UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the quarterly period ended June 30, 2010OR ̈
            TRANSITION REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF
      1934For
      the transition period from ________________ to
      _________________





Commission
File Number 333-120926





SOLAR
ENERTECH CORP.


(Exact
name of registrant as specified in its charter)





Delaware
            
            98-0434357State
      or other jurisdiction of
            
            (I.R.S.
      Employerincorporation
      or organization
            
            Identification
      No.)





655
West Evelyn Avenue, Suite #2


Mountain
View, CA 94041


(Address
of principal executive offices) (Zip Code)





Registrant’s
telephone number, including area code(650) 688-5800





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.


Yes xNo o





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 oNo o





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





Large
      accelerated filer
            o
            
            Accelerated
      Filer                 
      oNon-accelerated
      filer
            o
            
            Smaller
      reporting company x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes oNo x





Number of
shares outstanding of registrant’s class of common stock as of August 9, 2010:
170,003,045










SOLAR
ENERTECH CORP





FORM
10-Q





INDEX




PAGEPart I. Financial
      InformationItem
      1.
            Financial
      StatementsConsolidated
      Balance Sheets – June 30, 2010 (Unaudited) and September 30,
      2009 (Audited)
            
            3Unaudited
      Consolidated Statements of Operations – Three and Nine Months Ended
      June 30, 2010 and 2009
            
            4Unaudited Consolidated
      Statements of Cash Flows – Nine Months Ended June 30, 2010 and
      2009
            
            5Notes
      to Unaudited Consolidated Financial Statements
            
            6Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            26Item
      3.
            Quantitative
      and Qualitative Disclosures about Market Risks
            
            34Item
      4.
            Controls
      and Procedures
            
            35Part
      II. Other InformationItem
      1.
            Legal
      Proceedings
            
            36Item 1A.
            Risk
      Factors
            
            36Item
      2.
            Unregistered
      Sale of Equity Securities and Use of Proceeds
            
            48Item
      3.
            Defaults
      upon Senior Securities
            
            48Item
      4.
            Removed
      and Reserved
            
            48Item
      5.
            Other
      Information
            
            48Item
      6.
            Exhibits
            
            49Signatures
            
            50




2




PART
I




ITEM
1. FINANCIAL STATEMENTS


Solar
EnerTech Corp.


Consolidated
Balance Sheets




June
      30, 2010
              
              
              September
      30, 2009(Unaudited)
              
              
              (Audited)ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              2,662,000
              
              
              $
              1,719,000Accounts
      receivable, net of allowance for doubtful account of$96,000
      and $96,000 at June 30, 2010 and September 30, 2009,
      respectively
              
              
              13,544,000
              
              
              
              7,395,000Advance
      payments and other
              
              
              347,000
              
              
              
              799,000Inventories,
      net
              
              
              4,987,000
              
              
              
              3,995,000Deferred
      financing costs, net of accumulated amortization
              
              
              -
              
              
              
              1,250,000VAT
      receivable
              
              
              422,000
              
              
              
              334,000Other
      receivable
              
              
              173,000
              
              
              
              408,000Total
      current assets
              
              
              22,135,000
              
              
              
              15,900,000Property
      and equipment, net
              
              
              9,407,000
              
              
              
              10,509,000Other
      assets
              
              
              730,000
              
              
              
              -Investment
              
              
              -
              
              
              
              1,000,000Deposits
              
              
              101,000
              
              
              
              87,000Total
      assets
              
              $
              32,373,000
              
              
              $
              27,496,000LIABILITIES
      AND STOCKHOLDERS' EQUITYAccounts
      payable
              
              $
              12,286,000
              
              
              $
              5,794,000Customer
      advance payment
              
              
              420,000
              
              
              
              27,000Accrued
      expenses
              
              
              2,474,000
              
              
              
              1,088,000Accounts
      payable and accrued liabilities, related parties
              
              
              5,773,000
              
              
              
              5,646,000Short-term
      loans
              
              
              729,000
              
              
              
              -Convertible
      notes, net of discount
              
              
              -
              
              
              
              3,061,000Derivative
      liabilities
              
              
              -
              
              
              
              178,000Total
      current liabilities
              
              
              21,682,000
              
              
              
              15,794,000Convertible
      notes, net of discount
              
              
              1,542,000
              
              
              
              -Derivative
      liabilities
              
              
              562,000
              
              
              
              -Warrant
      liabilities
              
              
              1,044,000
              
              
              
              2,068,000Total
      liabilities
              
              
              24,830,000
              
              
              
              17,862,000STOCKHOLDERS'
      EQUITY:Common
      stock - 400,000,000 shares authorized at $0.001 par value
      169,793,496and
      111,406,696 shares issued and outstanding at June 30, 2010
    andSeptember
      30, 2009, respectively
              
              
              170,000
              
              
              
              111,000Additional
      paid in capital
              
              
              96,881,000
              
              
              
              75,389,000Other
      comprehensive income
              
              
              2,554,000
              
              
              
              2,456,000Accumulated
      deficit
              
              
              (92,062,000
              )
              
              
              (68,322,000
              )Total
      stockholders' equity
              
              
              7,543,000
              
              
              
              9,634,000Total
      liabilities and stockholders' equity
              
              $
              32,373,000
              
              
              $
              27,496,000





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




3




Solar
EnerTech Corp.


Consolidated
Statements of Operations


(Unaudited)





Three
      Months Ended June 30,
              
              
              Nine
      Months Ended June 30,2010
              
              
              2009
              
              
              2010
              
              
              2009Sales
              
              $
              16,355,000
              
              
              $
              10,143,000
              
              
              $
              51,799,000
              
              
              $
              19,639,000Cost
      of sales
              
              
              (15,051,000
              )
              
              
              (9,657,000
              )
              
              
              (47,637,000
              )
              
              
              (22,791,000
              )Gross
      profit (loss)
              
              
              1,304,000
              
              
              
              486,000
              
              
              
              4,162,000
              
              
              
              (3,152,000
              )Operating
      expenses:Selling,
      general and administrative
              
              
              2,475,000
              
              
              
              2,577,000
              
              
              
              7,243,000
              
              
              
              8,224,000Research
      and development
              
              
              54,000
              
              
              
              463,000
              
              
              
              287,000
              
              
              
              1,234,000Loss
      on debt extinguishment
              
              
              -
              
              
              
              36,000
              
              
              
              18,549,000
              
              
              
              527,000Total
      operating expenses
              
              
              2,529,000
              
              
              
              3,076,000
              
              
              
              26,079,000
              
              
              
              9,985,000Operating
      loss
              
              
              (1,225,000
              )
              
              
              (2,590,000
              )
              
              
              (21,917,000
              )
              
              
              (13,137,000
              )Other
      income (expense):Interest
      income
              
              
              1,000
              
              
              
              3,000
              
              
              
              5,000
              
              
              
              13,000Interest
      expense
              
              
              (59,000
              )
              
              
              (1,015,000
              )
              
              
              (5,383,000
              )
              
              
              (1,938,000
              )Gain
      (loss) on change in fair market value of compound embedded
      derivative
              
              
              717,000
              
              
              
              (238,000
              )
              
              
              1,115,000
              
              
              
              350,000Gain
      (loss) on change in fair market value of warrant liability
              
              
              1,393,000
              
              
              
              (3,158,000
              )
              
              
              4,369,000
              
              
              
              (1,415,000
              )Impairment
      loss on investment
              
              
              (1,000,000
              )
              
              
              -
              
              
              
              (1,000,000
              )
              
              
              -Other
      income (expense)
              
              
              (485,000
              )
              
              
              217,000
              
              
              
              (929,000
              )
              
              
              3,000Net
      loss
              
              $
              (658,000
              )
              
              $
              (6,781,000
              )
              
              $
              (23,740,000
              )
              
              $
              (16,124,000
              )Net
      loss per share - basic
              
              $
              (0.004
              )
              
              $
              (0.08
              )
              
              $
              (0.18
              )
              
              $
              (0.18
              )Net
      loss per share - diluted
              
              $
              (0.004
              )
              
              $
              (0.08
              )
              
              $
              (0.18
              )
              
              $
              (0.18
              )Weighted
      average shares outstanding - basic
              
              
              156,502,573
              
              
              
              88,256,706
              
              
              
              128,327,753
              
              
              
              87,669,839Weighted
      average shares outstanding - diluted
              
              
              156,502,573
              
              
              
              88,256,706
              
              
              
              128,327,753
              
              
              
              87,669,839





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




4




Solar
EnerTech Corp.


