PERFECTENERGY INTERNATIONAL LTD - FORM 10-K

Note 1 – Summary of Significant Accounting Policies

(a) Organization and Description of Business

Perfectenergy International Limited (“PFGY” or “the Company”) was incorporated in the State of Nevada on February 25, 2005. The Company, through its subsidiaries, is principally engaged in the research, development, manufacturing, and sale of solar cells, solar modules, and photovoltaic (“PV”) systems. The Company’s manufacturing and research facility is located in Shanghai, China, and it has sales and service offices in Shanghai, China and Germany.

In October 2007, the Company entered into an Investment Agreement with Shanghai Zizhu Science Park Development Co., Ltd. (“Science Park”), under which the Company planned to construct a new solar cell production facility on certain land in the Shanghai Zizhu Science-Based Industrial District of Shanghai, China, which would have expanded lamination and cell production capacity. As required by the Investment Agreement, on February 28, 2008, the Company formed Perfectenergy Solar-Tech (Shanghai) Ltd. (“Perfectenergy Solar-Tech”) under the laws of the People’s Republic of China (“PRC” or “China”) as a wholly owned subsidiary of Perfectenergy International Limited (“Perfectenergy BVI”). Perfectenergy BVI was required to contribute $20,000,000 to the registered capital of Perfectenergy Solar-Tech, of which $4,000,000 has been contributed with the remaining $16,000,000 which should have been contributed by February 28, 2010. Due to supplementary land use restrictions, the Company obtained approval from local authority for a reduction in Perfectenergy Solar-Tech’s required registered capital from $20 million to $4 million. All registration documents of Perfectenergy Solar-Tech were completed in early September 2010.

(b) Basis of Presentation and Principles of Consolidation

The consolidated financial statements reflect the activities of the Company and its wholly owned subsidiaries, Perfectenergy BVI, Perfectenergy (Shanghai) Limited (“Perfectenergy Shanghai”), Perfectenergy GmbH (“Perfectenergy GmbH”), and Perfectenergy Solar-Tech.

All significant intercompany balances and transactions have been eliminated in consolidation. The Company has reclassified certain prior year amounts to conform to the current year presentation. These reclassifications have no effect on net loss. The accompanying consolidated financial statements are in U.S. dollars and include PFGY and each of its wholly owned subsidiaries.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the amounts reported in the financial statements and accompanying notes. Management considers many factors in selecting appropriate operational and financial accounting policies and controls, and in developing the assumptions used to prepare these financial statements. Management must apply significant judgment. Among the factors, but not fully inclusive of all factors that may be considered by management, are the following: the range of accounting policies permitted by accounting principles generally accepted in the United States of America; management’s understanding of the Company’s business - both historical results and expected future results; the extent to which operational controls exist that provide high degrees of assurance that all desired information to assist in the estimation is available and reliable or whether there is greater uncertainty in the information that is available upon which to base the estimate; expectations of the future performance of the economy, both domestically, and globally, within various areas that serve the Company’s principal customers and suppliers of goods and services; expected rates of exchange; sensitivity and volatility associated with the assumptions used in developing estimates; and whether historical trends are expected to be representative of future trends.

F-6

The estimation process often times may yield a range of potentially reasonable estimates of the ultimate future outcomes, and management must select an amount that lies within that range of reasonable estimates based upon the quantity, quality, and risks associated with the variability that might be expected from the future outcome and the factors considered in developing the estimate. This estimation process may result in the selection of estimates that could be viewed as conservative or aggressive by others. Management attempts to use its business and financial accounting judgment in selecting the most appropriate estimate; actual amounts, however, may differ from those estimates.

(d) Fair Value of Financial Instruments

·	Level 1 inputs to the valuation methodology, which are quoted prices (unadjusted) for identical assets or liabilities in active markets.

·	Level 2 inputs to the valuation methodology that includes quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, substantially for the full term of the financial instrument.

·	Level 3 inputs to the valuation methodology that are unobservable and significant to the fair value measurement.

	Carrying Value as of October 31, 2010	Fair Value at October 31, 2010
		Level 1	Level 2	Level 3
Warrant liability (See Note 11)	$―	$―	$―	$―

F-7

The Company analyzes all financial instruments with features of both liabilities and equity, pursuant to which the Company’s warrants were required to be recorded as a liability at fair value and marked to market each reporting period. Except for the warrant liability, the Company did not identify any asset and liability that is required to be presented on the balance sheet at fair value in accordance with this accounting standard.

