SUNVALLEY SOLAR, INC.

Condensed Consolidated Notes to Financial Statements

March 31, 2012 and December 31, 2011

NOTE 8 – DERIVATIVE LIABILITY

Effective July 31, 2009, the Company adopted ASC Topic No. 815-40 which defines determining whether an instrument (or embedded feature) is solely indexed to an entity’s own stock. These debts are convertible at the holder’s option at 61% of the average of the lowest three trading prices during the 10 days prior to conversion. The number of shares issuable upon conversion of these debts are limited so that the Holder’s total beneficial ownership of our common stock may not exceed 4.99% of the total issued and outstanding shares.

The exercise price of these warrants are subject to “reset” provisions in the event the Company subsequently issues common stock, stock warrants, stock options or convertible debt with a stock price, exercise price or conversion price lower than conversion price of these notes. If these provisions are triggered, the conversion price of the note will be reduced.  As a result, the Company has determined that the conversion feature is not considered to be solely indexed to the Company’s own stock and is therefore not afforded equity treatment. In accordance with AC 815, the Company has bifurcated the conversion feature of the note and recorded a derivative liability.

The total fair value of the conversion option of the February 22, 2012 note was $86,900 and has been recognized as a derivative liability on the date of issuance with all future changes in the fair value of the conversion option being recognized in earnings in the Company’s statement of operations under the caption “Other income (expense) – Gain on derivative liability” until such time as the warrant is exercised or expires.

The Company uses the Black-Scholes option pricing model to value the derivative liability on February 22, 2012. Included in the model are the following assumptions: stock price at valuation date of $0.0027, exercise price of $0.0015, dividend yield of zero, years to maturity of nine months or 0.75, risk free rate of 0.17 percent, and annualized volatility of 143.32 percent. 

During the three month period ending March 31, 2012, the Company issued 52,184,755 shares of the Company’s common stock to convert the July 21, 2011 note in full. Accordingly, the remaining value of the associated derivative liability was recognized in earnings at conversion.

ASC 815 requires the Company to assess the fair market value of certain derivatives at each reporting period and recognize any change in the fair market value of the derivatives as gain (loss) on the income statements.   As of March 31, 2012 and December 31, 2011, the Company has recognized a gain of $271,075 and $220,279, respectively.

ASC 815 requires Company management to assess the fair market value of certain derivatives at each reporting period and recognize any change in the fair market value as another income or expense item.  The Company’s only asset or liability measured at fair value on a recurring basis is its derivative liability associated with the above convertible debts.  At March 31, 2012, the Company revalued the conversion features using the following assumptions: stock price of $0.0025, exercise price of $0.0015, dividend yield of zero, years to maturity vary according to convertible note, risk free rate ranging from 0.07 to 0.15 percent, and annualized volatility ranging from 123 to 133 percent and determined that, during the three months ended March 31, 2012, the Company’s derivative liability decreased to $317,472. The Company recognized a corresponding gain on derivative liability in conjunction with this revaluation.

 SUNVALLEY SOLAR, INC.

Condensed Consolidated Notes to Financial Statements

March 31, 2012 and December 31, 2011

NOTE 9 - FACTORING LINE PAYABLE

During March 2012, the Company paid $344,334 to its factoring provider, inclusive of accrued fees, and the Company borrowed a total of $685,794 from the factoring provider against its accounts receivable with a discount fee of approximately 0.95% for each 15-day period the accounts receivable remain unpaid. As of March 31, 2012, accrued interest and fees on this factoring line totaled $27,693. The Company’s credit facility with the factoring company was increased to one million in March 2012.

NOTE 10 – COMMON STOCK

On January 27, 2012, the Company issued 4,000,000 shares of its common stock for cash at $0.0049 per share. On February 9, 2012, the Company issued 6,000,000 shares of its common stock for cash at $0.0028 per share. On March 19, 2012, the Company issued 20,000,000 shares of its common stock for cash at $0.0022 per share, which as of the end of the period has been recorded as a subscription receivable in the amount of $45,000.

During the three months ended March 31, 2011, the Company issued 52,184,155 shares of common stock upon conversion of $100,000 of its debt plus accrued interest of $4,280.