Consolidated
Statements of Cash Flows


(Unaudited)





Nine
      Months Ended June 30,2010
              
              
              2009Cash
      flows from operating activities:Net
      loss
              
              $
              (23,740,000
              )
              
              $
              (16,124,000
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      of property and equipment
              
              
              1,842,000
              
              
              
              1,718,000Loss
      on disposal of property and equipment
              
              
              51,000
              
              
              
              -Stock-based
      compensation
              
              
              2,221,000
              
              
              
              4,689,000Loss
      on debt extinguishment
              
              
              18,549,000
              
              
              
              527,000Impairment
      loss on investment
              
              
              1,000,000
              
              
              
              -Payment
      of interest by issuance of shares
              
              
              210,000
              
              
              
              -Amortization
      of note discount and deferred financing cost
              
              
              5,146,000
              
              
              
              1,413,000Gain
      on change in fair market value of compound embedded
    derivative
              
              
              (1,115,000
              )
              
              
              (350,000
              )(Gain)
      loss on change in fair market value of warrant liability
              
              
              (4,369,000
              )
              
              
              1,415,000Changes
      in operating assets and liabilities:Accounts
      receivable, net
              
              
              (6,075,000
              )
              
              
              (4,498,000
              )Advance
      payments and other
              
              
              441,000
              
              
              
              2,291,000Inventories,
      net
              
              
              (962,000
              )
              
              
              269,000VAT
      receivable
              
              
              (84,000
              )
              
              
              834,000Other
      receivable
              
              
              236,000
              
              
              
              439,000Accounts
      payable, accrued liabilities and customer advance payment
              
              
              7,175,000
              
              
              
              7,592,000Accounts
      payable and accrued liabilities, related parties
              
              
              127,000
              
              
              
              154,000Net
      cash provided by operating activities
              
              
              653,000
              
              
              
              369,000Cash
      flows from investing activities:Acquisition
      of property and equipment
              
              
              (463,000
              )
              
              
              (325,000
              )Proceeds
      from sales of property and equipment
              
              
              9,000
              
              
              
              36,000Net
      cash used in investing activities
              
              
              (454,000
              )
              
              
              (289,000
              )Cash
      flows from financing activities:Borrowing
      under short-term loans
              
              
              1,141,000
              
              
              
              -Short-term
      loans repayment
              
              
              (412,000
              )
              
              
              -Net
      cash provided by financing activities
              
              
              729,000
              
              
              
              -Effect
      of exchange rate on cash and cash equivalents
              
              
              15,000
              
              
              
              5,000Net
      increase in cash and cash equivalents
              
              
              943,000
              
              
              
              85,000Cash
      and cash equivalents, beginning of period
              
              
              1,719,000
              
              
              
              3,238,000Cash
      and cash equivalents, end of period
              
              $
              2,662,000
              
              
              $
              3,323,000Supplemental
      disclosure of non-cash activities:Extinguishment
      of convertible notes by issuance of common stocks
              
              $
              (5,729,000
              )
              
              $
              104,000Extinguishment
      of convertible notes by issuance of Series B-1 Note
              
              $
              (1,815,000
              )
              
              $
              -Issuance
      of Series B-1 Note
              
              $
              1,535,000
              
              
              $
              -Acquisition
      of other assets
              
              $
              732,000
              
              
              $
              -





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




5




SOLAR
ENERTECH CORP.





Notes
to Consolidated Financial Statements


June
30, 2010 (Unaudited)





NOTE 1 — ORGANIZATION AND NATURE OF
OPERATIONS





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





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





On
January 15, 2010, the Company incorporated a wholly-owned subsidiary in Yizheng,
Jiangsu Province of China to supplement its existing production facilities to
meet increased sales demands.





On
February 8, 2010, the Company acquired land use rights of 68,025 square meter
parcel of land located in Yizheng, Jiangsu Province of China, which will be used
to house the Company’s second manufacturing facility.





NOTE
2 — LIQUIDITY AND GOING CONCERN





The
Company has incurred significant net losses from operations during each period
from inception through June 30, 2010 and has an accumulated deficit of
approximately $92.1 million at June 30, 2010. For the nine months ended June 30,
2010, the Company incurred a net loss of approximately $23.7
million.





As of
December 31, 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 $6.8 million,
collectively known as the “Notes”. These Notes bore interest at 6% per annum and
were due on March 7, 2010.  On January 7, 2010 (the “Conversion
Date”), the Company entered into a Series A and Series B Notes Conversion
Agreement (the “Conversion Agreement”) with the holders of Notes
representing at least seventy-five percent of the aggregate principal amounts
outstanding under the Notes to restructure the terms of the Notes. Pursuant
to the terms of the Conversion Agreement, the Notes would automatically be
converted into shares of the Company’s common stock at a conversion price
which was reduced from $0.69 and $0.57, respectively to $0.15 per share and were
amended to eliminate the maximum ownership percentage restriction prior to
such conversion. Under the Conversion Agreement, the Notes were 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 would automatically be
converted into shares of the Company’s common stock at a conversion price per
share of common stock of $0.15 effective as of January 7, 2010. As of the
Conversion Date, each Note no longer represented a right to receive any cash
payments (including, but not limited to, interest payments) and only
represented a right to receive the shares of common stock into which such Note
has been converted into. On January 7, 2010, a total of approximately $9.8
million of the Series A and B Convertible Notes were effectively converted into
shares of the Company’s common stock. As of June 30, 2010, the Company has an
outstanding convertible note with a principal balance of $1.8 million consisting
of the Series B-1 Note, which was recorded at a carrying amount of $1.5 million.
The Series B-1 Note bears interest at 6% per annum and is due on March 19,
2012.





On March
25, 2010, the Company entered into a one year contract with China Export &
Credit Insurance Corporation (“CECIC”) to insure the collectability of
outstanding accounts receivable for two of the Company’s key customers. The
Company pays a fee based on a fixed percentage of the accounts
receivable outstanding and expenses this fee when it is incurred. In
addition, on March 30, 2010, the Company entered into a one year revolving
credit facility arrangement with Industrial Bank Co., Ltd. (“IBC”) that is
secured by the accounts receivable balances of the Company’s two key customers
insured by CECIC above. The Company can draw up to the lower of $2.0
million or the cumulative amount of accounts receivable outstanding from the
respective two key customers. If any of the insured customers fail to repay
the amounts outstanding due to the Company, the insurance proceeds will be
remitted directly to IBC instead of the Company.  The interest rate of
the credit facility is variable and ranged from 3.30% to 4.48% during the
quarter ended June 30, 2010.  As of June 30, 2010, the Company drew on this
credit facility with IBC amounted to $0.7 million and there have been no
insurance claims submitted to CECIC. The credit facility contains
certain non-financial ratios related covenants, including maintaining
creditworthiness, complying with all contractual obligations, providing true and
accurate records as requested by IBC, fulfillment of other indebtedness (if
any), maintaining its business license and continuing operations, ensuring its
financial condition does not deteriorate, remaining solvent, and other
conditions, as defined in the credit facility agreement. The Company complied
with these covenants as of June 30, 2010.




6





The
Company has approximately $2.7 million in cash and cash equivalents on hand as
of June 30, 2010. 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 improve operations including
securing key new customer contracts, which have increased sales volumes.
In addition, the Company has engaged in various cost cutting programs and
renegotiated most of its contracts to reduce operating expenses. Due to these
actions and the decrease in raw material prices, specifically silicon wafer
prices, the Company has been generating positive gross margins since the third
quarter of fiscal year 2009.





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 sales and expenses during the reporting period. Actual
results could differ from those estimates.





Cash
and Cash Equivalents





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





Currency
and Foreign Exchange





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




7





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. Sales and expenses are
translated at weighted average exchange rates for the period to approximate
translation at the exchange rates prevailing at the dates those elements are
recognized in the consolidated financial statements. Translation adjustments
resulting from the process of translating the local currency consolidated
financial statements into U.S. dollars are included in determining comprehensive
loss.





Property
and Equipment





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





Useful Life (Years)Office
      equipment
            
            3
      to 5Machinery
            
            10Production equipment
            
            5Automobiles
            
            5Furniture
            
            5Leasehold
      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 a sale because it does
not meet the revenue recognition criteria. Provisions are made for excess, slow
moving and obsolete inventory as well as inventory whose carrying value is in
excess of net realizable value.