(e) Foreign Currency Translation

The reporting currency of the Company is the U.S. dollar. The Company’s principal operating subsidiaries established in the PRC use the local currency, Renminbi (“RMB”), as their functional currency. The Company’s sales offices in Germany use the Euro (“EUR”) as their functional currency. The assets and liabilities of the Company’s Chinese subsidiaries at October 31, 2010 were translated at 6.67 RMB to $1.00 as compared to 6.82 RMB to $1.00 at October 31, 2009. The assets and liabilities of the Company’s German subsidiary at October 31, 2010 were translated at €0.72 to $1.00 as compared to €0.68 to $1.00 at October 31, 2009. Equity accounts were stated at their historical rate. The average translation rates applied to statement of operations accounts of the Company’s Chinese subsidiaries for the years ended October 31, 2010 and 2009 were 6.79 RMB and 6.82 RMB, respectively. The average translation rates applied to statement of operations accounts of the Company’s German subsidiary for the years ended October 31, 2010 and 2009 were €0.74 and €0.73 to $1.00, respectively. For the periods presented, adjustments resulting from translating financial statements into U.S. dollars are reported as cumulative translation adjustments and are shown as a separate component of other comprehensive income (loss). Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

In accordance with the accounting standard regarding "Statement of Cash Flows," cash flows from the Company's operations are calculated based upon the local currencies using the average translation rate. As a result, amounts related to assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets.

(f) Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

(g) Accounts Receivable

The Company conducts its business operations in the PRC, and it has sales offices in Germany. Management reviews its accounts receivable on a regular basis and analyzes historical bad debts, customer credit worthiness, current economic trends, and changes in customer payment patterns to determine if the allowance for doubtful account is adequate and adjusts the allowance when necessary. An estimate for doubtful accounts is recorded when collection of the full amount is no longer probable.

F-8

Other receivables consist of advanced payment to be refunded by the Company’s suppliers and intercompany transfer of foreign currencies held by the Company’s export agents. Due to the passage of time, advanced payment to be refunded by the Company’s suppliers has been reclassified as a non-current asset. Management reviews its other receivables on a regular basis and analyzes the financial conditions of the Company’s suppliers and export agents to determine if the allowance for doubtful account is adequate and adjusts the allowance when necessary. An estimate for doubtful accounts is recorded when collection of the full amount is no longer probable. The Company took an additional charge of approximately $1,868,000 during the year ended October 31, 2010 and fully reserved the advanced inventory payment. The Company continues to seek reimbursement from the supplier, but made a full provision against the prepaid amount based on current situations. If the Company receives reimbursement in the future, it will recognize income of approximately $3,803,000. At October 31, 2010 and 2009, allowance for doubtful accounts amounted to $ 3,803,337 and $1,861,097, respectively.

(h) Other Receivables

(i) Inventories

Inventories are stated at the lower of cost or market using a weighted average cost method. The Company reviews its inventory periodically for possible obsolete goods to determine if any reserves are necessary for potential obsolescence. The Company provides for slow moving inventory based on an analysis of the aging and utility of the inventory. As of October 31, 2010 and 2009, the Company had $561,796 and $637,335, respectively, in inventory reserve. The Company believes that the reserve is adequate to provide for expected losses.

(j) Prepayments

Prepayments are prepayments to the Company’s suppliers. Some of the Company’s suppliers require advanced payment before a delivery is made. Such prepayments are recorded in the financial statements as prepayments until delivery has occurred.

(k) Equipment and Leasehold Improvements

Equipment and leasehold improvements are stated at cost. Depreciation is computed by using the straight-line method at rates based on the estimated useful lives of the various classes of property. Estimates of useful lives are based upon a variety of factors including durability of the asset, the amount of usage that is expected from the asset, the rate of technological change, and the Company’s business plans for the asset. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset. Should the Company change its plans with respect to the use and productivity of property and equipment, it may require a change in the useful life of the asset or incur a charge to reflect the difference between the carrying value of the asset and the proceeds expected to be realized upon the asset’s sale or abandonment. Expenditures for maintenance and repairs are expensed as incurred and significant major improvements are capitalized.