NOTE 11 – SUBSEQUENT EVENTS

During April and May 2012, the Company issued 106,583,665 shares of common stock upon conversion of $97,000 of its convertible debts issued during 2011.

On May 12, 2012 the Company received an additional $15,000 from the issuance of convertible debt.

In accordance with ASC 855, Company management reviewed all material events through the date of this report and there are no material subsequent events to report.

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

Forward-Looking Statements

Certain statements, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements.” These forward-looking statements generally are identified by the words “believes,” “project,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on our operations and future prospects on a consolidated basis include, but are not limited to: changes in economic conditions, legislative/regulatory changes, availability of capital, interest rates, competition, and generally accepted accounting principles. These risks and uncertainties should also be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

Company Overview and Plan of Operation

We are a California-based solar power technology and system integration company founded in January of 2007. We are focused on developing our expertise and proprietary technology to install residential, commercial and governmental solar power systems. We offer turnkey solar system solutions for owners, builders and architecture firms that include designing, building, operating, monitoring and maintaining solar power systems. Our customers range from small private residences to large commercial solar power users. We have the necessary licenses and expertise to design and install large scale solar power systems. We hold a C-46 Solar License from CBCL (California Board of Contractor License). Some of the large scale commercial solar power systems that we have designed and installed include large office buildings, manufacturing facilities and warehouses. Our proprietary technologies in solar installation provide our customers with a high quality, low cost and flexible solar power system solutions.

We are working to develop as an end-to-end solar energy solution provider by providing system solution, post-sale service, customer technical support, solar system design and field installation.

Business Development Plan

The primary components of our growth strategy are as follows:

Expansion of Installation Business

We are planning to expand its installation business. We will continue to execute our marketing and sales strategy in Southern California and, with additional capital, will be able to expand our business to cover Northern California, Arizona or other states.  The planned expansion is expected to occur through acquiring smaller installation companies in these regions and/or through the establishment of subsidiaries in these states and boost our installation profits. Our current intention is to establish two new offices located in Northern California or other states and in San Diego. The estimated start-up cost for each new branch would be approximately $500,000.

If we are able to expand our installation business, it will assist us in gaining favorable terms from OEM international manufacturers of our planned solar panel manufacturing operation.  In addition, an expanded installation business would allow us to accelerate the introduction of our new technologies and solar parts and would generate additional revenue to fund initial investment in our planned Distributed Power Plant business and to further fund our investments in R&D.

Commercialization of Research and Development

Prior to initiating our planned OEM manufacturing of Sunvalley-branded solar panels, we will need to commercialize our advanced panel technology through the design, fabrication, and characterization of a prototype solar cell.  The total expense for planned commercialization of our research and development will be approximately $500,000. The necessary equipment and facilities will be accessed from University of California, San Diego. The Nano3 clean room facilities in the school of Engineering at UCSD are equipped with state-of-the-art micro and nano fabrication equipment and facilities, and can be accessed by outside users with a $107 hourly fee.

The interference pattern that will be recorded in the solar cells will be obtained using an Argon laser operating at 362nm. This laser and its associated equipment is available to us through a special arrangement with the administration office in the University of California, San Diego, as well as the Ultrafast and Nano-scale Optics lab in the Department of Electrical and Computer Engineering in UCSD.

Other equipment will also be required, including coating machine for PV panel testing.

Initiate OEM Manufacturing of Solar Panels

By leveraging our solar panel installation business and R&D, we plan to procure OEM solar panels from selected Chinese manufacturers and to market them in the U.S. under our brand name. We will be responsible for R&D, quality control, customer service, sales and marketing activities, as well as panel certification in U.S.

The estimated OEM panel cost is less than $0.60 per watt. As a reference, currently, the lowest panel price is around $1.00 per watt (Mono-crystalline, Polycrystalline). We can use our own sales and installation platform to showcase the new panels and drive sales of the new panels in the U.S market. Meanwhile, we will continue our R&D effort on panel coating and other advanced technologies and apply the results to its panel manufacturing business. The goal will be to further improve the efficiency, lower the cost of solar panels with our proprietary technologies, and to grow our market share.