Warranty
Cost





The
Company provides product warranties and accrues for estimated future warranty
costs in the period in which revenue is recognized. The Company’s standard solar
modules are typically sold with a two-year warranty for defects in materials and
workmanship and a ten-year and twenty five-year warranty against declines of
more than 10.0% and 20.0%, respectively, of the initial minimum power generation
capacity at the time of delivery. The Company therefore maintains warranty
reserves to cover potential liabilities that could arise from its warranty
obligations and accrues the estimated costs of warranties based primarily on
management’s best estimate. In estimating warranty costs, the Company applied
460 – Guarantees, specifically paragraphs, 460-10-25-5 to 460-10-25-7 of the
FASB Accounting Standards Codification. This guidance requires that the Company
make a reasonable estimate of the amount of a warranty obligation. It also
provides that in the case of an entity that has no experience of its own,
reference to the experience of other entities in the same business may be
appropriate. Because the Company began to commercialize its products in fiscal
year 2007, there is insufficient experience and historical data that can be used
to reasonably estimate the expected failure rate of its solar modules. Thus, the
Company considers warranty cost provisions of other China-based manufacturers
that produce photovoltaic products that are comparable in engineering design,
raw material input and functionality to the Company’s products, and sold to a
similar target and class of customer with similar warranty coverage. In
determining whether such peer information can be used, the Company also
considers the years of experience that these manufacturers have in the industry.
Because the Company’s industry is relatively young as compared to other
traditional manufacturing industries, the selected peer companies that the
Company considers have less than ten years in manufacturing and selling history.
In addition, they have a manufacturing base in China, offer photovoltaic
products with comparable engineering design, raw material input, functionality
and similar warranty coverage, and sell in markets, including the geographic
areas and class of customer, where the Company competes. Based on the analysis
applied, the Company accrues warranty at 1% of sales. The Company has not
experienced any material warranty claims to date in connection with declines of
the power generation capacity of its solar modules and will prospectively revise
its actual rate to the extent that actual warranty costs differ from the
estimates. As of June 30, 2010 and September 30, 2009, the Company’s
warranty liabilities were $928,000 and $515,000, respectively. The Company’s
warranty costs for the three and nine months ended June 30, 2010 and 2009 were
$155,000, $411,000, $66,000 and $156,000, respectively. The Company did not make
any warranty payments during the nine months ended June 30, 2010 and
2009.




8





Other
Assets





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





Impairment
of Long-Lived Assets





The
Company reviews its long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying value of an asset may not be
recoverable. When such factors and circumstances exist, management compares the
projected undiscounted future cash flows associated with the future use and
disposal of the related asset or group of assets to their respective carrying
values. Impairment, if any, is measured as the excess of the carrying value over
the fair value, based on market value when available, or discounted expected
cash flows, of those assets and is recorded in the period in which the
determination is made. No loss on property and equipment impairment was recorded
during the nine months ended June 30, 2010 and 2009, respectively.





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.





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





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 each of its
foreign subsidiaries in the jurisdictions in which those entities operate. The
Company accounts for income taxes under liability method per the provisions of
Accounting Standards Codification Topic 740 (“ASC 740”), “Income
Taxes”.





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




9





Valuation
Allowance





In
assessing the realizability of deferred tax assets, the Company has considered
whether it is more-likely-than-not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. The Company
records a valuation allowance to reduce deferred tax assets to a net amount that
management believes is more-likely-than-not of being realizable based on the
weight of all available evidence. In the event that the Company changes its
determination as to the amount of deferred tax assets that are
more-likely-than-not to be realized, the Company will adjust its valuation
allowance with a corresponding impact to the provision for income taxes in the
period in which such determination is made.




Unrecognized
Tax Benefits




Effective
on October 1, 2007, the Company adopted the provisions related to uncertain tax
positions under ASC 740, “Income Taxes”, formerly referenced as FIN 48,
“Accounting for Uncertainty in Income Taxes - An Interpretation of FASB
Statement No. 109”.  Under ASC 740, the impact of an uncertain income tax
position on the income tax return must be recognized at the largest amount that
is more-likely-than-not to be sustained upon audit by the relevant taxing
authority based on the technical merits of the associated tax position.  An
uncertain income tax position will not be recognized if it has less than a 50%
likelihood of being sustained. The Company classifies the unrecognized tax
benefits that are expected to be effectively settled within one year as current
liabilities, otherwise, the unrecognized tax benefits will be classified as
non-current liabilities.





Derivative
Financial Instruments and Warrants





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.




The
Company’s management used the binomial valuation model to value the derivative
financial instruments and warrant liabilities at each valuation date. 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 derivative financial instruments and 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 derivative
financial instruments and 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.




10





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 to direct customers and
distributors in accordance with guidance provided in FASB ASC 605, “Revenue
Recognition”, which states that revenue is realized or realizable and earned
when all of the following criteria are met: persuasive evidence of an
arrangement exists; delivery has occurred or services have been rendered; the
price to the buyer is fixed or determinable; and collectability is reasonably
assured. Where a revenue transaction does not meet any of these criteria it is
deferred and recognized once all such criteria have been met. In instances where
final acceptance of the product, system, or solution is specified by a direct
customer, revenue is deferred until all acceptance criteria have been met.
Contracts with distributors do not have significant post-shipment obligations,
other than product warranty, which is accrued for as warranty costs at the time
revenue is recognized, based on the above criteria. The Company does not grant
price concessions to distributors after shipment.





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 provision
for bad debts based on an assessment of the recoverability of accounts
receivable. Specific provisions are made to the receivables where events or
changes in circumstances indicate that the balances may not be collectible. The
Company considers various factors, including 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. The Company performs a specific provision review of the
outstanding accounts receivable at least quarterly.





Shipping
and Handling Costs





The
Company incurred shipping and handling costs of $1,414,000 and $162,000 for the
nine months ended June 30, 2010 and 2009, 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 nine months ended June 30,
2010 and 2009 were $288,000 and $1,234,000, 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.




11





During
the nine months ended June 30, 2010 and 2009, the Company had three and four
customers, respectively, that accounted for more than 10% of sales.





Recent
Accounting Pronouncements





In
January 2010, the FASB issued ASU 2010-06, which amended “Fair Value
Measurements and Disclosures” (ASC Topic 820) — “Improving Disclosures about
Fair Value Measurements”. This guidance amends existing authoritative guidance
to require additional disclosures regarding fair value measurements, including
the amounts and reasons for significant transfers between Level 1 and Level 2 of
the fair value hierarchy, the reasons for any transfers into or out of Level 3
of the fair value hierarchy, and presentation on a gross basis of information
regarding purchases, sales, issuances, and settlements within the Level 3
rollforward.  This guidance also clarifies certain existing disclosure
requirements.  The guidance is effective for interim and annual reporting
periods beginning after December 15, 2009, except for the disclosures about
purchases, sales, issuances, and settlements within the Level 3 rollforward,
which are effective for interim and annual reporting periods beginning after
December 15, 2010.  The Company adopted this guidance on January 1, 2010.
The adoption of this guidance did not have a significant impact on the Company’s
financial statements.





In
February 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-09,
which amended “Subsequent Events” (ASC Topic 855) — “Amendments to Certain
Recognition and Disclosure Requirements”. The amendments were made to address
concerns about conflicts with SEC guidance and other practice issues. Among the
provisions of the amendment, the FASB defined a new type of entity, termed an
“SEC filer,” which is an entity required to file or furnish its financial
statements with the SEC. Entities other than registrants whose financial
statements are included in SEC filings (e.g., businesses or real estate
operations acquired or to be acquired, equity method investees, and entities
whose securities collateralize registered securities) are not SEC filers. While
an SEC filer is still required by U.S. GAAP to evaluate subsequent events
through the date its financial statements are issued, it is no longer required
to disclose in the financial statements that it has done so or the date through
which subsequent events have been evaluated. The Company adopted this guidance
on February 24, 2010. The adoption of this guidance did not have a significant
impact on the Company’s 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.





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 June 30, 2010 and September 30, 2009, the
Company had approximately $82,000 and $144,000, 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 since fiscal year 2009 as
the economy is recovering from the crisis. Potential credit risk 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 generally does not require collateral to
support customer receivables. All of the Company’s customers have gone
through a very strict credit approval process. The
Company diligently monitors the customers’ financial position. Payment
terms for our solar module sales generally range from 0 to 60 days. In some
cases, these terms are extended for certain qualifying customers of whom the
Company applied rigorous credit requirements. The Company has
also purchased insurance from the China Export & Credit Insurance
Company to insure the collectability of the outstanding accounts receivable
balances of two key customers. During the nine months ended June 30, 2010 and
2009, the Company had three and four customers, respectively that accounted for
more than 10% of sales.




12





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 sales 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 were cumulative foreign currency translation
adjustments amounting to $2.6 million and $2.5 million at June 30, 2010 and
September 30, 2009, respectively.   Foreign currency transaction
gains and losses are included in earnings. For the nine months ended June 30,
2010 and 2009, the Company recorded foreign exchange loss of $0.9 million and
gain of $3,000, respectively.