F-9

Estimated useful lives of the Company’s assets are as follows:

	Useful Life
Leasehold improvements	Lease term (expires on May 31, 2011)
Transportation equipment	5 years
Machinery	5 - 10 years
Office equipment	5 years

(l) Impairment of Long-Lived Assets

The Company evaluates long-lived assets for impairment annually, and more often if an event or circumstance occurs that triggers an impairment test. Substantial judgment is necessary in the determination as to whether an event or circumstance has occurred that may trigger an impairment analysis and in the determination of the related cash flows from the asset. Estimating cash flows related to long-lived assets is a difficult and subjective process that applies historical experience and future business expectations to revenues and related operating costs of assets. Should impairment appear to be necessary, subjective judgment must be applied to estimate the fair value of the asset, for which there may be no ready market, which oftentimes results in the use of discounted cash flow analysis and judgmental selection of discount rates to be used in the discounting process. If the Company determines an asset has been impaired based on the projected undiscounted cash flows of the related asset or the business unit over the remaining amortization period, and if the cash flow analysis indicates that the carrying amount of an asset exceeds related undiscounted cash flows, the carrying value is reduced to the estimated fair value of the asset or the present value of the expected future cash flows. As of October 31, 2010, the Company expects these assets to be fully recoverable.

(m) Customer Deposits

Customer deposits are prepayments from our customers. Some of our sales require customers to prepay before delivery is made. Such prepayments are recorded in our financial statements as customer deposits until delivery has occurred.

(n) Value Added Tax

The Company’s sales of products in the PRC and Germany are subject to a value added tax (“VAT”) in accordance with tax laws. The VAT applied is 17% in the PRC and 19% in Germany of the gross sales price. A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company’s finished products and payment of freight expenses can be used to offset the VAT due on sales of the finished products.

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(o) Provision for Income Taxes

The Company accounts for income taxes in accordance with the Financial Accounting Standards Board’s (“FASB”) accounting standard for income taxes. Under the asset and liability method as required by this accounting standard, the Company must recognize deferred income tax liabilities and assets for the expected future tax consequences of temporary differences between income tax basis and financial reporting basis of assets and liabilities. Provision for income taxes consist of taxes currently due plus deferred taxes.

The Company adopted FASB’s accounting standard for Accounting for Uncertainty in Income Taxes. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The accounting standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.

The Company accounts for income taxes using the asset and liability method. Deferred tax liabilities and assets are determined based on temporary differences between the basis of assets and liabilities for income tax and financial reporting purpose of the Company. The deferred tax assets and liabilities are classified according to the financial statement classification of the assets and liabilities generating the differences. Valuation allowances are established when necessary based upon the judgment of management to reduce deferred tax assets to the amount expected to be realized and could be necessary based upon estimates of future profitability and expenditure levels over specific time horizons in particular tax jurisdictions.

(p) Revenue Recognition

The Company’s revenue recognition policies are in accordance with the FASB’s accounting standard. Revenues from solar cells, solar modules, and PV systems are recognized upon shipment of the products only if no significant Company obligations remain, the fee is fixed or determinable, and collection is received or the resulting receivable is deemed probable. Revenue is recognized, net of discount and allowances, at the time of product shipment. All of the Company’s products that are sold in the PRC are subject to a Chinese VAT at a rate of 17% of the gross sales price or at a rate approved by the PRC local government. All of the Company’s products that are sold in Germany are subject to a Germany VAT at a rate of 19% of the gross sales price or at a rate approved by the Germany government. In general, the Company does not accept product returns; only under special situations, when both the Company and customers agree, is a product exchange allowed. For solar cells, solar modules, and PV systems, the Company is covered by product quality insurance and product liability insurance. The product quality insurance retroactively covers the period from July 1, 2007 to the end of the insurance period on June 30, 2011. As such, the Company does not maintain a provision for potential warranty cost.

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(q) Shipping and Handling

(r) Advertising

Advertising and promotion expenses are expensed as incurred, and the expense was immaterial for the years ended October 31, 2010 and 2009.

(s) Research and Development Costs

(t) Loss per Share

The Company reports earnings per share in accordance with the provisions of FASB’s related accounting standard. This standard requires the presentation of earnings per share (EPS) as basic EPS and diluted EPS in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic EPS excludes dilution and is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.