Our marketing strategy for its planned OEM solar panels is as follows:

Unlike other merchandise, solar panel is very unique in that it requires very high level of quality assurance and customer satisfaction. Providing satisfactory customer service and technical support is absolutely vital in solar panel sales. As the first step, we will strive to make its brand a household name. The Sunvalley solar panel will be used by our installation business as well as several other installation companies which have partnerships with us. We do not currently have partnerships with other solar installation companies, but we plan to pursue them after introducing the panels to the market through our own installation business. A marketing campaign aimed at other solar installation companies will help to achieve this goal. We will use our own installation business as the platform to showcase the product quality and build up consumer awareness of its brand.

By leveraging early successes and customer trust earned from our initial installations, we plan to penetrate into the mainstream distribution network with our OEM solar panels.

Once our brand name solar panels become well known, our sales team will begin an aggressive marketing campaign to connect the individual sales points (distributors and venders) to form a distribution network. The marketing campaigns will also include attending trade shows, advertising in the media (TV commercials and newspaper advertisement) and designating local representatives to boost the market share and brand awareness.

To boost our solar panel market share, our R&D team will work with our OEM partner to apply selective coating technique and other cutting edge technologies to further reduce the manufacturing cost and improve the panel efficiency.

The total capital required to initiate our planned panel manufacturing business would be approximately $2,000,000 which can be categorized into three parts:

Develop Distributed Power Plant Business

With our resources and experience gained from large scale solar power system designs, installation and other related business, we believe we have unique advantages in the design and installation of large roof-top power plant systems. We are aggressively proposing our Distributed Power Plant solution to utility companies in Southern California. We believe that by collaborating with us on this approach, utility companies will benefit in the form of free installation, field space, and our expertise on large commercial solar system designs, installation and maintenance services, as well as our technical and management experience. By collaborating with us, utility companies can help to achieve their alternative energy requirements under California law.

We are among the few companies in California that has the permit and expertise to install large-scale commercial and/or government solar power systems, together with roof constructional design and building interior/exterior electrical designs. We believe additional advantages are provided by our experience in filing solar power system permit applications and rebate applications and our expertise gained through our experience with governments and utility companies.

Expected Changes In Number of Employees, Plant, and Equipment

We do not currently plan to purchase specific additional physical plant and significant equipment within the immediate future. We do not currently have specific plans to change the number of our employees during the next twelve months.

Results of Operations for the three and six months ended June 30, 2011 and 2010

During the three months ended March 31, 2012, we generated gross revenues of $178,096. Total cost of sales was $169,960, resulting in gross profit of $8,136. Total operating expenses were $331,706, and consisted of salary and wage expenses of $175,762, selling, general and administrative expenses of $132,576, and professional fees of $23,368. We experienced interest expense of $206,560, other income of $469 and a gain of $271,075 due to the change in value of a derivative liability. Our net loss for the three months ended March 31, 2012 was therefore $258,586.

By comparison, during the three months ended March 31, 2011, we generated gross revenues of $797,810. Total cost of sales was $683,446 resulting in gross profit of $114,364. Total operating expenses were $313,241, and consisted of salary and wage expenses of $142,902 and selling, general and administrative expenses of $170,339. We experienced interest expense of $3,365, other income of $2,391, and a loss due to the change in value of a derivative liability of $2,653. The net loss for the three months ended March 31, 2011 was therefore $202,504.

Our revenues decreased significantly for the three months ended March 31, 2012 compared to the first quarter of last year. This change is due to the fact that we have been implementing several large commercial solar systems during the first and second quarter which are scheduled to be completed in the second quarter or third quarter of 2012. Under the completed contract method of accounting, no profit or income is recorded before substantial completion of the work. The revenue for these projects will therefore be recognized after their completion. Due to the implementation periods for different size of projects, revenue fluctuations like the one experienced during this quarter are a normal occurrence for construction companies, including solar system integration companies.

We use the Black-Scholes option pricing model to value our derivative liabilities and the subsequent remeasurement of our convertible notes. Due to these accounting procedures relating to our convertible notes, we recognized $202,940 as interest expenses and gain on derivative liabilities of $271,075 during the three months ended March 31, 2012.