NOTE
5 — INVENTORIES





At June
30, 2010 and September 30, 2009, inventories consist of:





June
      30, 2010
              
              
              September
      30, 2009Raw
      materials
              
              $
              3,346,000
              
              
              $
              1,708,000Work
      in process
              
              
              149,000
              
              
              
              945,000Finished
      goods
              
              
              1,492,000
              
              
              
              1,342,000Total
      inventories
              
              $
              4,987,000
              
              
              $
              3,995,000




NOTE
6 — PROPERTY AND EQUIPMENT





At June
30, 2010 and September 30, 2009, property and equipment consists
of:





June
      30, 2010
              
              
              September
      30, 2009Production
      equipment
              
              $
              8,025,000
              
              
              $
              7,383,000Leasehold
      improvements
              
              
              3,660,000
              
              
              
              3,620,000Machinery
              
              
              2,897,000
              
              
              
              2,749,000Automobiles
              
              
              361,000
              
              
              
              496,000Office
      equipment
              
              
              345,000
              
              
              
              342,000Furniture
              
              
              40,000
              
              
              
              39,000Construction
      in progress
              
              
              -
              
              
              
              22,000Total
      property and equipment
              
              
              15,328,000
              
              
              
              14,651,000Less:  accumulated
      depreciation
              
              
              (5,921,000
              )
              
              
              (4,142,000
              )Total
      property and equipment, net
              
              $
              9,407,000
              
              
              $
              10,509,000





NOTE
7 — INCOME TAX





The
Company has no taxable income and no provision for federal and state income
taxes is required for the nine months ended June 30, 2010 and 2009,
respectively, except certain minimum taxes.





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.





Utilization
of the U.S. federal and state net operating loss carry forwards may be subject
to substantial annual limitation due to certain limitations resulting from
ownership changes provided by U.S. federal and state tax laws. The annual
limitation may result in the expiration of net operating losses carryforwards
and credits before utilization. The Company has net operating losses in its
foreign jurisdictions and those losses can be carried forward 5 years from the
year the loss was incurred. As of June 30, 2010 and 2009, the Company’s deferred
tax assets were subject to a full valuation allowance.





There are
no ongoing examinations by taxing authorities at this time. The Company’s tax
years starting from 2006 to 2009 remain open in various tax jurisdictions. The
Company has not recorded any unrecognized tax benefits; and does not anticipate
any significant changes within the next 12 months.




13





NOTE 8 — CONVERTIBLE
NOTES





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





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




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




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





These
Notes bore an interest rate of 6% per annum and were due on March 7, 2010. Under
their original terms, the principal amount of the Series A Convertible
Notes may be converted at the initial rate of $0.69 per share for a total of
7,246,377 shares of common stock (which amount does not include shares of common
stock that may be issued for the payment of interest). Under their original
terms, the principal amount of the Series B Convertible Notes may be
converted at the initial rate of $0.57 per share for a total of 21,578,948
shares of common stock (which amount does not include shares of common stock
that may be issued for the payment of interest).





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





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





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





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





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




14





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





On
January 19, 2010, a holder of approximately $1.8 million of the Company’s
formerly outstanding Series B Notes and Series B Warrants (hereinafter referred
to as the “Holder”) of the Company’s common stock disputed the effectiveness of
the Conversion Agreement and the Warrant Amendment.  Accordingly, the
Holder did not tender its Series B Notes for conversion. After negotiations with
the Holder, on March 19, 2010, the Company entered into an Exchange Agreement
with the Holder (the “Exchange Agreement”), whereby the Company issued the
Series B-1 Note with a principal amount of $1.8 million (the “Series B-1 Note”)
to the Holder along with 283,498 shares of the Company’s common stock as
settlement of the accrued interest on the Holder’s Series B Notes and 666,666
shares of the Company’s common stock as settlement of the outstanding dispute
regarding the effectiveness of the Company’s Conversion Agreement and the
Warrant Amendment.  The Company did not capitalize any financing costs
associated with the issuance of the Series B-1 Note.  As of June 30, 2010,
the Company has an outstanding convertible note with a principal balance of $1.8
million consisting of the Series B-1 Note, which was recorded at a carrying
amount of $1.5 million. The Series B-1 Note bears interest at 6% per annum and
is due on March 19, 2012. During the three and nine months ended June 30, 2010,
the Company issued 2,082 and 24,073 shares of its common stock, respectively to
settle the accrued interest on the Series B-1 Note.





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





The costs
associated with the Conversion Agreement were directly derived from the
execution of the Company’s plan in improving its liquidity and business
sustainability, as disclosed in Note 2 — “Liquidity and Going Concern”. The
related loss on debt extinguishment was a cost that was integral to the
continuing operations of the business which is different in nature to the
continuing interest payments and change in fair value of the compound embedded
derivative and warrant liability. Accordingly, the loss on debt extinguishment
is included in operating expenses in the accompanying consolidated statements of
operations.





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





The loss
on debt extinguishment is computed as follows:




Three
      Months Ended June 30,
              
              
              Nine
      Months Ended June 30,2010
              
              
              2009
              
              
              2010
              
              
              2009Fair
      value of the common shares
              
              $
              25,000
              
              
              $
              35,000
              
              
              $
              18,863,000
              
              
              $
              316,000Fair
      value of Series B-1 Note
              
              
              -
              
              
              
              -
              
              
              
              3,108,000
              
              
              
              -Unamortized
      deferred financing costs associated with the converted
    notes
              
              
              -
              
              
              
              14,000
              
              
              
              594,000
              
              
              
              140,000Fair
      value of the CED liability associated with the converted
    notes
              
              
              -
              
              
              
              (6,000
              )
              
              
              (74,000
              )
              
              
              (33,000
              )Accreted
      amount of the notes discount
              
              
              (25,000
              )
              
              
              (7,000
              )
              
              
              (7,544,000
              )
              
              
              104,000Common
      shares issued in conjunction with Series B-1 Note
              
              
              -
              
              
              
              -
              
              
              
              100,000
              
              
              
              -Loss
      on extinguishment of warrants
              
              
              -
              
              
              
              -
              
              
              
              3,502,000
              
              
              
              -Loss
      on debt extinguishment
              
              $
              -
              
              
              $
              36,000
              
              
              $
              18,549,000
              
              
              $
              527,000





During
the three months ended June 30, 2010, $25,000 of the Series B-1 Note was
converted into 166,667 shares of the Company’s common stock. The Company
recorded a cumulative loss on debt extinguishment of approximately $18.5 million
as a result of the Conversion Agreement and the Exchange Agreement during the
nine months ended June 30, 2010.




15





During
the three months ended June 30, 2009, $0.1 million of Series B Convertible Notes
were converted into the Company’s 175,439 common shares. The Company recorded a
loss on debt extinguishment of approximately $36,000 as a result of the
conversion based on the quoted market closing price of its common shares on the
conversion dates. For the nine months ended June 30, 2009, $0.9 million of
Series A and B Convertible Notes were converted into 1,454,684 shares of the
Company’s common stock. The Company recorded a loss on debt extinguishment of
$0.5 million as a result of the conversion based on the quoted market closing
price of its common shares on the conversion dates.





The
following table summarizes the valuation of the Notes and the related Compound
Embedded Derivative, the Series A and Series B Warrants (including the Advisor
Warrants), and the Series B-1 Note and the related Compound Embedded
Derivative:





AmountCarrying
      amount of notes at September 30, 2009
              
              $
              3,061,000Amortization
      of note discount and conversion effect
              
              
              (3,061,000
              )Carrying
      amount of notes at June 30, 2010
              
              $
              -Carrying
      amount of Series B-1 Note at March 19, 2010
              
              $
              1,815,000Fair
      value of compound embedded derivative liabilities
              
              
              (1,573,000
              )Loss
      on debt extinguishment
              
              
              1,293,000Amortization
      of note discount and conversion effect
              
              
              7,000Carrying
      amount of Series B-1 Note at June 30, 2010
              
              $
              1,542,000Fair
      value of warrant liability at September 30, 2009
              
              $
              2,068,000Loss
      on PIPE warrant extinguishment
              
              
              3,502,000Cashless
      exercise of warrants
              
              
              (157,000
              )Gain
      on fair market value of warrant liability
              
              
              (4,369,000
              )Fair
      value of warrant liability at June 30, 2010
              
              $
              1,044,000Fair
      value of compound embedded derivative at September 30,
2009
              
              $
              178,000Gain
      on fair market value of embedded derivative liability
              
              
              (104,000
              )Loss
      on debt extinguishment
              
              
              (74,000
              )Fair
      value of Series A and B compound embedded derivative at June 30,
      2010
              
              $
              -Fair
      value of the Series B-1 compound embedded derivative liabilities at March
      19, 2010
              
              $
              1,573,000Gain
      on fair market value of embedded derivative liability
              
              
              (1,011,000
              )Fair
      value of the Series B-1compound embedded derivative liabilities at June
      30, 2010
              
              $
              562,000


Series
B-1 Note





The
material terms of the Series B-1 Note are as follows:





Interest
Payments





The
Series B-1 Note bears interest at 6% per annum and is due on March 19, 2012.
Accrued interest is payable quarterly in arrears on each of January 1,
April 1, July 1 and October 1, beginning on the first such
date after issuance, in cash or registered shares of common stock at the option
of the Company. If the Company elects to pay any interest due in registered
shares of the Company’s common stock: (i) the issuance
price will be 90% of the 5-day weighted average price of the common stock ending
on the day prior to the interest payment due date, and (ii) a trigger event
shall not have occurred.