The following is a reconciliation of the basic and diluted earnings per share computation:

	Year Ended October 31,
	2010			2009

Net loss for basic earnings per share	$	(2,728,098	)	$	(5,684,335	)

Weighted average shares used in basic computation		29,626,916			29,626,916
Diluted effect of options and warrants		-			-
Weighted average shares used in diluted computation		29,626,916			29,626,916

Weighted Average Earnings per share
Basic	$	(0.09	)	$	(0.19	)
Diluted	$	(0.09	)	$	(0.19	)

F-12

For the years ended October 31, 2010 and 2009, none of the issued and outstanding warrants and options were included in the calculation of diluted earnings per share since their effect would be anti-dilutive.

(u) Stock-Based Compensation

The Company records and reports stock based compensation pursuant to FASB’s related accounting standard which defines a fair-value-based method of accounting for stock based employee compensation and transactions in which an entity issues its equity instruments to acquire goods and services from non-employees. Stock compensation for stock granted to non-employees has also been determined in accordance with FASB’s related accounting standard as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

Note 2 – Recently Issued Accounting Standards

F-13

Note 3 – Accounts Receivable

Accounts receivable consisted of the following:

	October 31, 2010		October 31, 2009
Accounts receivable	$	3,992,826	$	3,744,299
Less: allowance for doubtful accounts		―		―
Total	$	3,992,826	$	3,744,299

At October 31, 2010 and 2009, there was no allowance for doubtful accounts as management believes all accounts balances were considered to be uncollectible.

F-14

Note 4 – Other Receivables

Other receivables consisted of the following:

	October 31, 2010			October 31, 2009
Other receivables - Current	$	457,943		$	2,287,510
Other receivables - Noncurrent		3,803,387			3,722,194
Less: allowance for doubtful accounts		(3,803,387	)		(1,861,097	)
Total	$	457,943		$	4,148,607

In June and July 2008, Perfectenergy Shanghai entered into three purchase contracts for purchasing original MEMC granular polysilicon from Sun Materials. In accordance with the terms of the purchase contracts, Perfectenergy Shanghai paid 100% of the advance payments to Sun Materials totaling approximately $3.7 million. However, as of October 31, 2010, Sun Materials was unable to either deliver the goods or return most of the advancement. Followed by an abstract debt acknowledgement and repayment agreement between Sun Materials and Regus BVI, its original supplier for the MEMC granular polysilicon, Regus BVI was obligated to repay the prepayments in five installments. Regus BVI’s repayment was not in accordance with the terms established in the repayment agreement. Based on the current status, management estimated that a 100% provision (approximately $3.8 million) is necessary against the full amount. The Company will continue to assess the collectability and make necessary adjustment if circumstances dictate.

Note 5 – Inventories

Inventories consisted of the following:

	October 31, 2010			October 31, 2009
Raw materials	$	703,452		$	2,992,806
Finished goods		7,726,441			6,104,204
Work in progress		277,760			1,576,788
Supplies		15,709			22,615
Less inventory reserve		(561,796	)		(637,335	)
Total	$	8,161,566		$	10,059,078

	October 31, 2010			October 31, 2009
Beginning balance	$	637,335		$	168,759
Additions charged to costs of goods sold		84,389			467,931
Recovery on obsolete inventory		(172,274	)		-
Foreign currency translation adjustments		12,346			645
Ending balance	$	561,796		$	637,335

Note 6 – Prepayments

Prepayments are mostly monies deposited or advanced to outside vendors on future inventory purchases. Some of the Company’s vendors require a certain amount of money to be deposited with them as a guarantee that the Company will receive their purchase on a timely basis and lower than market price. This amount is refundable and bears no interest. Total outstanding prepayments for inventory purchases were $1,197,636 and $491,913 as of October 31, 2010 and October 31, 2009, respectively.

F-15

Note 7 – Equipment and Leasehold Improvements

Equipment and leasehold improvements consisted of the following:

	October 31, 2010			October 31, 2009
Leasehold Improvements	$	1,959,528		$	1,658,986
Transportation equipment		321,774			276,131
Machinery		7,321,695			6,543,213
Office equipment		219,731			233,870
Construction in progress		―			37,232
Total		9,822,728			8,749,432
Less: accumulated depreciation		(3,790,339	)		(1,930,288	)
Total	$	6,032,389		$	6,819,144

Construction in progress represents the costs incurred in connection with the construction of machinery and equipments.

