations. With a limited amount of cash reserves, disruptions in the capital and credit markets could adversely affect the Company’s ability to raise additional cash as may be needed.

Longer-term disruptions in the capital and credit markets as a result of uncertainty, changing or tightened regulation, reduced financing alternatives or failures of significant financial institutions could adversely affect the Company’s access to liquidity needed in its businesses. Any disruption could require the Company to take measures to conserve cash until the markets stabilize or until alternative credit arrangements or other funding for business needs can be arranged. Such measures could include deferring capital expenditures, as well as reducing or eliminating other discretionary uses of cash.

Many of the Company’s customers and suppliers also have exposure to risks that their businesses are adversely affected by the current worldwide financial crisis and resulting potential disruptions in the capital and credit markets.  In the event that any of the Company’s significant customers or suppliers, or a significant number of smaller customers and suppliers, are adversely affected by these risks, the Company may face disruptions in supply, significant reductions in demand for its products and services, inability of customers to pay invoices when due, and other adverse effects that could negatively affect the Company’s financial condition, results of operations and/or cash flows.
We had a history of losses and cash outflow from operations which may continue if we do not continue to increase our revenue and/or further reduce our costs.

We incurred a net operating loss in all financial periods since inception. After various cost cutting efforts, our operational expenses have been reduced significantly. Our ability to achieve profitability depends on the growth rate of the photovoltaic portion of the market, the continued market acceptance of PV products, the competitiveness of products and services as well as our ability to provide new products and services to meet the demands of our customers. During the third quarter of fiscal 2009, we generated positive gross margins for the first time in the Company’s history. However, there is no guarantee that we may be profitable in the future.

Due to the significant fluctuations in our cash levels that result from timing differences between our payments to vendors and our collections from customers, our cash levels were at their lowest at the end of fiscal year 2009. 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.

The uncertainty regarding the eventual outcome of the our plan to continue on a going concern basis and the effect of other unknown adverse factors could threaten our existence as a going concern

Our consolidated financial statements have been prepared on the assumption that we will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The independent auditor’s report on our financial statements as of and for the fiscal year ended September 30, 2009 included herein contains an explanatory paragraph stating that our recurring net losses and negative cash flows from operations raise substantial doubt about our ability to continue as a going concern.

As of September 30, 2009, we had outstanding convertible notes with a principal balance of $11.6 million consisting of $2.5 million in principal amount of Series A Convertible Notes (the “Series A Notes”) and $9.1 million in principal amount of Series B Convertible Notes (the “Series B Notes”, and together with the Series A Notes, the “Notes”), which were recorded at carrying amount at $3.1 million. The Notes bear interest at 6% per annum and are due on March 7, 2010.

Failure to make payment on the outstanding Notes by March 7, 2010 would have a material adverse effect on our business, operating results and financial condition. This may cause us to restructure or cease operations entirely.

Our ability to repay the Notes when they are due or to refinance or renegotiate our obligations depends on our financial condition and operating performance, which is subject to prevailing economic and competitive conditions and certain financial, business and other factors beyond our control. There can be no assurance that we will generate a level of cash flows from operating activities sufficient to permit us to pay the principal and any interest, if any, owed under the Notes.

As of September 30, 2009, we only had, $1.7 million in cash and cash equivalents on hand, a working capital of $106,000 and incurred net loss of $14.2 million for the fiscal year 2009. Our minimal cash position is mostly due to funding operational losses in the earlier part of the year. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, or if we fail to comply with the various requirements of our indebtedness, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital, restructure, or refinance our indebtedness.  Failure to generate sufficient income, potentially raise additional capital, or renegotiate the terms and conditions of the Notes will be materially negatively impacted and it will be required to take actions that will harm our business, including ceasing of our operations.

 
8

 

During fiscal year 2009, we have significantly improved our operational results. The Company recruited an experienced sales director from the industry and built up a strong sales and marketing team, which resulted in new key customers. In fiscal year 2009, we acquired new key contracts , primarily a 10.00MW contract with a leading German solar system integrator. Accordingly, our module shipments increased from 6.67MW in fiscal year 2008 to 10.50MW in fiscal year 2009 and are expected to increase to at least 22MW in fiscal year 2010. The increased sales volume also resulted in lower average fixed manufacturing cost. Even though the average selling price in fiscal year 2009 has decreased approximately 41% compared to fiscal year 2008, it was offset by the decline in raw material prices primarily silicon wafers, which decreased by 65%. We have also restructured our management team and concentrated on lean production, efficiency improvement in manufacturing and various cost cutting programs. As a result, our operational costs have significantly decreased quarter by quarter. During the third quarter of fiscal year 2009, we generated a positive gross margin of 4.8% for the first time in the Company’s history. We continued this trend by generating a gross margin of 16% in the fourth quarter of fiscal year 2009.

On January 7, 2010, we entered into a Series A and Series B Conversion Agreement (the “Conversion Agreement”) with the holders holding over 75% of the outstanding principal amounts owed under the Notes to modify the terms of the Notes. Pursuant to the terms of the Conversion Agreement, the Notes will be automatically converted into shares of our common stock at a conversion price of $0.15 per share and shall be amended to eliminate the maximum ownership percentage restriction prior to such conversion.
 
In addition, the Company and the holders of over 50% of each of the outstanding Series A, Series B and Series C Warrants (collectively the “PIPE Warrants”) have agreed to enter into an Amendment to the Series A, B, and C Warrants (the “Warrant Amendment”) upon the closing of the transactions contemplated in the Conversion Agreement. Pursuant to the terms of the Warrant Amendment, the PIPE Warrants shall be amended to reduce their exercise prices from $1.21, $0.90 and $1.00, respectively, to $0.15. The PIPE Warrants shall also be amended to (a) waive the anti-dilution provisions of the PIPE Warrants that would increase the number of shares issuable pursuant to the PIPE Warrants in inverse proportion to the reduction in the exercise price, (b) waive all anti-dilution protections as to future transactions and (c) eliminate maximum ownership percentage restrictions.

Pursuant to the Conversion Agreement, after the closing of the transactions contemplated by it, we shall issue to our employees additional options to purchase shares of our common stock equal to approximately 30% of each employee’s pre-closing option holdings. This is to provide for additional equity incentives to our employees in order to account for the dilution from the conversion of the Notes and re-pricing of the PIPE Warrants. These additional options shall be priced at $0.15 per share.

Continuing on a going concern basis is dependent upon, among other things, our ability to improve our operational results and the success of the debt restructuring above. A forecast of future sales is inherently uncertain and when the sales activities are not progressing as well as planned, it requires a significant amount of cash to support our operations and we cannot be sure that our existing cash resources will be adequate. Having insufficient funds may require us to scale back on our operations. If we experience a material shortfall versus our plan for fiscal 2010, we have a range of actions we can take to remediate the cash shortage, as discussed in more detail in “Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”

Demand for our PV products has been, and may continue to be, adversely affected by the global financial crisis. The global credit crisis could also make it difficult for our customers and end-users to finance the purchases of our products.

Beginning in the fourth fiscal quarter 2008, many of our key markets, including Belgium, Germany, and Australia, has experienced a period of economic contraction or significantly slower economic growth. In particular, the current credit crises, weak consumer confidence and diminished consumer and business spending have contributed to a significant slowdown in the market demand PV products due to decreased energy requirements.

In addition, many of our customers and many end-users of our PV products depend on debt financing to fund the initial capital expenditure required to purchase our PV products. Due to the global credit crisis, many of our customers and many end-users of our PV products have experienced difficulties in obtaining financing, and even if they have been able to obtain financing, the cost of such financing has increased and they may change their decision or change the timing of their decision to purchase our PV products. As a result, an increase in the cost of financing have lowered and may continue to lower demand for our PV products and reduce our net revenues. We cannot assure you when an economic recovery may occur, or even when an economic recovery does occur, the demand for our PV products will increase. A protracted disruption in the ability of our customers to obtain financing could lead to a significant reduction in their future orders for our PV products, which in turn could have a material adverse effect on our business, financial condition and results of operations.

 
9

 

If PV technology is not suitable for widespread adoption, or sufficient demand for PV products does 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 PV market is at a relatively early stage of development and the extent to which PV products will be widely adopted is uncertain. Market data in the PV 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 PV technology proves unsuitable for widespread adoption or if the demand for PV products fails to develop sufficiently, we may not be able to grow our business or generate sufficient revenues to become profitable or sustain profitability. In addition, demand for PV 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 PV technology and the demand for PV products, including:

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

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

 
availability of government subsidies and incentives to support the development of the PV industry;

 
success of other alternative energy generation technologies, such as fuel cells, wind power and biomass;

 
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 PV products, which tend to decrease when economy slows down; and

 
deregulation of the electric power industry and broader energy industry.

The failure of the market for PV products to develop as we expect it to would have a material adverse effect on our business.

We face intense competition from other companies producing solar energy and other renewable energy products and because we are new to this industry, we are limited in our ability to be competitive.

The PV market is intensely competitive and rapidly evolving. We compete with many companies that have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial and marketing resources than us. They may also have existing relationships with suppliers of silicon wafers, which may give them an advantage in the event of a silicon shortage. We do not represent a significant competitive presence in the PV products industry.

Our failure to refine technology and develop and introduce new PV products could render our anticipated products uncompetitive or obsolete, and reduce our sales and market share, should we develop sales or market share.

The PV industry is rapidly evolving and competitive. We will need to invest significant financial resources in research and development to keep pace with technological advances in the PV industry and to effectively compete in the future. However, research and development activities are inherently uncertain, and we might encounter practical difficulties in commercializing our research results. Our significant expenditures on research and development may not reap corresponding benefits. A variety of competing PV technologies that other companies may develop could prove to be more cost-effective and have better performance than our PV products. Therefore, our development efforts may be rendered obsolete by the technological advances of others. Breakthroughs in PV technologies that do not rely in whole or in part on crystalline silicon could mean that companies such as us that rely entirely on crystalline silicon would encounter a sudden, sharp drop in sales.

Our failure to further refine our technology and develop and introduce new PV products could render our anticipated products uncompetitive or obsolete, and result in a decline in our market share. We do not have the working capital, at this time, to make a significant investment in research and development activities although we have hired personnel who have significant industry and PV expertise.