Voting
Rights





The
holder of the Series B-1 Note does not have voting rights under these
agreements.





Dividends





Until all
amounts owed under the Series B-1 Note have been converted, redeemed or
otherwise satisfied in accordance with their terms, the Company shall not,
directly or indirectly, redeem, repurchase or declare or pay any cash dividend
or distribution on its capital stock without the prior express written consent
of the required holders.




16





Conversion
Right





At any
time or times on or after the issuance date of the Series B-1 Note, the holder
is entitled to convert, at the holder’s sole discretion, any portion of the
outstanding and unpaid conversion amount (principal, accrued and unpaid interest
and accrued and unpaid late charges) may be converted into fully paid and
non-assessable shares of common stock, at the conversion rate discussed
next.





Conversion
Rate





The
number of shares of common stock issuable upon conversion of the Series B-1 Note
is determined by dividing (x) the conversion amount (principal, interest
and late charges accrued and unpaid), by (y) the then applicable conversion
price (initially $0.15 for Series B-1 Note, subject to adjustment as
provided in the agreement). No adjustment in the conversion price of the Series
B-1 Note will be made in respect of the issuance of additional shares of common
stock unless the consideration per share of an additional share of common stock
issued or deemed to be issued by the Company is less than the conversion price
of the Series B-1 Note in effect on the date of, and immediately prior to, such
issuance. Should the outstanding shares of common stock increase (by stock
split, stock dividend, or otherwise) or decrease (by reclassification or
otherwise), the conversion price of the Series B-1 Note in effect immediately
prior to the change shall be proportionately adjusted.





Redemptions





The
Series B-1 Note permits the holder the right of redemption in the event of
certain specified triggering events such as:




1)
            The
      suspension from trading or failure of the common stock to be listed on the
      principal market or an eligible market for a period of five
      (5) consecutive trading days or for more than an aggregate of ten
      (10) trading days in any 365-day period;2)
            The
      Company’s (A) failure to cure a conversion failure by delivery of the
      required number of shares of common stock within ten (10) trading
      days after the applicable conversion date or (B) notice, written or
      oral, to any holder of the Series B-1 Note, including by way of public
      announcement or through any of its agents, at any time, of its intention
      not to comply with a request for conversion of any Series B-1 Note into
      shares of common stock that is tendered in accordance with the provisions
      of the Series B-1 Note;3)
            The
      Company's failure to pay to the Holder any amount of principal (including,
      without limitation, any redemption payments), interest, late charges or
      other amounts when and as due under this Series B-1 Note except, in the
      case of a failure to pay any interest and late charges when and as due, in
      which case only if such failure continues for a period of at least five
      (5) business days;4)
            (A)
      The occurrence of any payment default or other default under any
      indebtedness of the Company or any of its subsidiaries that results in a
      redemption of or acceleration prior to maturity of $100,000 or more of
      such indebtedness in the aggregate, or (B) the occurrence of any
      material default under any indebtedness of the Company or any of its
      subsidiaries having an aggregate outstanding balance in excess of $100,000
      and such default continues uncured for more than ten (10) business days,
      other than, in each case (A) or (B) above, or a default with
      respect to any other Series B-1 Note;5)
            The
      Company or any of its subsidiaries, pursuant to or within the meaning of
      Title 11, U.S. Code, or any similar Federal, foreign or state law for the
      relief of debtors (A) commences a voluntary case, (B) consents
      to the entry of an order for relief against it in an involuntary case,
      (C) consents to the appointment of a receiver, trustee, assignee,
      liquidator or similar official, (D) makes a
      general assignment for the benefit of its creditors or (E) admits in
      writing that it is generally unable to pay its debts as they become
      due;6)
            A
      court of competent jurisdiction enters an order or decree under any
      bankruptcy law that (A) is for relief against the Company or any of
      its subsidiaries in an involuntary case, (B) appoints a custodian of
      the Company or any of its subsidiaries or (C) orders the liquidation
      of the Company or any of its subsidiaries;




17




7)
            A
      final judgment or judgments for the payment of money aggregating in excess
      of $250,000 are rendered against the Company or any of its subsidiaries
      and which judgments are not, within sixty (60) days after the entry
      thereof, bonded, discharged or stayed pending appeal, or are not
      discharged within sixty (60) days after the expiration of such stay;
      provided, however, that any judgment which is covered by insurance or an
      indemnity from a credit worthy party shall not be included in calculating
      the $250,000 amount set forth above so long as the Company provides the
      holder with a written statement from such insurer or indemnity provider
      (which written statement shall be reasonably satisfactory to the holder)
      to the effect that such judgment is covered by insurance or an indemnity
      and the Company will receive the proceeds of such insurance or indemnity
      within thirty (30) days of the issuance of such judgment; and8)
            The
      Company breaches any representation, warranty, covenant or other term or
      condition of any transaction document, except, in the case of a breach of
      a covenant which is curable, only if such breach continues for a period of
      at least ten (10) consecutive business days.


At any
time after becoming aware of a trigger event, the holder may require the Company
to redeem all or any portion of the Series B-1 Note at an amount equal to any
accrued and unpaid liquidated damages, plus the greater of (A) the
conversion amount to be redeemed multiplied by the redemption premium (125% for
trigger events described above in subparagraphs 1 to 5 and 8 above or 100% for
other events), or (B) the conversion amount to be redeemed multiplied by
the quotient of (i) the closing sale price at the time of the trigger event
(or at the time of payment of the redemption price, if greater) divided by
(ii) the conversion price, provided, however,
(B) shall be applicable only in the event that a trigger event of the type
specified above in subparagraphs 1, 2 or 3 has occurred and remains uncured or
the conversion shares otherwise could not be received or sold by the holder
without any resale restrictions.





Rights
upon Fundamental Transaction, Change of Control and Qualified
Financing





The
Series B-1 Note also contains certain provisions relating to the occurrences of
a fundamental transaction limiting the type of entity that can be a successor
entity and requiring the successor entity to assume the obligations of the
Series B-1 Note.  In addition, the Series B-1 Note contains certain
provisions relating to a change of control or qualified financing which permit
the holder the right of redemption for all or a portion of the Series B-1
Note.




1)
            Assumption. The Company
      may not enter into or be party to a fundamental transaction, as such terms
      is defined in the Series B-1 Note,
unless:




•
            The
      successor entity assumes in writing all of the obligations of the Company
      under the Series B-1 Note and related documents; and•
            The
      successor entity (including its parent entity) is a publicly traded
      corporation whose common stock is quoted on or listed for trading on an
      eligible market.




2)
            Redemption Right on Change of
      Control. At any time during the period beginning on the date of the
      holder’s receipt of a change of control notice and ending twenty
      (20) trading days after the consummation of such change of control,
      the holder may require the Company to redeem all or any portion of the
      Series B-1 Note in cash for an amount equal to any accrued and unpaid
      liquidated damages, plus the greater of (i) the product of (x) the
      conversion amount being redeemed and (y) the quotient determined by
      dividing (A) the greater of the closing sale price of the common
      stock immediately prior to the consummation of the change of control, the
      closing sale price immediately following the public announcement of such
      proposed change of control and the closing sale price of the common stock
      immediately prior to the public announcement of such proposed change of
      control by (B) the conversion price and (ii) 125% of the
      conversion amount being redeemed.