Depreciation expense for the years ended October 31, 2010 and 2009 amounted to $1,838,838 and $1,330,194, respectively.

Note 8 – Advances on Equipment Purchases

Advances on equipment purchases represent partial payments for deposits on equipment purchases and amounted to $0 and $470,108 as of October 31, 2010 and October 31, 2009, respectively.

Note 9 – Late Registration Penalties

In connection with the issuance of common stock and warrants (“Investor Warrants,” and together with the common stock, the “Securities”) on August 8, 2007, pursuant to Section 1(b) of the Registration Rights Agreement between the holder of the Securities (“Investors”) and the Company, the Company was required to have a registration statement relating to the resale of the Securities declared effective by the SEC by January 5, 2008. A late registration entitled the Investors to a payment by the Company of an amount equal to 2% of the purchase price paid for the Securities due for January 7, 2008 and each 30 days thereafter, not to exceed in the aggregate 15% of the purchase price of the Securities. The registration statement was declared effective on March 5, 2008. The Company owed the Investors a total of $1,079,467 as a late registration payment, which was accrued and charged to general and administrative expenses during the year ended October 31, 2008.

F-16

In lieu of making cash payments, the Company offered to issue restricted common stock at a valuation of $4.00 per share for the first 30 days that the registration statement was late in being declared effective by the SEC, to which certain of the Investors agreed. Thus, the Company owed the Investors taking cash payments a total of $912,347 as late registration payments. As of October 31, 2010, the Company paid $390,744 to the Investors and issued aggregate 41,780 shares of common stock valued at $167,120 to seven of the Investors in lieu of a cash payment. The settlement of the remaining $521,603 is still in progress and is recorded in accrued liabilities, and the expected final payment date is pending by the Company’s Board of Directors.

Note 10 – Retirement Benefit Plans

Regulations in the PRC require the Company to contribute to a defined contribution retirement plan for all permanent employees. All permanent employees are entitled to an annual pension equal to their basic salaries at retirement. The PRC government is responsible for the benefit liability to these retired employees. The Company is required to make contributions to the state retirement plan at 22% of the monthly basic salaries of the current employees. For the years ended October 31, 2010 and 2009, the Company made pension contributions in the amount of $227,504 and $165,365, respectively.

Note 11 – Derivative Instruments

In order for the Investor Warrants to be accounted for as equity, such warrants must comply with FASB’s accounting standard related to derivative instruments and hedging activities. The Investor Warrants contain a provision permitting the holder to redeem the warrants for cash, based on a Black-Scholes valuation, in the event of a change in control deemed not to be within the Company’s control resulting in a classification of the Investor Warrants as derivative instrument liabilities rather than as equity instruments. The Company allocated the proceeds received between the common stock and Investor Warrants first to the Investor Warrants based on the fair value on the date the proceeds were received with the balance to common stock. Net proceeds were allocated as follows:

Warrants	$	12,226,600
Common stock		3,766,371
Total net proceeds	$	15,992,971

The change in the fair value of the Investor Warrants, determined under the Cox-Ross-Rubinstein binomial model, at each reporting date will result in either an increase or decrease the amount recorded as liability, based on the fluctuation of the Company’s stock price with a corresponding adjustment to other income (or expense). For the years ended October 31, 2010 and 2009, a gain of $29,564 and $700,125, respectively, was recognized in the accompanying statement of operations based on the decrease in fair value since the last reporting date. At October 31, 2010 and October 31, 2009, the fair value of the derivative instrument totaled $0 and 29,563, respectively.

F-17

All warrants expired on August 8, 2010. The value of the Investor Warrants at October 31, 2009 was determined using the Cox-Ross-Rubinstein binomial model using the following assumptions: volatility 170%; risk free interest rate 0.05% for the Investor warrants and 0.27% for the Placement and Advisory warrants; dividend yield of 0%; and expected term of 0.27 years of the Investor Warrants and 0.77 years of the Placement and Advisory Warrants. The volatility of the Company’s common stock was estimated by management based on the historical volatility of our common stock, the risk free interest rate was based on Treasury Constant Maturity Rates published by the U.S. Federal Reserve for periods applicable to the expected life of the warrants, the expected dividend yield was based on the Company’s current and expected dividend policy, and the expected term is equal to the contractual life of the warrants.