Our future success substantially depends on our ability to expand manufacturing capacity and output. Our ability to achieve our expansion goals is subject to a number of risks and uncertainties.

Our future success depends on our ability to significantly expand manufacturing capacity and output. If we are unable to do so, we may be unable to expand our business, decrease our costs per watt, maintain our competitive position and improve profitability. Our ability to establish manufacturing capacity and increase output is subject to significant risks and uncertainties, including:

 
the need to raise significant additional funds to purchase and prepay for raw materials or to buy equipment for our manufacturing facilities, which we may be unable to obtain on reasonable terms or at all;


 
10

 

 
delays and cost overruns as a result of a number of factors, many of which may be beyond our control, such as increases in raw materials prices and problems with manufacturing equipment vendors;

 
delays or denial of required approvals by relevant government authorities;

 
diversion of significant management attention and other resources; and

 
failure to execute our plan of operations effectively.

If we are unable to expand our manufacturing capacity or to increase manufacturing output, or if we encounter any of the risks described above, we may be unable to expand our business as planned. Moreover, we cannot assure you that if we do establish or expand our manufacturing capacity and output we will be able to generate sufficient customer demand for our PV products to support production levels.

Our dependence on a spot market and price volatility for key raw materials, and customized manufacturing equipment could prevent us from timely delivering our anticipated products to our customers in the required quantities, which could result in order cancellations and decreased revenues.

If we fail to obtain silicon wafer, our key raw material from the spot market, due to the volatility of raw material prices, we may be unable to manufacture our products or our products may be available at a higher cost or after a long delay, and we could be prevented from delivering our products to potential customers in the required quantities and at prices that are profitable. Problems of this kind could cause us to experience order cancellations and loss of market share. 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.

Our dependence on a limited number of customers may cause significant fluctuations or declines in our revenues.

We have a limited number of customers and will be dependent on these customers for our continued operations. Our dependence on a limited number of customers will continue for the foreseeable future. Consequently, any one of the following events may cause material fluctuations or declines in our revenues and have a material adverse effect on our results of operations:

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

 
selection by one or more significant distributor customers of products competitive with ours;

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

 
failure of any significant customers to make timely payment for products.

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, oversea markets;

 
increased costs associated with maintaining marketing efforts in various countries;

 
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

 
11

 

 
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 revenues 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. Therefore, fluctuations in the value of foreign currencies could have a negative impact on the profitability of our global operations, which would seriously harm our business, results of operations, and financial condition.

Our business depends to a significant extent on the continuing efforts of our president and chief executive officer. Our business may be severely disrupted if we lose his services.

Due to his extensive experiences in managing businesses in China, 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 or our directors. 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.

If we are unable to attract, train and retain technical personnel, our business may be materially and adversely affected.

Our future success depends, to a significant extent, on our ability to attract, train and retain technical personnel. Recruiting and retaining capable personnel, particularly those with expertise in the PV industry, are vital to our success. There is substantial competition for qualified technical personnel, and there can be no assurance that we will be able to attract or retain our technical personnel. If we are unable to attract and retain qualified employees, our business may be materially and adversely affected.

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 PV 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, patent opposition proceedings 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.

Because the currency we use to do business is generally RMB Yuan, fluctuations in exchange rates could adversely affect our business.

Our consolidated financial statements are expressed in U.S. dollars but our functional currency is RMB Yuan. Our results may be affected by the foreign exchange rate between U.S. dollars and RMB Yuan. To the extent we hold assets denominated in U.S. dollars, any appreciation of the RMB Yuan against the U.S. dollar could result in a change to our income statement and a reduction in the value of our U.S. dollar denominated assets. On the other hand, a decline in the value of RMB Yuan against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results which may have a material adverse effect on the price of our shares.

We have limited insurance coverage and may incur losses resulting from product liability claims or business interruptions.

We may be exposed to risks associated with product liability claims in the event that the use of the PV products we sell results in injury. Since our products are electricity producing devices, it is possible that users may be injured or killed by our products, whether by product malfunctions, defects, improper installation or other causes. We are unable to predict whether product liability claims will be brought against us in the future or the effect of any resulting adverse publicity on our business. Moreover, we do not have any product liability insurance and may not have adequate resources to satisfy a judgment in the event of a successful claim against us. The successful assertion of product liability claims against us could result in potentially significant monetary damages and require us to make significant payments. In addition, as the insurance industry in China is still in an early stage of development, business interruption insurance available in China offers limited coverage compared to that offered in many other countries. We do not have any business interruption insurance. Any business disruption or natural disaster could result in substantial costs and diversion of resources.

 
12

 

Together, our directors own a significant number of shares of our common stock. If our directors act together, they will be able to exert significant influence over, and possibly control, the outcome of all actions requiring stockholder approval.

As of November 30, 2009, our director, President and Chief Executive Officer, Leo Shi Young, beneficially owns 15,284,286 shares of our common stock, or approximately 13.71%, of our common stock. Shi Jian Yin, an executive officer and a director, also beneficially owns 11,100,000 shares of our common stock, or approximately 9.95%, of our common stock. Our executive officers and directors as a group have the ability to control up to 25.45% of our voting stock. As long as management owns such a significant percentage of our common stock, our other stockholders may be unable to affect or change the management or the direction of our company without their support. If they act together, our executive officers and directors will be able to exert significant influence over the outcome of all corporate actions requiring stockholder approval, including the election of directors, amendments to our certificate of incorporation and approval of significant corporate transactions.

Our net future income, if any, could be adversely affected based on share-based compensation granted to employees and consultant, and changes in the fair value of the Series A and Series B warrants outstanding.

The Company has granted and will continue to grant options to purchase common stock of the Company to employees and consultants in accordance with the terms of the Company’s Amended and Restated 2007 Equity Incentive Plan and 2008 Restricted Stock Plan. The Company accounts for options and restricted shares granted to our directors and employees in accordance with the Financial Accounting Standards Board (“FASB”) ASC 718, “Compensation – Stock Compensation”, formerly referenced as Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share-Based Payments”, or SFAS 123R, which requires all companies to recognize, as an expense, the fair value of share options, restricted shares and other share-based compensation to employees. As a result, we have to account for compensation costs for all share options and restricted shares using a fair-value based method and recognize expenses in our consolidated statement of operations in accordance with the relevant rules under generally accepted accounting principles in the United States of America ("GAAP"), which may have a material and adverse effect on our reported earnings. If we try to avoid incurring these compensation costs, we may not be able to attract and retain key personnel, as options to purchase common stock are an important employee recruitment and retention tool. As we grant employee options to purchase common stock or other share-based compensation, our net income may be adversely affected by such grants.

During March 2007, in conjunction with the issuance of $17,300,000 in convertible debt, the board of directors approved the issuance of Series A and Series B Warrants to purchase shares of the Company’s common stock. The Series A and Series B Warrants are 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. These terms remain unchanged upon the closing of the transactions contemplated in the Conversion Agreement discussed above. Accordingly, the warrants will continue to be measured at fair value at each reporting period and the changes in fair value of the warrants are recorded in the account “gain (loss) on fair market value of warrant liability” in our accompanying consolidated statements of operations. As a result, our net income could be adversely affected if there is a loss on the fair market value of the warrant liability.

Existing regulations and changes to such regulations 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 foreign, federal, state and local government regulations and policies concerning the electric utility industry, as well as internal policies and regulations promulgated by electric utilities. These regulations and policies often relate to electricity pricing and technical interconnection of customer-owned electricity generation. In the United States and in a number of other 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 potential demand for our PV products.

The Company is 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.

In its manufacturing process, the Company uses, generates and discharges toxic, volatile or otherwise hazardous chemicals and wastes in its manufacturing activities. We believe that we have properly handled our hazardous materials and wastes and have appropriately remediated any contamination at any of our premises. If the Company fails 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. 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.
 
 
13

 

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.

The practice in our industry is to offer long product warranties. We offer a product warranty with a term of 25 years. Due to the long warranty period, we bear the risk of extensive warranty claims long after we have shipped the product and recognized the revenues. 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 we expect them to and we are required to cover a significant number of warranty claims, the expenses related to such claims could have a material adverse affect on our business and results of operations.

The reduction or elimination of government economic incentives could prevent us from achieving sales and market share.

We believe that the near-term growth of the market for PV products depends in large part on the availability and size of government and economic incentives. The reduction or elimination of government economic incentives may adversely affect the growth of this market or result in increased price competition, which could prevent us from achieving sales and market share.

Today, the cost of solar power exceeds the cost of power furnished by the electric utility grid in many locations. As a result, federal, state and local government bodies in many countries, most notably Germany, Spain, Japan and the United States, have provided incentives in the form of rebates, tax credits and other incentives to end users, distributors, system integrators and manufacturers of solar power products to promote the use of solar energy in on-grid applications and to reduce dependency on fossil fuels. These government economic incentives could be reduced or eliminated altogether, which would significantly harm our business as we have marketed products in those economies.

We are subject to new corporate governance and internal control reporting requirements, and our costs related to compliance with, or our failure to comply with existing and future requirements, could adversely affect our business.

We face new corporate governance requirements under the Sarbanes-Oxley Act of 2002, as well as new rules and regulations subsequently adopted by the SEC and the Public Company Accounting Oversight Board. These laws, rules and regulations continue to evolve and may become increasingly stringent in the future. In particular, under rules proposed by the SEC, we are required to include management’s report on internal controls as part of our annual report for the fiscal year ending September 30, 2008 pursuant to Section 404 of the Sarbanes-Oxley Act. Furthermore, under the applicable rules, an attestation report on our internal controls from our independent registered public accounting firm will be included as part of our annual report for the fiscal year ending September 30, 2010. The financial cost of compliance with these laws, rules and regulations is expected to be substantial. We cannot assure you that we will be able to fully comply with these laws, rules and regulations that address corporate governance, internal control reporting and similar matters. Failure to comply with these laws, rules and regulations could materially adversely affect our reputation, financial condition and the value of our securities.

Our management discovered material weaknesses in our internal controls over financial reporting that, if not properly remediated, could result in material misstatements in our financial statements, which could cause inventors to lose confidence in our reported financial information and have a negative effect on the trading price of our stock.
 