During 2011, due to the incentives provided by utility companies’ rebate programs and the Federal Recovery Act’s cash grant program, we were able to obtain more large commercial installation projects than we did in 2010. We implemented over 1M watts in solar installation projects in year 2011, We have signed installation contracts for over 1.5M watts in solar systems for 2012 and they are currently under implementation. We expect these projects to be completed before the end of Q4, 2012.

Liquidity and Capital Resources

As of March 31, 2012, we had current assets in the amount of $5,777,546, consisting of cash in the amount of $117,847, accounts receivable of $4,156,833, inventory in the amount of $1,076,872, costs in excess of billings on uncompleted contracts of $387,989, prepaid expenses and other current assets of $9,917, other receivables of $3,088, and restricted cash of $25,000. As of March 31, 2012, we had current liabilities in the amount of $5,845,659. These consisted of accounts payable and accrued expenses in the amount of $3,854,489, a derivative liability of $317,472, customer deposits of $541,272, a factoring payable of $713,488, convertible debt of $210,933, related party notes payable of $121,308, accrued warranty of $69,807, the current portion of long term debt in the amount of $14,245, and the current portion of a capital lease in the amount of $2,645. Our working capital deficit as of March 31, 2012 was therefore $68,113.

Our accounts payable and accrued expenses as of March 31, 2012 consisted of the following:

As of March 31, 2012, our long-term liabilities were $69,420, which consisted of a loan owing to East West Bank with a long term portion of $56,614 and the remaining long term obligations of a capital lease in the amount of $12,806. The current portion of East West Bank loan due within the next year is $14,245 and the principal amount outstanding accrues annual interest at the bank's variable index rate. The East West Bank loan is collateralized by all business assets.

In September 2011, we entered a lease-to-own purchase agreement. We evaluated the lease at the time of purchase and determined that the agreement contained a beneficial by-out option wherein we have the option to buy the equipment for $1 at the end of the lease term. Under the guidance in ASC 840, we have classified the lease as a capital lease.   We used the discounted value of future payments as the fair value of this asset and have recorded the discounted value of the remaining payments as a liability. As of March 31, 2012 the capital lease payable outstanding was $15,451, with $2,645 due within the next year. 

In addition, we have received debt financing from Asher Enterprises, Inc. under a series of Convertible Promissory Notes. The notes, both converted and currently outstanding, are as follows:

All Notes issued to Asher Enterprises, Inc. bear interest at a rate of 8% per year and are convertible at a conversion price equal to 61% of the Market Price of our common stock on the conversion date.  For purposes of the Notes, “Market Price” is defined as the average of the 3 lowest closing prices for our common stock on the 10 trading days immediately preceding the conversion date.  The number of shares issuable upon conversion of the Notes is limited so that the holder’s total beneficial ownership of our common stock may not exceed 4.99% of the total issued and outstanding shares. This condition may be waived at the option of the holder upon not less than 61 days notice.

We have determined that the conversion feature of these notes is not considered to be solely indexed to our own stock and is therefore not afforded equity treatment. In accordance with ASC 815, we have bifurcated the conversion feature of the notes and recorded a derivative liability. As of March 31, 2012 the value of the derivative liability was $317,472 and we recognized a gain on the derivative of $271,075 for the quarter ended March 31, 2012.

In addition, we have also recently received debt financing from Tonaquint, Inc. in the amount of $200,000 under a Convertible Promissory Note as follows:

The note issued to Tonaquint, Inc. bears interest at a rate of 8% per year and is convertible at a conversion price equal to 61% of the Market Price of our common stock on the conversion date.  For purposes of the Note, “Market Price” is defined as the average of the 3 lowest closing prices for our common stock on the 10 trading days immediately preceding the conversion date.  The number of shares issuable upon conversion of the Note is limited so that the holder’s total beneficial ownership of our common stock may not exceed 9.99% of the total issued and outstanding shares. This condition may be waived at the option of the holder upon not less than 61 days notice.