As of October 31, 2010, the Company had warrants as follows:

Average Remaining Contractual

Life

Balance, October 31, 2008

Balance, October 31, 2009

Balance, October 31, 2010

―

Note 12 – Accounting for Stock-Based Compensation

PFGY Stock Options

On September 5, 2007, the Company adopted the “Perfectenergy International Limited 2007 Stock Incentive Plan” (the “Stock Incentive Plan”). The Company reserved 1,500,000 shares of its common stock pursuant to the Stock Incentive Plan. Options are generally vested on an annual basis over the three years following the date of grant and expire after 10 years.

F-18

On April 7, 2010, the Company granted a total of 200,000 stock options to three executives and four directors at $0.20 per share. The shares were valued at the market price on the date of grant. The estimated fair value of stock options granted was $0.19 per share. The fair value of the options was estimated on the date of grant using a Black-Scholes Option Pricing model using the following assumptions:

	4/7/2010
Expected volatility	170.0%
Risk-free interest rate	2.98%
Expected dividend	―
Expected life	6.50

The volatility of the Company’s common stock was estimated by management based on the historical volatility of the Company’s common stock, the risk free interest rate was based on Treasury Constant Maturity Rates published by the U.S. Federal Reserve for periods applicable to the estimated life of the options, and the expected dividend yield was based on the current and expected dividend policy. The value of the options was based on the Company’s common stock price on the date each option was granted. Because the Company does not have a history of employee stock options, the estimated life is based on one-half of the sum of the vesting period and the contractual life of each option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.

Stock-based award activity was as follows:

Balance, October 31, 2008

Balance, October 31, 2009

Balance, October 31, 2010

1,369,387

2.54

―

As of October 31, 2010, approximately $59,146 of estimated expense with respect to non-vested stock-based awards has yet to be recognized and will be recognized as an expense over the employee’s remaining weighted average service period of approximately 1.5 years. As of October 31, 2010, 1,127,720 of the outstanding options are exercisable. Compensation expenses for the years ended October 31, 2010 and 2009 were $1,270,721 and $1,627,868, respectively.

Stock-based award as of October 31, 2010 is as follows:

Outstanding Options					Exercisable Options
Number of Options	Exercise Price		Average Remaining Contractual Life		Number of Options		Exercise Price		Average Remaining Contractual Life

1,044,387	$	2.80		6.78		1,044,387	$	2.80		6.78
125,000	$	4.08		2.25		83,333	$	4.08		2.25
200,000	$	0.20		9.28		―		―		9.28

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Note 13 – Statutory Reserves

The laws and regulations of the PRC require that before an enterprise distributes profits to its owners, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations to investors, in proportions determined at the discretion of the board of directors, after the statutory reserve. The statutory reserve includes the surplus reserve fund and the enterprise fund. The statutory reserve represents restricted retained earnings.

Surplus Reserve Fund

Pursuant to the PRC’s accounting standards, Perfectenergy Shanghai and Perfectenergy Solar-Tech are required to set aside 10% of their after-tax profit each year to their general reserves until the accumulative amount of such general reserves reaches 50% of their respective registered capital. These allocations must be made before Perfectenergy Shanghai or Perfectenergy Solar-Tech can distribute any cash dividends to each of their sole shareholder, Perfectenergy BVI.

In addition to using the funds in their surplus reserves to distribute cash dividends to their shareholders, Perfectenergy Shanghai and Perfectenergy Solar-Tech may also use such funds (i) during a liquidation, (ii) to cover a previous years’ losses, if any, (iii) for business expansion, or (iv) for conversion to registered capital by issuing new shares to existing shareholders in proportion to their holdings, provided that the remaining surplus reserve fund balance after such issue is not less than 25% of each of their registered capital, or by increasing the par value of the shares currently held by existing shareholders. For the years ended October 31, 2010 and 2009, neither Perfectenergy Shanghai nor Perfectenergy Solar-Tech made any contribution to their respective surplus reserve fund.

Enterprise Fund

The enterprise fund may be used to acquire plant and equipment or to increase working capital to expand on production and business operations. No minimum contribution is required, and neither Perfectenergy Shanghai nor Perfectenergy Solar-Tech made any contributions to their respective enterprise fund for the years ended October 31, 2010 and 2009.