In connection with our 2009 financial statement audit, our management identified material weaknesses.  The weaknesses were related to the Company’s lack of a sufficient number of finance personnel with an appropriate level of knowledge, experience and training in the application of GAAP as well as inadequate controls over the closing and reporting processes, which resulted in audit adjustments to our fiscal year 2009 annual consolidated financial statements.  A discussion of the material weaknesses in our internal control over financial reporting and management’s remediation efforts is available herein under the subheading “Management’s Report on Internal Control over Financial Reporting”.
 
Material weaknesses in internal control over financial reporting may materially impact our reported financial results and the market price of our stock could significantly decline. Additionally, adverse publicity related to a material failure of internal control over financial reporting could have a negative impact on our reputation and business.

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 and most of our sales are made in China, although we are in the process of attempting to establish US distribution for our future products. 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:

 
14

 

 
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 these measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.

The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the PRC government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of the productive assets in China is still owned by the PRC government. The continued control of these assets and other aspects of the national economy by the 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.

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

 
15

 

RISKS RELATED TO AN INVESTMENT IN OUR SECURITIES

Our stock price is volatile. There is no guarantee that the shares you purchase will appreciate in value or that you will be able to sell your shares at a price that is greater than the price you 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 you that the shares you purchase will appreciate in value or that you will be able to sell the shares at a price equal to or greater than what you paid for them.

The OTC Bulletin Board is a quotation system, not an issuer listing service, market or exchange. Therefore, buying and selling stock on the OTC Bulletin Board is not as efficient as buying and selling stock through an exchange. As a result, it may be difficult for you to sell your common stock or you may not be able to sell your common stock for an optimum trading price.

The OTC Bulletin Board is a regulated quotation service that displays real-time quotes, last sale prices and volume limitations in over-the-counter securities. Because trades and quotations on the OTC Bulletin Board involve a manual process, the market information for such securities cannot be guaranteed. In addition, quote information, or even firm quotes, may not be available. The manual execution process may delay order processing and intervening price fluctuations may result in the failure of a limit order to execute or the execution of a market order at a significantly different price. Execution of trades, execution reporting and the delivery of legal trade confirmations may be delayed significantly. Consequently, one may not be able to sell shares of our common stock at the optimum trading prices.

When fewer shares of a security are being traded on the OTC Bulletin Board, volatility of prices may increase and price movement may outpace the ability to deliver accurate quote information. Lower trading volumes in a security may result in a lower likelihood of an individual’s orders being executed, and current prices may differ significantly from the price one was quoted by the OTC Bulletin Board at the time of the order entry.

Orders for OTC Bulletin Board securities may not be canceled or edited like orders for other securities. All requests to change or cancel an order must be submitted to, received and processed by the OTC Bulletin Board. Due to the manual order processing involved in handling OTC Bulletin Board trades, order processing and reporting may be delayed, and an individual may not be able to cancel or edit his order. Consequently, one may not able to sell shares of common stock at the optimum trading prices. The dealer’s spread (the difference between the bid and ask prices) may be large and may result in substantial losses to the seller of securities on the OTC Bulletin Board if the common stock or other security must be sold immediately. Further, purchasers of securities may incur an immediate “paper” loss due to the price spread. Moreover, dealers trading on the OTC Bulletin Board may not have a bid price for securities bought and sold through the OTC Bulletin Board. Due to the foregoing, demand for securities that are traded through the OTC Bulletin Board may be decreased or eliminated.

 
16

 

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.

There may be a limited market for our securities and we may fail to qualify for another listing.

In the event that our common stock fails to qualify for continued inclusion on OTC Bulletin Board our common stock could become quoted in what are commonly referred to as the “pink sheets.” Under such circumstances, it may be more difficult to dispose of, or to obtain accurate quotations, for our common stock, and our common stock would become substantially less attractive to certain investors, such as financial institutions and hedge funds.

We have no plans to pay dividends.

We have not paid any cash dividends to date and do not expect to pay dividends for the foreseeable future. We intend to retain earnings, if any, as necessary to finance the operation and expansion of our business.

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 (the “Securities Act”), 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. DESCRIPTION OF PROPERTY

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, 2011. The termination clause in the agreement requires a notice of three months. Monthly costs are $21,000. We leased the second manufacturing facility with 21,506 square feet with monthly rent of $11,000. The lease expires in August 2012.

The Company also has an operating lease for 9,588 square foot of office space in Shanghai, at a monthly cost of $34,000. The lease expires in May 2010, can be renewed with a three-month advance notice, and cannot be terminated prior to expiration.

Finally, the Company leases 678 square feet of office space 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

From time to time, we may be engaged in various legal proceedings incidental to our normal business activities. Although the results of litigation and claims cannot be predicted with certainty, we believe the final outcome of such matters will not have a material adverse effect on its financial position, results of operations or cash flows.

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

None.

 
17

 

PART II

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

Our common stock is traded on the Over-The-Counter Bulletin Board (“OTCBB”) operated by the Financial Industry Regulatory Authority (FINRA) 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,
 
   
2009
   
2008
 
   
High
   
Low
   
High
   
Low
 
             
First Quarter
  $ 0.40     $ 0.17     $ 1.30     $ 0.82  
Second Quarter
  $ 0.26     $ 0.12     $ 1.65     $ 0.47  
Third Quarter
  $ 0.45     $ 0.19     $ 0.86     $ 0.55  
Fourth Quarter
  $ 0.44     $ 0.28     $ 0.69     $ 0.40  

As of January 6, 2010, there were 49 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 effected 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.

 
18

 

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, 2009, the Board of Directors has granted options to purchase 2,940,000 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.

 
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
    2,940,000 (1)   $ 0.55       12,060,000  
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 Bulletin Board under the symbol “SOEN”.
b — We have approximately 49 record holders on January 6, 2010.
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 FINRA’s OTCBB.

Quotations on the OTCBB 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.

 
19

 

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.

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.

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

We originally incorporated under the laws of the State of Nevada on July 7, 2004 and reincorporated to the State of Delaware on August 13, 2008. We engaged in a variety of businesses, including home security assistance, until March 2006, when we began our current operations. We manufacture and sell photovoltaic (commonly known as “PV”) cells and modules. PV modules consist of solar cells that produce electricity from the sun’s rays. Our manufacturing operations consisted of one 25MW solar cell production line and 50MW of solar module production facility. Our 67,107 square foot manufacturing facility is located in Shanghai, China.

Our solar cells and modules are sold under the brand name “SolarE”.  Our total revenue for fiscal year 2009 was $32.8 million and our end users are mainly in Europe.  In anticipation of entering the US market, we had established a 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 wafer, from the spot market.  We do not have a long term contract with any silicon supplier.  However, on August 21, 2008, we entered into an equity purchase agreement with 21-Century Silicon, Inc., a polysilicon manufacturer based in Dallas, Texas (“21-Century Silicon”) to acquire two million shares of common stock, for $1 million cash. As of September 30, 2009, the two million shares acquired by us constituted approximately 5.5% of 21-Century Silicon’s outstanding equity.  Related to the equity purchase agreement, we also signed a memorandum of understanding with 21-Century Silicon for a four-year supply framework agreement for polysilicon shipments. Through its proprietary technology, processes and methods, 21-Century Silicon is planning to manufacture solar-grade polysilicon at a lower manufacturing and plant setup cost, as well as a shorter plant setup time than those of its major competitors. If 21-Century Silicon's manufacturing goals are met, 21-Century Silicon’s customers, including us, will benefit from the cost advantages and will expect to receive a high-purity product at a price significantly lower than that offered elsewhere within the industry.

On April 27, 2009, we entered into a Joint Venture Agreement (the “JV Agreement”) with Jiangsu Shunda Semiconductor Development Co., Ltd. (“Jiangsu Shunda”) to form a joint venture in the United States by forming a new company, to be known as Shunda-SolarE Technologies, Inc. (the “Joint Venture Company”), in order to jointly pursue opportunities in the United States solar market. After its formation, the Joint Venture Company’s name was later changed to SET-Solar Corp.

 
20

 

Pursuant to the terms of the JV Agreement, Jiangsu Shunda owns 55% of the Joint Venture Company, we own 35% of the Joint Venture Company and the remaining 10% of the Joint Venture Company is owned by the Joint Venture Company’s management.  The Joint Venture Company’s Board of Directors consist of five directors: three of the directors are nominated by Jiangsu Shunda and two of whom were nominated by us.  Furthermore, Mr. Yunda Ni, the President of Jiangsu Shunda, serves as the Joint Venture Company’s Chairman of the Board and Mr. Leo Shi Young, our Chief Executive Officer serves as the Joint Venture Company’s Vice Chairman of the Board.  Jiangsu Shunda is responsible for managing the Joint Venture Company in China and we are responsible for the managing the Joint Venture Company in the United States.  The JV Agreement is valid for 18 months.

SET-Solar Corp appointed Roland Chu, an experienced Silicon Valley entrepreneur as Chief Executive Officer. The Joint Venture team had made significant progress during the fiscal year 2009. It obtained the a California Solar Initiative listing, which enabled SET-Solar Corp to penetrate multiple sectors of the PV market in the United States. SET Solar’s strategy with customers has been to move beyond simply supplying solar panels to offer a more comprehensive service solution that includes inverters and other accessories, as well as financing and leasing options. SET-Solar Corp also made a very successful appearance at the Solar Power International Conference from October 27 to October 29, 2009 at the Anaheim Convention Center in Anaheim, California. SET-Solar Corp exhibited its polysilicon material, silicon ingots and wafers produced by Jiangsu Shunda and high-efficiency solar cells and high-performance solar modules produced by Solar EnerTech.

In December 2006, we entered into an agreement with Shanghai University to jointly operate a research facility to study various aspects of advanced PV technology. Our collaboration 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:

we plan to research and test theories of PV, thermo-physics, physics of materials and chemistry;

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

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

we plan to develop highly reliable, low-cost manufacturing technology and equipment for thin film PV cells;

we plan to research and develop key material for low-cost flexible film PV cells and non-vacuum technology; and

we plan to research and develop key technology and fundamental theory for third-generation PV cells.