3)
            Redemption Right on Subsequent
      Financing.
      In the event that the Company or any of its subsidiaries shall issue any
      of its or its subsidiaries' equity or equity equivalent securities, or
      commit to issue or sell in one or more series of related transactions or
      financings, including without limitation any debt, preferred stock or
      other instrument or security that is, at any time during its life and
      under any circumstances, convertible into or exchangeable or exercisable
      for shares of common stock, options or convertible securities (any such
      offer, sale, grant, disposition or announcement of such current or future
      committed financing is referred to as a "Subsequent Financing"), the
      Company is obligated to provide the Holder written notice of the
      Subsequent Financing and the Holder, at its option, may require the
      Company to redeem the Series B-1 Note up to the Redemption
      Amount.




18




(A)
      In the event that the Gross Proceeds of the Subsequent Financing equals or
      exceeds $15,000,000 (a “Qualified Financing”), the “Redemption Amount”
      shall equal 100% of the Principal Amount then outstanding.  For
      purposes hereof, “Gross Proceeds” shall mean the aggregate proceeds
      received or receivable by the Company in respect of one or more series of
      related future transactions or financings for which the Company is
      committed in connection with such Qualified Financing.
              
              (B)
      In the event that the Gross Proceeds of the Subsequent Financing is less
      than $15,000,000, the Redemption Amount shall equal a pro-rated portion of
      the Principal Amount equaling a ratio, the numerator of which is the
      amount of proceeds raised by the Company in the Subsequent Financing and
      the denominator which is
$15,000,000.




NOTE 9 — EQUITY
TRANSACTIONS





Warrants





During
March 2007, in conjunction with the issuance of $17.3 million in convertible
debt, the board of directors approved the issuance of warrants (as described in
Note 8 — “Convertible Notes” above) to purchase shares of the Company’s common
stock. The 7,246,377 Series A warrants and the 21,578,948 Series B warrants are
exercisable at $1.21 and $0.90, respectively and expire in March 2012. In
addition, in March 2007, as additional compensation for services as placement
agent for the convertible debt offering, the Company issued the advisor
warrants, which entitle the placement agent to purchase 507,247 and 1,510,528
shares of the Company’s common stock at exercise prices of $0.69 and $0.57 per
share, respectively. The advisor warrants expire in March 2012.




The
Series A and Series B Warrants (including the Advisor Warrants) are classified
as a liability in accordance with FASB ASC 480, “Distinguishing Liabilities from
Equity”, due to the terms of the warrant agreements which contain cash
redemption provisions in the event of a fundamental transaction, which provide
that the Company would repurchase any unexercised portion of the warrants at the
date of the occurrence of the fundamental transaction for the value as
determined by the Black-Scholes Merton valuation model. As a result, the
warrants are measured at fair value both initially and in subsequent periods.
Changes in fair value of the warrants are recorded in the account “gain (loss)
on fair market value of warrant liability” in the accompanying Consolidated
Statements of Operations.





Additionally,
in connection with the offering all of the Company’s Series A and
Series B warrant holders waived their full ratchet anti-dilution and price
protection rights previously granted to them in connection with the Company’s
March 2007 convertible note and warrant financing.








On
January 12, 2008, the Company sold 24,318,181 shares of its common stock and
24,318,181 Series C warrants (the “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. Under its original terms, the
exercise price of the Series C Warrants is $1.00 per share. The warrants are
exercisable for a period of 5 years from the date of issuance of the Series C
Warrants.





For the
services in connection with this closing, the placement agent and the selected
dealer, Knight Capital Markets, LLC and Ardour Capital Investments, received an
aggregate of a 6.0% cash commission, a 1.0% advisory fee and warrants to
purchase 1,215,909 shares of common stock at $0.88 per share, exercisable for a
period of 5 years from the date of issuance of the warrants. The net proceeds
from issuing common stock and Series C warrants in January 2008 after all the
financing costs were $19.9 million and were recorded in additional paid in
capital and common stock. Neither the shares of common stock nor the shares of
common stock underlying the warrants sold in this offering were granted
registration rights.





In
connection with the Conversion Agreement, on January 7, 2010, the Company
entered into an Amendment (the “Warrant Amendment”) to the Series A, Series B
and Series C Warrants with the holders of at least a majority of the common
stock underlying each of its outstanding Series A Warrants, Series B Warrants
and Series C Warrants (collectively the “PIPE Warrants”). The Warrant Amendment
reduced the exercise price for all of the PIPE Warrants from $1.21, $0.90 and
$1.00, respectively, to $0.15, removed certain maximum ownership provisions and
removed anti-dilution provisions for lower-priced security issuances. Given the
above, the liability associated with the PIPE Warrants at the pre Conversion
Agreement exercise price was considered extinguished and was replaced with the
liability associated with the PIPE Warrants at the post Conversion Agreement
exercise price, which were recorded at fair value.





During
the nine months ended June 30, 2010, a warrants holder exchanged 1,147,394 warrants for 450,878
shares of the Company’s common stock after a cashless exercise.  There
was no warrants exercise during the nine months ended June 30,
2009.




19





A summary
of outstanding warrants as of June 30, 2010 is as follows:





Number
      of Shares
              
              
              Exercise
      Price ($)
              
              Recognized
      asGranted
      in connection with convertible notes — Series A
              
              
              7,246,377
              
              
              
              1.21
              
              Discount
      to notes payableGranted
      in connection with convertible notes — Series B
              
              
              21,578,948
              
              
              
              0.90
              
              Discount
      to notes payableGranted
      in connection with common stock purchase — Series C
              
              
              24,318,181
              
              
              
              1.00
              
              Additional
      paid in capitalGranted
      in connection with placement service
              
              
              507,247
              
              
              
              0.69
              
              Deferred
      financing costGranted
      in connection with placement service
              
              
              1,510,528
              
              
              
              0.57
              
              Deferred
      financing costGranted
      in connection with placement service
              
              
              1,215,909
              
              
              
              0.88
              
              Additional
      paid in capitalExtinguishment
      in accordance with the Conversion Agreement
              
              
              (53,143,506
              )
              
              
              N/A
              
              Loss
      on debt extinguishmentIssuance
      in accordance with the Conversion Agreement
              
              
              53,143,506
              
              
              
              0.15
              
              Warrant
      liabilitiesCashless
      exercise of warrants
              
              
              (1,147,394
              )
              
              
              0.15
              
              Additional
      paid in capitalOutstanding
      at June 30, 2010
              
              
              55,229,796





At June
30, 2010, the range of warrant prices for shares under warrants and the
weighted-average remaining contractual life is as follows:





Warrants
      Outstanding and ExercisableWeighted-Weighted-
              
              
              AverageRange
      of
              
              
              
              
              
              Average
              
              
              RemainingWarrant
              
              
              Number
      of
              
              
              Exercise
              
              
              ContractualExercise Price
              
              
              Warrants
              
              
              Price
              
              
              Life$
              0.15
              
              
              
              51,996,112
              
              
              $
              0.15
              
              
              
              2.10$
              0.57-$0.88
              
              
              
              3,233,684
              
              
              $
              0.71
              
              
              
              2.02





Restricted
Stock





On August
19, 2008, Mr. Leo Young, the Company’s 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 of Directors 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 the
Company’s Board of Directors, and has a term of 10 years. Restricted stock
vest over a three year period and unvested restricted stock are forfeited and
cancelled as of the date that employment terminates. 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.





Issuance
of fully vested restricted stock to the Company’s former Board of
Directors





On
January 12, 2010, the Company issued 400,000 shares of fully vested restricted
stock to the Company’s former board of directors on their resignation date. As
the former directors no longer provide services to the Company, these awards
were properly accounted for as awards to non-employees in accordance with FASB
ASC 718.




20





The
following table summarizes the activity of the Company’s unvested restricted
stock units as of June 30, 2010 and changes during the nine months ended June
30, 2010:





Restricted
      StockNumber of
              
              
              Weighted-
                  average
                  grant-dateshares
              
              
              fair valueUnvested
      as of September 30, 2008
              
              
              25,250,000
              
              
              $
              0.62Restricted
      stock canceled
              
              
              (2,100,000
              )
              
              $
              0.62Unvested
      as of September 30, 2009
              
              
              23,150,000
              
              
              $
              0.62Restricted
      stock canceled
              
              
              (10,000,000
              )
              
              $
              0.62Restricted
      stock granted
              
              
              400,000
              
              
              $
              0.31Restricted
      stock vested
              
              
              (400,000
              )
              
              $
              0.31Unvested
      as of June 30, 2010
              
              
              13,150,000
              
              
              $
              0.62





The total
unvested restricted stock as of June 30, 2010 and September 30, 2009 were
13,150,000 and 23,150,000 shares, respectively.




Stock-based
compensation expense for restricted stock for the three and nine months ended
June 30, 2010 were $0.7 million and $2.1 million, respectively. As of June 30,
2010, the total unrecognized compensation cost net of forfeitures relate to
unvested awards not yet recognized is $3.1 million and is expected to be
amortized over a weighted average period of 1.1 years.