F-20

Note 14 – Income Taxes

Under the income tax laws of the PRC, Chinese companies were generally subject to an income tax at an effective rate of 33% (30% state income taxes plus 3% local income taxes) on income reported in the statutory financial statements after appropriate tax adjustments, unless the enterprise is located in a specially designated region where enterprises are granted a three-year income tax exemption and a 50% income tax reduction for the next three years or the enterprise is a manufacturing related joint venture with a foreign enterprise or a wholly owned subsidiary of a foreign enterprise, which are granted a two-year income tax exemption and a 50% income tax reduction for the next three years.

Beginning January 1, 2008, the new Enterprise Income Tax (“EIT”) law will replace the existing laws for Domestic Enterprises (“DES’”) and Foreign Invested Enterprises (“FIEs”). The key changes are as follows:

a.	The new standard EIT rate of 25% will replace the 33% rate currently applicable to both DES’ and FIEs, except for high tech companies that pay a reduced rate of 15%; and

b.	Companies established before March 16, 2007 will continue to enjoy tax holiday treatment approved by local government for a grace period of 5 years or until the end of the tax holiday term, whichever is sooner.

Perfectenergy Shanghai was established on July 8, 2005 as a wholly owned subsidiary of the Company, a foreign enterprise in the PRC. Thus, Perfectenergy Shanghai was granted an income tax exemption for the years ended December 31, 2006 and 2005, was entitled to a 50% reduction of the income tax rate of 33% for 2007 (or a rate of 16.5%), and was entitled to a 50% reduction of the income tax rate of 25% for 2008 and 2009 (or a rate of 12.5%).

On January 1, 2008, Perfectenergy Shanghai received the high technology certification from the tax authority. The certification allows the Company to receive the 15% preferential income tax rate for a period of three years from January 1, 2008 to December 31, 2010. Because of the lower tax rate, the Company continued to follow the status of a foreign enterprise in 2009 and 2008. In 2010, the Company exercised and applied the 15% preferential income tax rate.

The following table reconciles the U.S. statutory tax rates to the Company’s effective tax rate for the years ended October 31, 2010 and 2009:

	Years Ended October 31,
	2010			2009
U.S. statutory rates		34.0	%		34.0	%
Foreign income not recognized in U.S.		(34.0	)		(34.0	)
China income taxes		25.0			25.0
China income tax exemption		(10.0	)		(12.5	)
Germany income taxes		31.5			31.5
Germany income tax exemption		(0.0	)		(0.0	)
Other Item (a)		(71.1	)		(44.0	)
Effective income tax rates		(24.6	) %		0.0	%

F-21

These rates differ from the stated effective tax rate in China mainly due to losses incurred by the non-Chinese entities or other non-deductible expenses that are not deductible in the PRC. In addition, Perfectenergy Shanghai took a charge of approximately $1,868,000 to fully reserve the advanced inventory payment and recorded intercompany commission expenses of approximately $798,000. These charges, attributed to 18% of the rate change, are non-deductible expenses for tax purposes under the PRC tax law.

(a)

Since Perfectenergy Shanghai had an operating loss for the year ended October 31, 2009, the loss can be carried forward to offset income for the next five years. The Company recorded non-current deferred tax assets of $0 and $95,105 as of October 31, 2010 and 2009, respectively. The Company believes that a valuation allowance is not deemed necessary for the deferred assets for the following reasons: (i) there will be sufficient operating income generated in future years based on the fact that the Company’s wholly owned subsidiary, Perfectenergy Shanghai, is expected to generate profits based on sales orders received for future periods, and (ii) the current operating loss of Perfectenergy Shanghai can be carried forward for five years to offset future operating income under PRC tax regulations.

The estimated tax savings due to the reduced tax rate for the years ended October 31, 2010 and 2009 amounted to $195,381 and $126,519, respectively. There was no material effect to loss per share if the statutory income tax had been applied.