To date, we have raised money for the development of our business through the sale of our equity securities.  On January 12, 2008, we sold 24,318,181 shares of our common stock and 24,318,181 Series C warrants to purchase shares of common stock for an aggregate purchase price of $21.4 million in a private placement offering to accredited investors. The original exercise price of the warrants is $1.00 per share. Pursuant to the Warrant Amendment, the exercise price has been reduced to $0.15. The warrants are exercisable for a period of 5 years from the date of issuance of the warrants. We used the net proceeds from the offering for working capital and general corporate purposes.   In March 2007 we also raised $17.3 million through sales of units consisting of our Series A and Series B Convertible Notes and warrants. As discussed elsewhere, the Series A and Series B Convertible Notes have been converted into shares of our common stock pursuant to the Conversion Agreement and the Series A and Series B warrants exercise price have been reduced to $0.15 pursuant to the Warrant Amendment. The proceeds were used to complete our production line and working capital purpose.

Our future operations are dependent upon the achievement of profitable operations. Other than as discussed in this report, we know of no trends, events or uncertainties that are reasonably likely to impact our future liquidity.

 
21

 

Results of Operations

Comparison of the Fiscal Years Ended September 30, 2009 and 2008

Revenues, Cost of Sales and Gross Margin

   
Year Ended September 30, 2009
   
Year Ended September 30, 2008
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Sales
  $ 32,835,000       100.0 %   $ 29,412,000       100.0 %   $ 3,423,000       11.6 %
Cost of sales
    (33,876,000 )     (103.2 )%     (33,104,000 )     (112.6 )%     (772,000 )     2.3 %
Gross loss
  $ (1,041,000 )     (3.2 )%   $ (3,692,000 )     (12.6 )%   $ 2,651,000       (71.8 )%

For the fiscal year ended September 30, 2009, the Company reported total revenue of $32.8 million, representing an increase of $3.4 million or 11.6% compared to $29.4 million of revenue in the same period of fiscal year 2008. The increase in revenue resulted from increases in solar module shipments from 6.67 MW in fiscal year 2008 to 10.50MW in fiscal year 2009, partially offset by a 25% decrease in average selling prices for solar modules from $4.10 per watt in fiscal year 2008 to $3.07 per watt in fiscal year 2009. In fiscal year 2009, we recruited an experienced sales director in April 2009 and adjusted the reward system for the sales team which contributed to higher sales. Further, during the last quarter of fiscal year 2009, we acquired a new key customer, specifically a 10.00MW contract with a German system integrator contributing to the increase in sales volume.

For the fiscal year ended September 30, 2009, we incurred a negative gross margin of $1.0 million compared to $3.7 million in the same period of fiscal year 2008. The gross margin improvement is more apparent if a quarter-by-quarter comparison is made. We began generating a positive gross margin, 4.8% as percentage of net sales in the third quarter of fiscal year 2009, and improved our gross margin to 16.0% as percentage of net sales in the fourth quarter of fiscal year 2009, while the gross margin in the first and second quarters of fiscal year 2009 was negative 46% and negative 30%, respectively. The improvement in the gross profit margin was primarily due to the decrease in raw material prices, specifically the silicon wafer prices which offset the decrease in module sales prices. Silicon wafer prices decreased approximately 65% from RMB 46/piece during fiscal year 2008 to RMB16/piece during fiscal year 2009, as compared to module sales prices that decreased approximately 41% from EUR2.2/watt during fiscal year 2008 to EUR1.3/watt during fiscal year 2009. A special team led by our Chief Financial Officer spent significant amount of time and efforts on securing high quality key raw materials on the spot market with favorable credit terms. The Company also promoted a lean and zero inventory system to control quality and unqualified products. Further, the Company recruited an experienced sales director from the industry and built up a strong sales and marketing team, which resulted in new key customers. The increased sales volume also resulted in lower average fixed manufacturing cost. In addition, the Company engaged in various cost cutting programs and renegotiated most of the contracts to reduce operating expenses.

Selling, general and administrative

   
Year Ended September 30, 2009
   
Year Ended September 30, 2008
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Selling, general and administrative
  $ 9,224,000       28.1 %   $ 11,778,000       40.0 %   $ (2,554,000 )     (21.7 )%

For the fiscal year ended September 30, 2009, we incurred selling, general and administrative expense of $9.2 million, representing a decrease of $2.6 million or 21.7% from $11.8 million in the same period of fiscal year 2008. Selling, general and administrative expense as a percentage of net sales for the fiscal year ended September 30, 2009 decreased to 28.1% from 40.0% for fiscal year 2008. The decrease in the selling, general and administrative expenses were primarily due to a decrease of $2.3 million in stock-based compensation expenses related to employee options and restricted stock from $5.3 million for fiscal year ended September 30, 2008 to $3.0 million for the fiscal year ended September 30, 2009, which resulted from termination of several senior executives and forfeiture rate adjustment as a result of our recent management team restructuring.

Research & development

   
Year Ended September 30, 2009
   
Year Ended September 30, 2008
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Research and development
  $ 700,000       2.1 %   $ 702,000       2.4 %   $ (2,000 )     (0.3 )%

Research and development expenses in the fiscal years ended September 30, 2009 and 2008 were flat at $0.7 million. Research and development expenses as a percentage of net sales for the fiscal years ended September 30, 2009 and 2008 were 2.1% and 2.4%, respectively. The research and development expenses primarily relate to personnel expenses, stock-based compensation expenses and our commitments to fund our research and development contract with Shanghai University.

 
22

 

Loss on debt extinguishment

   
Year Ended September 30, 2009
   
Year Ended September 30, 2008
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Loss on debt extinguishment
  $ 527,000       1.6 %   $ 4,240,000       14.4 %   $ (3,713,000 )     (87.6 )%

For the fiscal year ended September 30, 2009, we incurred a loss on debt extinguishment of $0.5 million. The loss of $0.5 million was related to converting some of the Series A and B Convertible Notes into common stock. For the fiscal year ended September 30, 2008, we incurred a loss on debt extinguishment of $4.2 million. That loss was the result of a loss of $4.6 million related to converting Series A and B Convertible Notes into common stock, partially offset by a gain of approximately $0.4 million on the settlement of loan due to Coach Capital LLC and Infotech Essentials Ltd. The decrease in loss on debt extinguishment was mainly due to less Series A and B Convertible Notes that were converted into the Company’s common shares. A total of Series A and B Convertible Notes were converted into the Company’s common shares for fiscal years ended September 30, 2009 and 2008 were $0.9 million and $4.9 million, respectively.

Impairment Loss on Property and Equipment

   
Year Ended September 30, 2009
   
Year Ended September 30, 2008
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
 
% of change
 
Impairment loss on property and equipment
  $ 960,000       2.9 %   $ -       0.0 %   $ 960,000  
*NM
 
*NM= Not measureable
                                           
During the fourth quarter of fiscal year 2009 we recognized an impairment loss on property and equipment of $960,000 on the idle production equipment which was below standard quality.

Other income (expense)

   
Year Ended September 30, 2009
   
Year Ended September 30, 2008
   
Year-Over-Year Change
 
   
Amount
   
% of net sales
   
Amount
   
% of net sales
   
Amount
   
% of change
 
Interest income
  $ 16,000       0.0 %   $ 87,000       0.3 %   $ (71,000 )     (81.6 )%
Interest expense
    (3,998,000 )     (12.2 )%     (1,035,000 )     (3.5 )%     (2,963,000 )     286.3 %
Gain on change in fair market value of compound embedded derivative
    770,000       2.3 %     13,767,000       46.8 %     (12,997,000 )     (94.4 )%
Gain on change in fair market value of warrant liability
    1,344,000       4.1 %     13,978,000       47.5 %     (12,634,000 )     (90.4 )%
Other income (expense)
    139,000       0.4 %     (846,000 )     (2.9 )%     985,000       (116.4 )%
Total other income (expense)
  $ (1,729,000 )     (5.3 )%   $ 25,951,000       88.2 %   $ (27,680,000 )     (106.7 )%

For the fiscal year ended September 30, 2009, total other expenses were $1.7 million, representing an increase of $27.7 million or 106.7% compared to total other income of $26.0 million for the prior year. Other expenses as a percentage of net sales for the fiscal year ended September 30, 2009 changed to negative 5.3% from positive 88.2%, which is other income as a percentage of net sales for the fiscal year ended September 30, 2008. In the fiscal year ended September 30, 2009, we recorded a gain on change in fair market value of compound embedded derivative of $0.8 million and a gain on change in fair market value of warrant liability of $1.3 million compared to a gain on change in fair market value of compound embedded derivative of $13.8 million and a gain on change in fair market value of warrant liability of $14.0 million during the fiscal year ended September 30, 2008. The decrease in the Company’s stock price is less significant in the fiscal year ended September 30, 2009 than in the fiscal year ended September 30, 2008, which resulted in less decrease in the fair value of the compound embedded derivative and warrant liability and less gains on change in fair market value of the compound embedded derivative and warrant liability. We incurred interest expenses of $4.0 million and $1.0 million in the fiscal years ended September 30, 2009 and 2008, respectively, primarily related to amortization on discounted convertible notes and deferred financing cost, and 6% interest charges on Series A and B Convertible Notes. Other income of $0.1 million for the fiscal year ended September 30, 2009 and other expense of $0.8 million for the fiscal year ended September 30, 2008 were primarily related to foreign exchange gain (loss).

 
23

 

Liquidity and Capital Resources

   
Year Ended September 30,
       
   
2009
   
2008
   
Change
 
                   
Cash and cash equivalents
  $ 1,719,000     $ 3,238,000     $ (1,519,000 )
                         
Net cash provided by (used in):
                       
Operating activities
  $ (1,142,000 )   $ (10,181,000 )   $ 9,039,000  
Investing activities
    (383,000 )     (10,499,000 )     10,116,000  
Financing activities
    -       19,887,000       (19,887,000 )
Effect of exchange rate changes on cash and cash equivalents
    6,000       123,000       (117,000 )
Net decrease in cash and cash equivalents
  $ (1,519,000 )   $ (670,000 )   $ (849,000 )

As of September 30, 2009 and 2008, we had cash and cash equivalents of $1.7 million and $3.2 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, additional acquisitions, or other events, may cause us to seek additional equity or debt financing in the future.