Issuance
of common shares to non-employees





On
February 1, 2010, the Company issued 400,000 shares of common stock to the
Company’s third party financial advisors. These awards were properly accounted
for as awards to non-employees in accordance with FASB ASC 718.





Options





Amended
and Restated 2007 Equity Incentive Plan





In
September 2007, the Company adopted the 2007 Equity Incentive Plan (the
“2007 Plan”) that allows the Company to grant non-statutory stock options to
employees, consultants and directors. A total of 10 million shares of the
Company’s common stock are authorized for issuance under the 2007 Plan. The
maximum number of shares that may be issued under the 2007 Plan will be
increased for any options granted that expire, are terminated or repurchased by
the Company for an amount not greater than the holder’s purchase price and may
also be adjusted subject to action by the stockholders for changes in capital
structure. Stock options may have exercise prices of not less than 100% of the
fair value of a share of stock at the effective date of the grant of the
option.





On
February 5, 2008, the Board of Directors of the Company 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. As of June 30, 2010 and
September 30, 2009, 12,860,000 and 12,060,000 shares of common stock,
respectively remain available for future grants under the Amended 2007
Plan.




21










These
options vest over various periods up to four years and expire no more than ten
years from the date of grant. A summary of activity under the Amended 2007 Plan
is as follows:





Option
      Available ForGrant
              
              
              Number
      of Option
                Outstanding
              
              
              Weighted
      Average
                Fair
      Value Per
                Share
              
              
              Weighted
      Average
                Exercise
      Price Per
                ShareBalance
      at September 30, 2008
              
              
              7,339,375
              
              
              
              7,660,625
              
              
              $
              0.39
              
              
              $
              0.62Options
      granted
              
              
              (500,000
              )
              
              
              500,000
              
              
              $
              0.13
              
              
              $
              0.20Options
      cancelled
              
              
              5,220,625
              
              
              
              (5,220,625
              )
              
              $
              0.39
              
              
              $
              0.62Balance
      at September 30, 2009
              
              
              12,060,000
              
              
              
              2,940,000
              
              
              $
              0.32
              
              
              $
              0.55Options
      granted
              
              
              (250,000
              )
              
              
              250,000
              
              
              $
              0.20
              
              
              $
              0.32Options
      cancelled
              
              
              1,050,000
              
              
              
              (1,050,000
              )
              
              $
              0.39
              
              
              $
              0.62Balance
      at June 30, 2010
              
              
              12,860,000
              
              
              
              2,140,000
              
              
              $
              0.27
              
              
              $
              0.49





The total
fair value of shares vested during the nine months ended June 30, 2010 and 2009
were $36,000 and $337,000, respectively.





At June
30, 2010 and September 30, 2009, 2,140,000 and 2,940,000 options were
outstanding, respectively and had a weighted-average remaining contractual life
of 7.91 years and 6.98 years, respectively. Of these options, 1,507,917 and
2,333,127 shares were vested and exercisable on June 30, 2010 and September 30,
2009, respectively.  The weighted-average exercise price and
weighted-average remaining contractual term of options currently exercisable
were $0.58 and 7.40 years, respectively.





The fair
values of employee stock options granted during the three and nine months ended
June 30, 2010 were estimated using the Black-Scholes option-pricing model with
the following weighted average assumptions:




Three
      Months Ended
              
              
              Nine
      Months EndedJune
      30,
                2010
              
              
              June
      30,
                2009
              
              
              June
      30,
                2010
              
              
              June
      30,
                2009Volatility
              
              
              -
              
              
              
              97.0
              %
              
              
              93.0
              %
              
              
              97.0
              %Expected
      dividend
              
              
              -
              
              
              
              0.0
              %
              
              
              0.0
              %
              
              
              0.0
              %Risk-free
      interest rate
              
              
              -
              
              
              
              1.68
              %
              
              
              1.70
              %
              
              
              1.68
              %Expected
      term in years
              
              
              -
              
              
              
              3.90
              
              
              
              3.32
              
              
              
              3.90Weighted-average
      fair value
              
              
              -
              
              
              $
              0.13
              
              
              $
              0.20
              
              
              $
              0.13





There
were no employee stock options granted during the three months ended June 30,
2010.





In
accordance with the provisions of FASB ASC 718, the Company has recorded
stock-based compensation expense of $0.7 million and $2.2 million for the three
and nine months ended June 30, 2010, respectively, which include the
compensation effect for the options repriced and restricted stock. The Company
recorded $1.5 million and $4.7 million for the three and nine months ended June
30, 2009, respectively, which include the compensation effect for the options
repriced and restricted stock. The stock-based compensation expense is based on
the fair value of the options at the grant date.  The Company
recognized compensation expense for share-based awards based upon their value on
the date of grant amortized over the applicable service period, less an
allowance estimated future forfeited awards.





NOTE
10 — FAIR VALUE OF FINANCIAL INSTRUMENTS





In
September 2006, the FASB issued SFAS 157, “Fair Value Measurements”, codified in
FASB ASC 820, “Fair Value Measurements and Disclosures”, which defines fair
value to measure assets and liabilities, establishes a framework for measuring
fair value, and requires additional disclosures about the use of fair value.
FASB ASC 820 is applicable whenever another accounting pronouncement requires or
permits assets and liabilities to be measured at fair value. FASB ASC 820 does
not expand or require any new fair value measures. FASB ASC 820 is effective for
fiscal years beginning after November 15, 2007. In December 2007, the FASB
agreed to a one year deferral of FASB ASC 820’s fair value measurement
requirements for nonfinancial assets and liabilities that are not required or
permitted to be measured at fair value on a recurring basis. The Company adopted
FASB ASC 820 on October 1, 2008, which had no effect on the Company’s financial
position, operating results or cash flows.





FASB ASC
820 defines fair value and establishes a hierarchal framework which prioritizes
and ranks the market price observability used in fair value measurements. Market
price observability is affected by a number of factors, including the type of
asset or liability and the characteristics specific to the asset or liability
being measured. Assets and liabilities with readily available, quoted market
prices or for which fair value can be measured from actively quoted prices
generally are deemed to have a higher degree of market price observability and a
lesser degree of judgment used in measuring fair value. Under FASB ASC 820, the
inputs used to measure fair value must be classified into one of three levels as
follows:





Level
      1 -
            Quoted
      prices in an active market for identical assets or
      liabilities;




22




Level
      2 -
            Observable
      inputs other than Level 1, quoted prices for similar assets or liabilities
      in active markets, quoted prices for identical or similar assets and
      liabilities in markets that are not active, and model-derived prices whose
      inputs are observable or whose significant value drivers are observable;
      and





Level
      3 -
            Assets
      and liabilities whose significant value drivers are
      unobservable.





Observable
inputs are based on market data obtained from independent sources, while
unobservable inputs are based on the Company’s market assumptions. Unobservable
inputs require significant management judgment or estimation. In some cases, the
inputs used to measure an asset or liability may fall into different levels of
the fair value hierarchy. In those instances, the fair value measurement is
required to be classified using the lowest level of input that is significant to
the fair value measurement. Such determination requires significant management
judgment.





The
Company’s liabilities measured at fair value on a recurring basis consisted of
the following types of instruments as of June 30, 2010:





Fair
      Value at
                June
      30, 2010
              
              
              Quoted
      prices in
                active
      markets
                for
      identical
                assets
                (Level
      1)
              
              
              Significant
      other
                observable
      inputs
                (Level
      2)
              
              
              Significant
                unobservable
                inputs
                (Level
      3)Derivative
      liabilites
              
              $
              562,000
              
              
              
              -
              
              
              
              -
              
              
              $
              562,000Warrant
      liabilities
              
              
              1,044,000
              
              
              
              -
              
              
              
              -
              
              
              
              1,044,000Total
      liabilities
              
              $
              1,606,000
              
              
              
              -
              
              
              
              -
              
              
              $
              1,606,000





The
method used to estimate the value of the Series B-1 Note compound embedded
derivatives (“CED”) was a binomial model with the following
assumptions:





June
      30,
                2010Implied
      term(years)
              
              
              1.72Suboptimal
      exercise factor
              
              
              2.50Volatility
              
              
              79.50
              %Dividend
      yield
              
              
              0.00
              %Risk-free
      interest rate
              
              
              0.46
              %





The fair
value of the Series A and Series B Warrants (including the Advisor Warrants)
were estimated using a binomial valuation model with the following
assumptions:





June
      30,
                2010
              
              
              September
      30,
                2009Implied
      term (years)
              
              
              1.68
              
              
              
              2.43Suboptimal
      exercise factor
              
              
              2.5
              
              
              
              2.5Volatility
              
              
              82
              %
              
              
              106
              %Dividend
      yield
              
              
              0
              %
              
              
              0
              %Risk
      free interest rate
              
              
              0.52
              %
              
              
              1.15
              %




23




The
carrying values of cash and cash equivalents, accounts receivable, accrued
expenses, accounts payable, accrued liabilities and amounts due to related party
approximate fair value because of the short-term maturity of these instruments.
The Company does not invest its cash in auction rate
securities.