Perfectenergy GmbH’s aggregated tax burden, including corporate income tax plus solidarity surcharge and trade tax is 31.5%. The Company recorded non-current deferred tax assets of $10,184 and $281,000 as of October 31, 2010 and 2009, respectively. The Company believes that a valuation allowance is not deemed necessary for the deferred assets as there will be sufficient operating income generated in future years based on the fact that Perfectenergy GmbH is expected to generate profits based on sales orders received for future periods. German corporations will now be subject to limitation on the utilization of loss carryforwards for corporation tax. This so-called minimum tax is computed by allowing the first €1 million of net operating loss carryforwards to offset taxable income. Any utilization above that threshold will generally be limited to 60% of taxable income. There is no expiration date for the net operating loss carryforwards. Under the prior law, German corporations were able to offset 100% of their income with loss carryforwards.

PFGY was incorporated in the United States and has incurred net operating losses for income tax purposes for the year 2010 and 2009. The estimated accumulated net operating loss carryforwards for the U.S. income taxes amounted to $397,000 and $397,000 as of October 31,2010 and 2009, respectively, which may be available to reduce future years’ taxable income. These carryforwards will expire, if not utilized, between 2027 and 2030. Management believes that the realization of the benefits from these losses appears uncertain due to the Company’s limited operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero. The valuation allowance at October 31, 2010 was $135,000. Management will review this valuation allowance periodically and make adjustments as warranted.

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The Company did not have cumulative undistributed earnings of foreign subsidiaries as of October 31, 2010. Should the Company have any undistributed earnings, such earnings will be included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations. No provision will be made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if the Company concludes that such earnings will be remitted in the future.

Taxes Payables

Taxes payables consisted of the following:

		October 31, 2010		October 31, 2009
Value added taxes payable	$	2,978,218	$	3,079,786
Employee individual income tax withheld		16,061		42,052
Income tax payable		201,087		-
Total	$	3,195,366	$	3,121,838

Note 15 – Concentration of Risk

Cash

Cash includes cash on hand and demand deposits in accounts maintained with either state owned banks or renowned local banks within the PRC, the United States, Hong Kong, and Germany. Certain financial instruments, which subject the Company to concentration of credit risk, consist of cash. The Company maintains cash balances at financial institutions which, from time to time, may exceed Federal Deposit Insurance Corporation insured limits for the banks located in the United States, may exceed Hong Kong Deposit Protection Board insured limits for the banks located in Hong Kong, or may exceed Compensation Scheme of German Banks and Deposit Protection Fund of Association of German Banks insured limits for the banks located in Germany (amounts up to €1.5 million per depositor are fully protected in German Banks). Balances at financial institutions or state owned banks within the PRC are not covered by insurance. Total cash in banks at which the Company’s deposits are not covered by insurance amounted to $1,170,245 and $1,347,547 at October 31, 2010 and 2009, respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.

Major Customers

For the years ended October 31, 2010 and 2009, five customers accounted for approximately 64% and 74%, respectively, of the Company’s sales. These customers accounted for approximately 47% and 59% of the Company’s accounts receivable as of October 31, 2010 and 2009, respectively.

F-23

For the years ended October 31, 2010 and 2009, the Company purchased approximately 46% and 61%, respectively, of their raw materials from three major suppliers. These suppliers represented 64% and 45% of the Company’s total accounts payable as of October 31, 2010 and 2009, respectively.

Major Vendors

Political and Economic Risk

The Company's major operations are carried out in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by the political, economic, and legal circumstances in the PRC and by the general state of the PRC's economy.

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

Revenue by Geographic Area

Revenues are attributed to geographic areas based on the final shipping destination of the Company’s products. Perfectenergy GmbH remains a sales branch and does not maintain its own supply channel. The following table summarizes the financial information for the Company’s revenues based on geographic area:

Geographic Area	Year Ended October 31,
	2010		2009
China	$	4,341,814	$	2,666,300
Germany		70,259,276		28,788,656
Total revenues	$	74,601,090	$	31,454,956

Note 16 – Commitments

Operating Lease Commitments

The Company’s office lease for Perfectenergy Shanghai is under a five-year term expiring May 31, 2011 with a monthly rent of approximately $17,000 (RMB 115,199). The Company entered into a three-year office lease for Perfectenergy GmbH expiring November 30, 2010 with a monthly rent of approximately $2,176 (approximately EUR 1,452). The Company entered into a two-year lease for Perfectenergy Solar-Tech expiring March 14, 2010 with a monthly rent of $5,900 (approximately RMB 40,000), the lease is extended up to the end of 2010 based on oral agreement with the landlord. At October 31, 2010, total future minimum lease payments under an operating lease were as follows:

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