Net cash used in operating activities were $1.1 million and $10.2 million for the fiscal years ended September 30, 2009 and 2008, respectively. To present cash flows from operating activities, net loss for each of the past two years had to be adjusted for certain significant items. After adjusting for the impact of $1.7 million and $23.4 million for fiscal years 2009 and 2008 respectively resulting from the change on the fair market value of the compound derivative liabilities and warrants liabilities, amortization of note discount and deferred financing cost, and loss on debt extinguishment, the net loss is $12.5 million and $17.8 million for the fiscal year ended September 30, 2009 and September 30, 2008 respectively. The decrease of $9.0 million in net cash used in operating activities from 2009 to 2008 was mainly attributable to the following reasons:

 
·
The decrease of $5.3 million in the net loss, after the adjustments related to the compound derivative liabilities and warrants liabilities, amortization of note discount and deferred financing cost, and loss on debt extinguishment, which mainly results from stronger sales generated in the fiscal year ended September 30, 2009;
 
·
The decrease of $0.2 million in the non-cash charges related to depreciation of property and equipment, stock-based compensation, and the impairment loss on property and equipment; and
 
·
Favorable changes in operating assets of $3.9 million primarily resulting from higher accounts payable related to inventory, lower VAT receivables, and lower advance payments for raw material purchases, partially offset by higher accounts receivable, reflecting the Company’s improved operational results, coupled with strong reputation and creditability among key raw material suppliers, which allows us to obtain more favorable payment terms. Lower advance payments is another change in the industry after the financial crisis, which changed the previously required 100% cash advance to secure key raw material (wafer) to zero in the current economic situation.

Net cash used in investment activities were $0.4 million and $10.5 million in the fiscal years ended September 30, 2009 and 2008. The decrease of $10.1 million in net cash used in investing activities was primarily due to lower property and equipment acquisitions during the fiscal year ended September 30, 2009 compared to the fiscal year ended September 30, 2008, because our current property and equipment are adequate to support our productions and we have no plan to expand our production lines.

There was no cash provided by financing activities for the fiscal year ended September 30, 2009.  Net cash provided by financing activities totaled $19.9 million for the fiscal year ended September 30, 2008 was mainly due to proceeds in January 2008 from issuing common stock and warrants, net of financing cost through a private equity financing.

Future minimum payments under all non-cancelable lease obligations and payments under our agreement with Shanghai University are as follows as of September 30, 2009:

 
24

 

         
Payments Due by Period
 
   
Total
   
Less than 1
year
   
1 to 3 years
   
4 to 5 year
   
More than 5
years
 
                               
Operating lease
  $ 1,008,000     $ 656,000     $ 352,000     $ -     $ -  
Research and development commitment
    3,780,000       2,667,000       1,113,000       -       -  
 
                                       
Total contractual obligations
  $ 4,788,000     $ 3,323,000     $ 1,465,000     $ -     $ -  

Our consolidated financial statements 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. The independent auditor’s report on our financial statements as of and for the fiscal year ended September 30, 2009 included herein contains an explanatory paragraph stating that our recurring net losses and negative cash flows from operations raises substantial doubt about our ability to continue as a going concern. The fiscal year 2009 consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from uncertainty related to the Company’s ability to continue as a going concern.

As of September 30, 2009, we had outstanding convertible notes with a principal balance of $11.6 million consisting of $2.5 million in principal amount of Series A Convertible Notes and $9.1 million in principal amount of Series B Convertible Notes, which were recorded at carrying amount at $3.1 million. These Notes bear interest at 6% per annum and are due on March 7, 2010.

We only had $1.7 million in cash and cash equivalents on hand as of September 30, 2009. On January 7, 2010, we entered into the Conversion Agreement with the holders of Notes representing at least seventy-five percent of the aggregate principal amounts outstanding under the Notes to modify the terms of the Notes. Pursuant to the terms of the Conversion Agreement, the Notes will be automatically converted into shares of our common stock at a conversion price of $0.15 per share and shall be amended to eliminate the maximum ownership percentage restriction prior to such conversion.  Under the Conversion Agreement, the Notes have been amended and election has been taken such that all outstanding principal, all accrued but unpaid interest, and all accrued and unpaid Late Charges (as defined in the Notes) with respect to all of the outstanding Notes have been automatically converted into shares of the Company’s common stock (the “Conversion”) at a conversion price per share of common stock of $0.15 effective as of January 7, 2010 (the “Conversion Date”).  As of the Conversion Date, no further payments are owing or payable under the Notes.  As of the Conversion Date, each Note no longer represents a right to receive any cash payments (including, but not limited to, interest payments) and only represents a right to receive the shares of common stock into which such Note has been automatically converted into.
 
In connection with the Conversion, on January 7, 2010, we entered into an Amendment to the Series A, Series B and Series C Warrants (the “Warrant Amendment”) with the holders of at least a majority of the common stock underlying each of our outstanding Series A Warrants, Series B Warrants and Series C Warrants (collectively the “PIPE Warrants”). The Warrant Amendment reduces the exercise price for all of the PIPE Warrants from $1.21, $0.90 and $1.00, respectively, to $0.15, removes certain maximum ownership provisions and removes anti-dilution provisions for lower-priced security issuances.

Historically, we have incurred operating loss and cash outflows from operations. Since early fiscal 2009 significant steps were taken to reach operational profitability. Gross margin has turned into positive territory and expenses have been significantly reduced. Starting in the third quarter of fiscal year 2009, we achieved operational profits. Our management expects the current upward trend to continue and we will generate positive cash flow to support our future operations in fiscal year 2010.

We believe that the successful completion of the debt restructuring, along with our existing cash resources and the cash expected to be generated from sales during fiscal year 2010 will be sufficient to meet our projected operating requirements through at least the next twelve months and enable us to continue as a going concern. If we experience a material shortfall versus our plan for fiscal year 2010, 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, including securing a credit facility, entering into secured or unsecured bank loans, or undertaking equity offerings such a rights offering to existing shareholders. However, due to the tight 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.
 
25

 
Off-Balance Sheet Arrangements
 
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, a polysilicon manufacturer based in Dallas, Texas, for $1.0 million in cash. The Company is obligated to acquire an additional two million shares at the same per share price upon the first polysilicon shipment meeting the quality specifications determined solely by the Company. On August 21, 2008, the two million shares acquired by the Company constituted approximately 7.8% of 21-Century Silicon’s outstanding equity. As of September 30, 2009, the two million shares acquired by the Company have been diluted and constituted approximately 5.5% of 21-Century Silicon’s outstanding equity. The equity purchase agreement further provides that the Company will be obligated to acquire an additional two million shares upon 21-Century Silicon meeting certain milestones. In connection with the equity purchase agreement, the Company has also signed a memorandum of understanding with 21-Century Silicon for a four-year supply framework agreement for polysilicon shipments. As of September 30, 2009, the Company has not yet acquired the additional two million shares. On March 5, 2009, the Emerging Technology Fund created by the State of Texas invested $3.5 million in 21-Century Silicon.

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.

Warranty Cost

The Company provides product warranties and accrues for estimated future warranty costs in the period in which the revenue is recognized. Our standard solar modules are typically sold with a two-year warranty for defects in materials and workmanship and a 10-year and 25-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 our warranty obligations and accrues the estimated costs of warranties based primarily on management’s best estimate. 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, 2009 and 2008, the Company’s warrant liability was $515,000 and $252,000, respectively. The Company’s warranty costs for the fiscal years ended September 30, 2009 and 2008 were $263,000 and $248,000, respectively. The Company did not make any warranty payments during the fiscal years ended September 30, 2009 and 2008.

Impairment of Long Lived Assets

The Company reviews its long-lived assets and identifiable intangibles 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. During fiscal year ended September 30, 2009 the Company recorded an impairment loss on property and equipment of approximately $960,000 to reflect the idle machinery which could not meet the quality requirements and cannot be put into mass production. No loss on property and equipment impairment was recorded during fiscal year ended September 30, 2008.

Investment

Investment 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. Investment 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.

 
26

 

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 for $1.0 million in cash. On August 21, 2008, the two million shares acquired by the Company constituted approximately 7.8% of 21-Century Silicon’s outstanding equity.
 
On March 5, 2009, the Emerging Technology Fund, created by the State of Texas had invested $3.5million to expedite innovation and commercialization of research. As of September 30, 2009, the two million shares acquired by the Company have been diluted and constituted approximately 5.5% of 21-Century Silicon’s outstanding equity. The company had performed the impairment assessment during the meeting and determined that the investment was not impaired. As of September 30, 2009, the Company accounted for the investment in 21-Century Silicon at cost amounting to $1.0 million.

Income Taxes

The Company files federal and state income tax returns in the United States for its United States operations, and files separate foreign tax returns for its foreign subsidiary in the jurisdictions in which this entity operates. The Company accounts for income taxes under 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, 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 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. 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 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. Additionally, this guidance provides guidance on de-recognition, accounting in interim periods, disclosure and transition.

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”.

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:

 
27

 

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, 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. 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 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 its 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 the Company’s 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.