On November 10, 2011, we entered into a Factoring and Security Agreement (the “Agreement”) with CapFlow Funding Group Managers LLC (“CapFlow”). The Agreement is a credit facility for the purpose of factoring our accounts receivable. The cost of this funding is a discount of 1.85% of the gross amount of each receivable factored for the first 30 days, and an additional 0.95% for each additional 15 day period thereafter until the factored account receivable is closed. Under the Agreement, 20% to 25% of the amount of the purchased invoices is reserved. Our obligations to CapFlow under the Agreement are secured by substantially all of our assets. The total available credit line under the Agreement is $1,000,000. During March 2012, the Company paid $344,334 to its factoring provider, inclusive of accrued fees, and the Company borrowed a total of $685,794 from the factoring provider against its accounts receivable with a discount fee of approximately 0.95% for each 15-day period the accounts receivable remain unpaid. As of March 31, 2012, accrued interest and fees on this factoring line totaled $27,693. The Company’s credit facility with the factoring company was increased to one million in March 2012.

In order to move forward with our business development plan set forth above, we will require additional financing in the approximate amount of $4,500,000, to be allocated as follows:

We will require substantial additional financing in the approximate amount of $4,500,000 in order to execute our business expansion and development plans and we may require additional financing in order to sustain substantial future business operations for an extended period of time.  We currently do not have any firm arrangements for financing and we may not be able to obtain financing when required, in the amounts necessary to execute on our plans in full, or on terms which are economically feasible.

We are currently seeking additional financing through the sale of common equity, including the sale of common equity to Auctus Private Equity Fund, LLC through an existing Draw-Down Equity Financing Agreement, and/or the issuance of short-term debt convertible to common equity as discussed above. If we are unable to obtain the necessary capital to pursue our strategic plan, we may have to reduce the planned future growth of our operations.

Off Balance Sheet Arrangements

As of March 31, 2012, there were no off balance sheet arrangements.

Going Concern

We have experienced recurring losses from operations and had an accumulated deficit of $1,616,376 as of March, 2012. To date, we have not been able to produce sufficient sales to become cash flow positive and profitable on an ongoing basis. The success of our business plan during the next 12 months and beyond will be contingent upon generating sufficient revenue to cover our costs of operations and/or upon obtaining additional financing. For these reasons, our auditor has raised substantial doubt about our ability to continue as a going concern.

Critical Accounting Policies

In December 2001, the SEC requested that all registrants list their most “critical accounting polices” in the Management Discussion and Analysis. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of a company’s financial condition and results, and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We do not believe that any accounting policies currently fit this definition.

Recently Issued Accounting Pronouncements

Our management has considered all recent accounting pronouncements issued since the last audit of our financial statements. Our management believes that these recent pronouncements will not have a material effect on our financial statements.

Item 3.     Quantitative and Qualitative Disclosures About Market Risk

A smaller reporting company is not required to provide the information required by this Item.

Item 4.     Controls and Procedures

We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of March 31, 2012. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer, Zhijian (James) Zhang and our Chief Financial Officer, Mandy Chung. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2012, our disclosure controls and procedures are not effective. There have been no changes in our internal controls over financial reporting during the quarter ended March 31, 2012.

Management determined that the material weaknesses that resulted in controls being ineffective are primarily due to lack of resources and number of employees. Material weaknesses exist in the segregation of duties required for effective controls and various reconciliation and control procedures not regularly performed due to the lack of staff and resources.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act are recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Limitations on the Effectiveness of Internal Controls

Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error.   Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the internal control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

PART II – OTHER INFORMATION

Item 1.     Legal Proceedings

We are not a party to any pending legal proceeding. We are not aware of any pending legal proceeding to which any of our officers, directors, or any beneficial holders of 5% or more of our voting securities are adverse to us or have a material interest adverse to us.

Item 1A. Risk Factors

A smaller reporting company is not required to provide the information required by this Item.

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

None.

Item 3.     Defaults upon Senior Securities

None

Item 4.     Mine Safety Disclosures

Not applicable.

Item 5.     Other Information

On April 16, 2012, we borrowed an additional sum of $50,000 from our President, James Zhang under the terms of a Private Loan Agreement. The loan bears interest at 6.50% per year, and is due in less than one year.

Item 6.      Exhibits

SIGNATURES

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