28


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, 2009 and 2008, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended September 30, 2009.  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, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the two years in the period ended September 30, 2009, 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 2009 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
 January 12, 2010

 
29

 

Solar EnerTech Corp.
Consolidated Balance Sheets

   
September 30,
 
   
2009
   
2008
 
             
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 1,719,000     $ 3,238,000  
Accounts receivable, net of allowance for doubtful account of $96,000 and $21,000 at September 30, 2009 and 2008, respectively
    7,395,000       1,875,000  
Advance payments and other
    799,000       3,175,000  
Inventories, net
    3,995,000       4,886,000  
Deferred financing costs, net of accumulated amortization
    1,250,000       1,812,000  
VAT receivable
    334,000       2,436,000  
Other receivable
    408,000       730,000  
Total current assets
    15,900,000       18,152,000  
Property and equipment, net
    10,509,000       12,934,000  
Investment
    1,000,000       1,000,000  
Deposits
    87,000       701,000  
Total assets
  $ 27,496,000     $ 32,787,000  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Accounts payable
  $ 5,794,000     $ 1,771,000  
Customer advance payment
    27,000       96,000  
Accrued expenses
    1,088,000       910,000  
Accounts payable and accrued liabilities, related parties
    5,646,000       5,450,000  
Derivative liabilities
    178,000       980,000  
Convertible notes, net of discount
    3,061,000       85,000  
Total current liabilities
    15,794,000       9,292,000  
Warrant liabilities
    2,068,000       3,412,000  
Total liabilities
    17,862,000       12,704,000  
                 
STOCKHOLDERS' EQUITY:
               
Common stock - 400,000,000 shares authorized at $0.001 par value 111,406,696 and 112,052,012 shares issued and outstanding at September 30, 2009 and 2008, respectively
    111,000       112,000  
Additional paid in capital
    75,389,000       71,627,000  
Other comprehensive income
    2,456,000       2,485,000  
Accumulated deficit
    (68,322,000 )     (54,141,000 )
Total stockholders' equity
    9,634,000       20,083,000  
Total liabilities and stockholders' equity
  $ 27,496,000     $ 32,787,000  

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

 
30

 

Solar EnerTech Corp.
Consolidated Statements of Operations

   
Year Ended September 30,
 
   
2009
   
2008
 
             
Sales
  $ 32,835,000     $ 29,412,000  
Cost of sales
    (33,876,000 )     (33,104,000 )
Gross loss
    (1,041,000 )     (3,692,000 )
                 
Operating expenses:
               
Selling, general and administrative
    9,224,000       11,778,000  
Research and development
    700,000       702,000  
Loss on debt extinguishment
    527,000       4,240,000  
Impairment loss on property and equipment
    960,000       -  
Total operating expenses
    11,411,000       16,720,000  
                 
Operating loss
    (12,452,000 )     (20,412,000 )
                 
Other income (expense):
               
Interest income
    16,000       87,000  
Interest expense
    (3,998,000 )     (1,035,000 )
Gain on change in fair market value of compound embedded derivative
    770,000       13,767,000  
Gain on change in fair market value of warrant liability
    1,344,000       13,978,000  
Other income (expense)
    139,000       (846,000 )
Net (loss) income
  $ (14,181,000 )   $ 5,539,000  
                 
Net (loss) income per share - basic
  $ (0.16 )   $ 0.07  
Net (loss) income per share - diluted
  $ (0.16 )   $ (0.18 )
                 
Weighted average shares outstanding - basic
    87,817,762       75,944,461  
Weighted average shares outstanding - diluted
    87,817,762       98,124,574  

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

 
31

 

Solar EnerTech Corp.
Consolidated Statements of Stockholders’ Equity

               
Other
         
Total
   
Total
 
   
Common Stock
   
Additional Paid-
   
Comprehensive
   
Accumulated
   
Stockholders'
   
Comprehensive
 
   
Number
   
Amount
   
In Capital
   
Income
   
Deficit
   
Equity
   
Loss
 
Balance at September 30, 2007
    78,827,012     $ 79,000     $ 39,192,000     $ 592,000     $ (59,680,000 )   $ (19,817,000 )   $ (59,088,000 )
Issue of stock to settle outstanding notes
    1,038,000       1,000       871,000       -       -       872,000       -  
Issue of stock and warrants for cash
    24,318,000       24,000       19,863,000       -       -       19,887,000       -  
Stock-based compensation
    -       -       5,619,000       -       -       5,619,000       -  
Reversal of interest related to related party loan
    -       -       83,000       -       -       83,000       -  
Issue of stock for convertible notes
    7,869,000       8,000       5,999,000       -       -       6,007,000       -  
Currency translation adjustment
    -       -       -       1,893,000       -       1,893,000       1,893,000  
Net income for the year ended September 30, 2008
    -       -       -       -       5,539,000       5,539,000       5,539,000  
Balance at September 30, 2008
    112,052,012     $ 112,000     $ 71,627,000     $ 2,485,000     $ (54,141,000 )   $ 20,083,000     $ (51,656,000 )
Stock-based compensation
    -       -       3,446,000       -       -       3,446,000       -  
Issue of stock for convertible notes
    1,454,684       1,000       314,000       -       -       315,000       -  
Cancellation of unvested restricted stock
    (2,100,000 )     (2,000 )     2,000       -       -       -       -  
Currency translation adjustment
    -       -       -       (29,000 )     -       (29,000 )     (29,000 )
Net loss for the year ended September 30, 2009
    -       -       -       -       (14,181,000 )     (14,181,000 )     (14,181,000 )
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 )

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

 
32

 

Solar EnerTech Corp.
Consolidated Statements of Cash Flows

   
Year Ended September 30,
 
   
2009
   
2008
 
Cash flows from operating activities:
           
Net (loss) income
  $ (14,181,000 )   $ 5,539,000  
Adjustments to reconcile net (loss) income to net cash used in operating activities:
               
Depreciation of property and equipment
    2,308,000       1,359,000  
Disposal loss on  property and equipment
    15,000       -  
Stock-based compensation
    3,446,000       5,619,000  
Loss on debt extinguishment
    527,000       4,240,000  
Impairment loss on property and equipment
    960,000       -  
Amortization of note discount and deferred financing cost
    3,298,000       144,000  
Gain on change in fair market value of compound embedded derivative
    (770,000 )     (13,767,000 )
Gain on change in fair market value of warrant liability
    (1,344,000 )     (13,978,000 )
Changes in operating assets and liabilities:
               
Accounts receivable, net
    (5,518,000 )     (724,000 )
Advance payments and other
    2,371,000       3,981,000  
Inventories, net
    884,000       1,379,000  
VAT receivable
    2,097,000       (1,850,000 )
Other receivable
    321,000       (549,000 )
Accounts payable, accrued liabilities and customer advance payment
    4,132,000       (3,055,000 )
Deposits
    116,000       -  
Accounts payable and accrued liabilities, related parties
    196,000       1,481,000  
Net cash used in operating activities
    (1,142,000 )     (10,181,000 )
                 
Cash flows from investing activities:
               
Acquisition of property and equipment
    (419,000 )     (9,499,000 )
Proceeds from sales of property and equipment
    36,000       -  
Investment
    -       (1,000,000 )
Net cash used in investing activities
    (383,000 )     (10,499,000 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of common stock, net of offering cost
    -       19,887,000  
Net cash provided by financing activities
    -       19,887,000  
                 
Effect of exchange rate on cash and cash equivalents
    6,000       123,000  
Net decrease in cash and cash equivalents
    (1,519,000 )     (670,000 )
Cash and cash equivalents, beginning of period
    3,238,000       3,908,000  
Cash and cash equivalents, end of period
  $ 1,719,000     $ 3,238,000  
                 
Cash paid:
               
Interest
  $ 530,000     $ 1,138,000  
Non-cash investing and financing activities:
               
Warrants issued to placement agent in connection with convertible notes
  $ -     $ 1,006,080  
Warrants issued to note holders
  $ -     $ 19,563,167  

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

 
33

 

SOLAR ENERTECH CORP.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER 30, 2009

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.

The Company’s management in February 2008 decided that it was in the Company’s and its shareholders best interests to change the Company’s state of domicile from Nevada to Delaware (the “Reincorporation”).  On August 13, 2008, the Company, a Nevada entity at the time, entered into an Agreement and Plan of Merger with Solar EnerTech Corp., a Delaware corporation and wholly-owned subsidiary of the Nevada entity (the “Delaware Subsidiary”), whereby the Nevada entity merged with and into the Delaware Subsidiary in order to effect the Reincorporation. After the Reincorporation, the Nevada entity ceased to exist and the Company survived as a Delaware entity.

The Reincorporation was duly approved by both the Company’s Board of Directors and a majority of the Company’s stockholders at its annual meeting of stockholders held on May 5, 2008. On August 13, 2008, the Reincorporation was completed. The Reincorporation into Delaware did not result in any change to the Company’s business, management, employees, directors, capitalization, assets or liabilities.

On April 27, 2009, the Company entered into a Joint Venture Agreement (the “JV Agreement”) with Jiangsu Shunda Semiconductor Development Co., Ltd. (“Jiangsu Shunda”) to form a joint venture in the United States by forming a new company, to be known as Shunda-SolarE Technologies, Inc. (the “Joint Venture Company”), in order to jointly pursue opportunities in the United States solar market. After its formation, the Joint Venture Company’s name was later changed to SET-Solar Corp.

Pursuant to the terms of the JV Agreement, Jiangsu Shunda owns 55% of the Joint Venture Company, the Company owns 35% of the Joint Venture Company and the remaining 10% of the Joint Venture Company is owned by the Joint Venture Company’s management.  The Joint Venture Company’s Board of Directors consist of five directors: three of the directors were nominated by Jiangsu Shunda and two of whom were nominated by the Company.  Furthermore, Mr. Yunda Ni, the President of Jiangsu Shunda, serves as the Joint Venture Company’s Chairman of the Board and Mr. Leo Shi Young, the Company’s Chief Executive Officer serves as the Joint Venture Company’s Vice Chairman of the Board.  Jiangsu Shunda is responsible for managing the Joint Venture Company in China and the Company is responsible for the managing the Joint Venture Company in the United States.  The JV Agreement is valid for 18 months. As of September 30, 2009, due to the foreign currency controls imposed by the PRC government, Jiangsu Shunda and the Company have not contributed any capital to the Joint Venture Company and no equity interest has been issued to either Jiangsu Shunda or the Company.

NOTE 2 — LIQUIDITY AND GOING CONCERN ISSUES
 
The Company has incurred significant net losses and has had negative cash flows from operations during each period from inception through September 30, 2009 and has an accumulated deficit of approximately $68.3 million at September 30, 2009. For the fiscal year ended September 30, 2009, the Company had negative operating cash flows of approximately $1.1 million and incurred a net loss of approximately $14.2 million. As of September 30, 2009, the Company had outstanding convertible notes with a principal balance of $11.6 million consisting of $2.5 million in principal amount of Series A Convertible Notes (the “Series A Notes”) and $9.1 million in principal amount of Series B Convertible Notes (the “Series B Notes”), which were recorded at carrying amount at $3.1 million, collectively known as the “Notes”. These Notes bear interest at 6% per annum and are due on March 7, 2010. The Company only had approximately $1.7 million in cash and cash equivalents on hand as of September 30, 2009. 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. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
 
Since April 2009, significant steps were taken to reach operational profitability including securing key new contracts, which will generate increased sales volumes. In addition, the Company engaged in various cost cutting programs and renegotiated most of the contacts to reduce operating expenses. Due to the above and the decrease in raw material prices, specifically silicon wafer prices, the Company has been generating positive gross margins starting in the third quarter of fiscal year 2009.
 
 
34

 
 
As discussed in “Note 16-Subsequent Events”, all of the Notes will automatically be converted into shares and the terms of the warrants issued in conjunction with the Notes will be amended. The Company believes that the successful completion of the conversion, along with our existing cash resources and the cash expected to be generated from operations during fiscal year 2010 will be sufficient to meet the Company’s projected operating requirements through at least the next twelve months and enable it to continue as a going concern.
 
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 Infotech Hong Kong New Energy Technologies, Limited (“Infotech HK”) and Solar EnerTech (Shanghai) Co., Ltd (“Infotech Shanghai” and together with Infotech HK, “Infotech”). While the Company did not own Infotech, the Company’s financial statements have included the results of the financials of each of Infotech 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 revenue 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.

 
35

 

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

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 the 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 10-year and 25-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. 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, 2009 and 2008, the Company’s warrant liability was $515,000 and $252,000, respectively. The Company’s warranty costs for the fiscal years ended September 30, 2009 and 2008 were $263,000 and $248,000, respectively. The Company did not make any warranty payments during the fiscal years ended September 30, 2009 and 2008.

Impairment of Long Lived Assets

The Company reviews its long-lived assets and identifiable intangibles 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. During fiscal year ended September 30, 2009 the Company recorded an impairment loss on property and equipment of approximately $960,000 to reflect the idle machinery which could not meet the quality requirements and cannot be put into mass production. No loss on property and equipment impairment was recorded during fiscal year ended September 30, 2008.

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.

 
36

 

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 for $1.0 million in cash. On August 21, 2008, the two million shares acquired by the Company constituted approximately 7.8% of 21-Century Silicon’s outstanding equity.
 
As of September 30, 2009, the Company accounted for the investment in 21-Century Silicon at cost amounting to $1.0 million. On March 5, 2009, the Emerging Technology Fund, created by the State of Texas had invested $3.5million in 21-Century Silicon to expedite innovation and commercialization of research. As of September 30, 2009, the two million shares acquired by the Company have been diluted and constituted approximately 5.5% of 21-Century Silicon’s outstanding equity. In October 2009, the Company’s core management team, the Chief Executive Officer and Chief Financial Officer, visited the new manufacturing site of 21-Century Silicon. The Company performed an impairment assessment during the meeting and determined that the investment was not impaired.

Income Taxes

The Company files federal and state income tax returns in the United States for its United States operations, and files separate foreign tax returns for its foreign subsidiary in the jurisdictions in which this entity operates. The Company accounts for income taxes under 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, 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 position 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. 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 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. Additionally, this guidance provides guidance on de-recognition, accounting in interim periods, disclosure and transition.

Derivative Financial Instruments

FASB ASC 815, “Derivatives and Hedging”, formerly referenced as SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, requires all derivatives to be recorded on the balance sheet at fair value. These derivatives, including embedded derivatives in the Company’s structured borrowings, are separately valued and accounted for on the balance sheet. Fair values for exchange-traded securities and derivatives are based on quoted market prices. Where market prices are not readily available, fair values are determined using market based pricing models incorporating readily observable market data and requiring judgment and estimates.
 
FASB ASC 815 requires freestanding contracts that are settled in a company’s own stock, including common stock warrants, to be designated as an equity instrument, an asset or a liability. Under FASB ASC 815 guidance, a contract designated as an asset or a liability must be carried at fair value on a company’s balance sheet, with any changes in fair value recorded in the company’s results of operations.

The Company’s management used market-based pricing models to determine the fair values of the Company’s derivatives. The model uses market-sourced inputs such as interest rates, exchange rates and volatilities. Selection of these inputs involves management’s judgment and may impact net income.

 
37

 

The method used to estimate the value of the compound embedded derivatives (“CED”) as of each valuation date was a Monte Carlo simulation. Under this method the various features, restrictions, obligations and option related to each component of the CED were analyzed and spreadsheet models of the net expected proceeds resulting from exercise of the CED (or non-exercise) were created. Each model is expressed in terms of the expected timing of the event and the expected stock price as of that expected timing.

Because the potential timing and stock price may vary over a range of possible values, a Monte Carlo simulation was built based on the possible stock price paths (i.e., daily expected stock price over a forecast period). Under this approach an individual potential stock price path is simulated based on the initial stock price on the measurement date, and the expected volatility and risk free interest rate over the forecast period. Each path is compared against the logic described above for potential exercise events and the present value (or non-exercise which result in $0 value) recorded. This is repeated over a significant number of trials, or individual stock price paths, in order to generate an expected or mean value for the present value of the CED.

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 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.

 
38

 

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are carried at net realizable value. The Company records its 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 the Company’s customers, current economic conditions, and other factors that may affect customers’ ability to pay.

Shipping and Handling Costs

The Company incurred shipping and handling costs of $239,000 and $191,000 for the fiscal years ended September 30, 2009 and 2008, 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 years ended September 30, 2009 and 2008 were $700,000 and $702,000, respectively.

Comprehensive Loss

Comprehensive 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 loss is reported in the consolidated statements of shareholder’s equity.  Other comprehensive income 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, 2009 and 2008, the Company had four customers and one customer, respectively that accounted for more than 10% of net sales.

Reclassifications

Certain amounts in the prior year consolidated financial statements have been reclassified to conform to the current year presentation. These reclassifications have no effect on previously reported results of operations.

Recent Accounting Pronouncements

On September 30, 2009, the Company adopted Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification TM and The Hierarchy of Generally Accepted Accounting Principles (“ASC” or “Codification” – a replacement of FASB Statement No.162). The Codification became the source of authoritative generally accepted accounting principles recognized by the Financial Accounting Standards Board (“FASB”) to be applied by nongovernmental entities. Rules and interpretive releases of the U.S. Securities and Exchange Commission (the “SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification supersedes all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification is non-authoritative. GAAP is not intended to be changed as a result of this statement, but will change the way the guidance is organized and presented. The Company has implemented the Codification in the consolidated financial statements by providing references to the ASC topics.

In February 2007, the FASB issued FASB ASC 825, “Financial Instruments”, formerly referenced as Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” which provides companies with an option to report selected financial assets and liabilities at fair value. FASB ASC 825 establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities.  FASB ASC 825 was effective for fiscal years beginning after November 15, 2007.  The Company did not elect to report any of its financial assets or liabilities at fair value, and as a result, the adoption of FASB ASC 825 had no material impact on its financial and results of operations.

 
39

 

 In December 2007, the FASB issued FASB ASC 805, “Business Combination”, formerly referenced as SFAS No. 141 (revised), “Business Combinations”. FASB ASC 805 changes the accounting for business combinations, including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs, and the recognition of changes in the acquirer’s income tax valuation allowance. FASB ASC 805 is effective for the first annual reporting period beginning on or after December 15, 2008. Thus, FASB ASC 805 will be effective for the Company on October 1, 2009, with early adoption prohibited. The Company is evaluating the potential impact of the implementation of FASB ASC 805 on its financial position and results of operations.

In December 2007, the FASB issued FASB ASC 810, “Consolidation”, formerly referenced as SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”. FASB ASC 810 changes the accounting for non-controlling (minority) interests in consolidated financial statements, including the requirements to classify non-controlling interests as a component of consolidated stockholders’ equity, and the elimination of “minority interest” accounting in results of operations with earnings attributable to non-controlling interests reported as part of consolidated earnings. Additionally, FASB ASC 810 revises the accounting for both increases and decreases in a parent’s controlling ownership interest. FASB ASC 810 is effective for the first annual reporting period beginning on or after December 15, 2008. Thus, FASB ASC 810 will be effective for the Company on October 1, 2009, with early adoption prohibited. The Company is evaluating the potential impact of the implementation of FASB ASC 810 on its financial position and results of operations.

In December 2007, an update was made to FASB ASC 808-10, “Collaborative Arrangements”, formerly referenced as EITF Consensus for Issue No. 07-1, “Accounting for Collaborative Arrangements” which defines collaborative arrangements and establishes reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. This guidance also establishes the appropriate income statement presentation and classification for joint operating activities and payments between participants, as well as the sufficiency of the disclosures related to these arrangements. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008 and will be effective for the Company on October 1, 2009. The Company is currently evaluating the impact of the adoption of this guidance on its consolidated financial statements.

In February 2008, an update was made to FASB ASC 860, “Transfers and Servicing”, formerly referenced as FASB Staff Position No. FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” that addresses the issue of whether or not these transactions should be viewed as two separate transactions or as one linked” transaction. FASB ASC 860 includes a rebuttable presumption” that presumes linkage of the two transactions unless the presumption can be overcome by meeting certain criteria. This update will be effective for fiscal years beginning after November 15, 2008 and will apply only to original transfers made after that date; early adoption will not be allowed. This update will be effective to the Company after the beginning of its fiscal year 2010. The Company is currently evaluating the impact of the adoption of FASB ASC 860 on the Company’s financial position and results of operations.

In March 2008, the FASB issued FASB ASC 815, “Derivatives and Hedging”, formerly referenced as SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities”. FASB ASC 815 requires additional disclosures related to the use of derivative instruments, the accounting for derivatives and how derivatives impact financial statements.  FASB ASC 815 is effective for fiscal years and interim periods beginning after November 15, 2008.  Thus, the Company adopted this standard on January 1, 2009. Since FASB ASC 815 only required additional disclosures, the adoption did not impact the Company’s financial position and results of operations.

In May 2008, an update was made to the FASB ASC 470, “Debt”, formerly referenced as FASB Staff Position No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled In Cash Upon Conversion (Including Partial Cash Settlement)”.  FASB ASC 470 requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer's nonconvertible debt borrowing rate. As a result, the liability component would be recorded at a discount reflecting its below market coupon interest rate, and the liability component would subsequently be accreted to its par value over its expected life, with the rate of interest that reflects the market rate at issuance being reflected in the results of operations. This change in methodology will affect the calculations of net income and earnings per share, but will not increase the Company's cash interest payments. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years and will be effective for the Company on October 1, 2009. Retrospective application to all periods presented is required and early adoption is prohibited. The Company is evaluating the potential impact of the implementation of FASB ASC 470 on its financial position and results of operations.

In June 2008, an update was made to the FASB ASC 718, “Compensation – Stock Compensation”, which concluded that all unvested share-based payment awards that contain rights to receive non-forfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computing basic and diluted earnings per share. This guidance is effective for fiscal years beginning after December 15, 2008. This guidance will be effective to the Company on October 1, 2009.The Company is currently evaluating the requirement of this guidance as well as the impact of the adoption on its consolidated financial statements.

 
40

 
In November 2008, an update was made to the FSAB ASC 323, “Investments – Equity Method and Joint Ventures”, which addresses the impact that FASB ASC 805, “Business Combination” and FASB ASC 810, “Consolidation” might have on the accounting for equity method investments, including how the initial carrying value of an equity method investment should be determined, how an impairment assessment of an underlying indefinite lived intangible asset of an equity method investment should be performed and how to account for a change in an investment from the equity method to the cost method. This guidance is effective in fiscal periods beginning on or after December 15, 2008. This guidance will be effective to the Company on October 1, 2009.The Company is currently assessing the impact of the adoption of the provisions of this guidance on its consolidated financial statements.

In April 2009, an update was made to the FASB ASC 820, “Fair Value Measurements and Disclosures”, that provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. This update is effective for interim and annual periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. During the quarter ended June 30, 2009, the Company adopted this guidance and did not have a significant impact on its consolidated financial statements.

In April 2009, an update was made to the FASB ASC 825, “Financial Instruments”, which requires a publicly traded company to include disclosures about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. This update is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted this guidance during the quarter ended June 30, 2009. There was no significant impact on its consolidated financial statements as a result of adoption.

In April 2009, an update was made to the FASB ASC 320, “Investments – Debt and Equity Securities”, which introduced new disclosure requirements affecting both debt and equity securities and extend the disclosure requirements to interim periods including disclosure of the cost basis of securities classified as available-for-sale and held-to-maturity and provides further specification of major security types. This update is effective for fiscal years and interim periods beginning after June 15, 2009.  The Company adopted the guidance during the quarter ended June 30, 2009. The adoption of this guidance did not have a significant impact on the Company’s financial statements.

In May 2009, the FASB issued FASB ASC 855, “Subsequent Events”, formerly referenced as SFAS No. 165, “Subsequent Events” to establish general standards of accounting for and disclosure of subsequent events. FASB ASC 855 renames the two types of subsequent events as recognized subsequent events or non-recognized subsequent events and to modify the definition of the evaluation period for subsequent events as events or transactions that occur after the balance sheet date, but before the financial statements are issued. This will require entities to disclose the date, through which an entity has evaluated subsequent events and the basis for that date (the issued date for public companies). FASB ASC 855 is effective for interim or annual financial periods ending after June 15, 2009.  The Company adopted FASB ASC 855 during the quarter ended June 30, 2009. The adoption of FASB ASC 855 did not have a significant impact on the Company's financial statement disclosures (see Note 16 – Subsequent Events).

In June 2009, the FASB issued FASB ASC 810-10, “Consolidation”, formerly referenced as SFAS No. 167, “Amendments to FASB Interpretations No. 46(R)”. FASB ASC 810-10 revises the approach to determining the primary beneficiary of a variable interest entity (“VIE”) to be more qualitative in nature and requires companies to more frequently reassess whether they must consolidate a VIE. FASB ASC 810 is effective for interim and annual periods that begin after November 15, 2009. This guidance will be effective to the Company on January 1, 2010. The Company does not expect the adoption of FASB ASC 810-10 will have any impact on its results of operations and financial position as the Company does not have any VIEs.

In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05, an update to ASC 820. This update provides amendments to reduce potential ambiguity in financial reporting when measuring the fair value of liabilities. Among other provisions, this update provides clarification that in circumstances, in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the valuation techniques described in ASU 2009-05. ASU 2009-05 is effective for the first interim or annual reporting period beginning after its issuance. This guidance will be effective to the Company on October 1, 2009. The Company does not expect the adoption of ASU 2009-05 to have a material effect on its financial statements.
 
NOTE 4 — FINANCIAL INSTRUMENTS

Concentration of Credit risk

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.

 
41

 

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, 2009 and 2008, the Company had approximately $144,000 and $869,000, respectively in excess of insured limits.

Advance payments to suppliers are typically unsecured and arise from deposits paid in advance for future purchases of raw materials. During the financial crisis in 2008, the Company was generally required to make prepayments for some of its raw materials. The Company does not require collateral or other security against the prepayments to suppliers for raw materials.  In the event of a failure by the Company’s suppliers to fulfill their contractual obligations and to the extent that the Company is not able to recover its prepayments, the Company would suffer losses. The Company’s prepayments to suppliers have been steadily decreasing due to the change in the industry practice from requiring full cash advance to secure key raw material (silicon wafers) as a result of the financial crisis in 2008 to requiring less or no cash advance during fiscal year 2009 as the economy is recovering from the crisis. The economic crisis may affect the Company’s customers’ ability to pay the Company for its products that the Company has delivered.  If the customers fail to pay the Company for its products and services, the Company’s financial condition, results of operations and liquidity may be adversely affected.

Other financial instruments that potentially subject the Company to concentration of credit risk consist principally of accounts receivables.  Concentrations of credit risk with respect to accounts receivables 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 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. Certain key customers have also been insured by China Export & Credit Insurance Company. Therefore, the credit risk in accounts receivable is controllable even though the Company has a relatively high accounts receivable balance. During the fiscal years ended September 30, 2009 and 2008, the Company had four customers and one customer, respectively that accounted for more than 10% of net sales.

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 other accumulated comprehensive income was a cumulative foreign currency translation adjustment loss of $29,000 and a cumulative foreign currency translation adjustment gain of $1.9 million at September 30, 2009 and 2008, respectively.   Foreign currency transaction gains and losses are included in earnings. For fiscal years ended September 30, 2009 and 2008, the Company recorded foreign exchange gain of $0.1 million and foreign exchange loss of $0.8 million, respectively.

NOTE 5 — ADVANCE PAYMENTS AND OTHER

At September 30, 2009 and 2008, advance payments and other consist of:

   
September 30, 2009
   
September 30, 2008
 
Prepayment for raw materials
  $ 698,000     $ 2,959,000  
Others
    101,000       216,000  
Total advance payments and other
  $ 799,000     $ 3,175,000  
 
 
42

 

NOTE 6 — INVENTORY

At September 30, 2009 and 2008, inventory consists of:

   
September 30, 2009
   
September 30, 2008
 
Raw materials
  $ 1,708,000     $ 2,111,000  
Work in process
    945,000       145,000  
Finished goods
    1,342,000       2,630,000  
Total inventories
  $ 3,995,000     $ 4,886,000  

NOTE 7 — PROPERTY AND EQUIPMENT

The Company depreciates its assets over their estimated useful lives. A summary of property and equipment at September 30, 2009 and 2008 is as follows:

   
September 30, 2009
   
September 30, 2008
 
Production equipment
  $ 7,383,000     $ 5,564,000  
Leasehold improvements
    3,620,000       3,201,000  
Automobiles
    496,000       542,000  
Office equipment
    342,000       339,000  
Machinery
    2,749,000       2,170,000  
Furniture
    39,000       39,000  
Construction in progress
    22,000       2,915,000  
Total property and equipment
    14,651,000       14,770,000  
Less:  accumulated depreciation
    (4,142,000 )     (1,836,000 )
Total property and equipment, net
  $ 10,509,000     $ 12,934,000  

Total depreciation expenses for the years ended September 30, 2009 and 2008 were $2.3 million and $1.4 million, respectively.

NOTE 8 — INCOME TAXES

The Company has no taxable income and no provision for federal and state income taxes is required for 2009 and 2008, except certain state minimum tax.

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.

A reconciliation of the statutory federal rate and the Company’s effective tax rate for the fiscal years ended September 30, 2009 and 2008 are as follows:
 
   
Year Ended September 30,
 
   
2009
   
2008
 
U.S. federal taxes (benefit)
           
At statutory rate
   
34
%
   
34
%
Gain (loss) on derivative/warrant and other permanents
   
(5
)%
   
(89
)%
Stock-based compensation
   
(7
)%
   
29
%
Tax rate differences
   
(3
)%
   
6
%
Change in valuation allowance
   
(19
)%
   
20
%
Total
   
0
%
   
0
%
 
 
43

 

Significant components of the Company’s deferred tax assets and liabilities as of September 30, 2009 and 2008 are as follows:
 
   
Year Ended September 30,
 
   
2009
   
2008
 
Deferred tax assets:
           
Net operating loss carryforwards
 
$
5,678,000
   
$
3,622,000
 
Stock-based compensation
   
1,093,000
     
390,000
 
Allowances and reserve
   
1,779,000
     
1,704,000
 
Depreciation and amortization
   
151,000
     
282,000
 
Total deferred tax assets
   
8,701,000
     
5,998,000
 
Less valuation allowance
   
(8,701,000
)
   
(5,998,000
)
Net deferred tax assets
 
$
-
   
$
-
 

As of September 30, 2009 and 2008, the Company had United States federal net operating loss carry forwards of approximately $5.7 million and $4.6 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 $4.5 million and $0.3 million as of September 30, 2009 and 2008, respectively, and these losses will begin to expire at various dates beginning in 2018 if not utilized. In addition, the Company had foreign net operating loss carry forwards of approximately $14.0 million and $8.3 million as of September 30, 2009 and 2008, respectively. These net operating loss carryforwards will begin to expire in 2012 if not utilized.  The Company has no tax credit carry forwards.

As of September 30, 2009, 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 def