At June
30, 2010, the principal outstanding and the carrying value of the Company’s
Series B-1 Note were $1.8 million and $1.5 million, respectively. The Series B-1
Note contains two embedded derivative features, the conversion option and a
redemption privilege accruing to the holder if certain conditions exist (the
“compound embedded derivative”), which are measured at fair value both initially
and in subsequent periods. The fair value of the convertible notes can be
determined based on the fair value of the entire financial
instrument.




NOTE
11 — COMPREHENSIVE LOSS





The
components of comprehensive loss were as follows:





Three
      Months Ended
                June
      30,
              
              
              Nine
      Months Ended
                June
      30,2010
              
              
              2009
              
              
              2010
              
              
              2009Net
      loss
              
              $
              (658,000
              )
              
              $
              (6,781,000
              )
              
              $
              (23,740,000
              )
              
              $
              (16,124,000
              )Other
      comprehensive income:Change
      in foreign currency translation
              
              
              87,000
              
              
              
              15,000
              
              
              
              98,000
              
              
              
              (33,000
              )Comprehensive
      loss
              
              $
              (571,000
              )
              
              $
              (6,766,000
              )
              
              $
              (23,642,000
              )
              
              $
              (16,157,000
              )





The
accumulated other comprehensive income at June 30, 2010 and September 30, 2009
comprised of accumulated translation adjustments of $2.6 million and $2.5
million, respectively.




NOTE 12 — COMMITMENTS AND
CONTINGENCIES





Research
and development commitment





Pursuant
to a joint research and development laboratory agreement with
Shanghai University, dated December 15, 2006 and expiring on
December 15, 2016, Solar EnerTech is committed to fund the establishment of
laboratories and completion of research and development activities. The Company
committed to invest no less than RMB5 million each year for the first three
years and no less than RMB30 million cumulatively for the first five years.
The following table summarizes the commitments in U.S. dollars based upon a
translation of the RMB amounts into U.S. dollars at an exchange rate of 6.7909
as of June 30, 2010.





Year
              
              Amount2010
              
              $
              2,604,0002011
              
              
              1,119,000Total
              
              $
              3,723,000





The
Company intends to increase research and development spending as it
grows its business. The payment to Shanghai University will be used to
fund program expenses and equipment purchase. Due to the delay in the progress
of research and development activities, the amount of $1.7 million originally
committed to be paid during fiscal years 2009 and 2008 has not been paid as of
June 30, 2010, (included in the total amount of $3.7 million above), as Shanghai
University has not incurred the additional costs to meet its research and
development milestones and therefore has not made the request for payments. If
the Company fails to make payments, when requested, it is deemed to be a breach
of the agreement. If the Company is unable to correct the breach within the
requested time frame, Shanghai University could seek compensation up to an
additional 15% of the total committed amount for approximately $0.7 million. As
of June 30, 2010, the Company is not in breach as it has not received any
additional compensation requests from Shanghai University.





24


The
agreement is for shared investment in research and development on fundamental
and applied technology 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. The
Company will provide funding, personnel and facilities for conducting research
and testing. Research and development achievements from this joint research and
development agreement will be available to both parties. The Company is entitled
to intellectual property rights including copyrights and patents obtained as a
result of this research.





Expenditures
under this agreement will be accounted for as research and development
expenditures under FASB ASC 730, "Research and Development” and expensed as
incurred.





Capital
commitments





On August
21, 2008, the Company acquired two million shares of common stock of 21-Century
Silicon for $1.0 million in cash as previously discussed in “Note 3 — Summary of
Significant Accounting Policies – Investments”  above.  In
July 2010, members of the Company’s executive team, including the CEO, visited
21-Century Silicon and conducted reviews of the production facility and
technical development. The review indicated that 21-Century Silicon’s production
facility and technical development were significantly below expected standards.
In addition, management of 21-Century Silicon expressed the need for more
funding to sustain operations. Moreover, 21-Century Silicon could not provide
the Company with updated financial information concerning 21-Century Silicon’s
working capital condition and future cash flows. The timing of the first
polysilicon shipment is unknown and it is unknown whether it will even occur.
The Company considered the factors above as indicators that a significant
adverse effect on the fair value of the Company’s investment in 21-Century
Silicon had occurred.  Accordingly, an impairment loss of $1.0 million
is recorded in the Consolidated Statements of Operations for the three months
ended June 30, 2010 to fully write-down the carrying amount of the
investment. The Company may also be obligated to acquire an additional two
million shares of 21-Century Silicon upon the first polysilicon shipment meeting
the quality specifications determined solely by the Company. As of June 30,
2010, the Company has not yet acquired the additional two million shares as the
product shipment has not occurred.  In connection with its impairment
of the investment in 21-Century Silicon, the Company considers the likelihood
that it will be required to acquire the additional two million shares to be
remote.





On
September 22, 2008, the registered capital of Solar EnerTech (Shanghai) Co., Ltd
was increased from $25 million to $47.5 million, which was approved by the Board
of Directors of the Company and authorized by Shanghai Municipal Government (the
“Shanghai Government”). The paid-in capital as of June 30, 2010 was $31.96
million, with an outstanding remaining balance of $15.54 million to be
originally funded by September 21, 2010. In August 2010, the Company received
the approval of the Shanghai Government to extend the funding requirement date
by nine months to June 2011. The Company plans to raise funds to meet this
capital requirement through participation in the capital markets, such as
undertaking equity offerings. If external financing is not available, the
Company will file an application with the Shanghai Government to reduce the
capital requirement, which is legally permissible under PRC law.





On
January 15, 2010, the Company incorporated a wholly-owned subsidiary in Yizheng,
Jiangsu Province of China to supplement its existing production facilities to
meet increased sales demands.  The subsidiary was formed with a
registered capital requirement of $33 million, of which $23.4 million is to be
funded by October 16, 2011.  In order to fund the registered capital
requirement, the Company will have to raise funds or otherwise obtain the
approval of local authorities to reduce the amount of registered capital for the
subsidiary. The registered capital requirement outstanding as of June 30, 2010
is $23.4 million.





On
February 8, 2010, the Company acquired land use rights of a parcel of land at
the price of approximately $0.7 million. This piece of land is 68,025 square
meters and is located in Yizheng, Jiangsu Province of China, which will be used
to house the Company’s second manufacturing facility. As part of the acquisition
of the land use right, the Company is required to complete construction of the
facility by February 8, 2012.





NOTE 13 — RELATED PARTY
TRANSACTIONS





At June
30, 2010 and September 30, 2009, the accounts payable and accrued liabilities,
related party balance was $5.8 million and $5.6 million, respectively. The $5.8
million accrued liability represents $4.8 million of compensation expense
related to the Company’s obligation to withhold tax upon exercise of stock
options by Mr. Young in the fiscal year 2006 and the related interest and
penalties, and $1.0 million of indemnification provided by the Company to Mr.
Young  for any liabilities he may incur as a result of previous stock
options granted to him by Ms. Blanchard, a former officer, in conjunction with
the purchase of Infotech on August 19, 2008.





On April
27, 2009, the Company entered into a Joint Venture Agreement with Jiangsu Shunda
Semiconductor Development Co., Ltd. to form a joint venture in the United
States by forming a new company, to be known as Shunda-SolarE Technologies,
Inc., in order to jointly pursue opportunities in the United States solar
market. After its formation, the joint venture company’s name was later changed
to SET-Solar Corp. During the three and nine months ended June 30, 2010, the
Company recorded sales from SET-Solar Corp in the amount of $0.5 million. As of
June 30, 2010, the accounts receivable due from SET-Solar Corp. and the cash
collateral received from SET-Solar Corp. are $0.4 million and $0.3 million,
respectively.





25


NOTE
14 — FOREIGN OPERATIONS





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
Company’s sales occurred in Europe, Australia, North America and
China.




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





All
references to “Solar EnerTech”, the “Company,” “we,” “our,” and “us” refer to
Solar EnerTech Corp. and its subsidiaries.





The
following discussion contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 that relate to our current
expectations and views of future events. 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 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 an Investment in
Our Securities” and under the heading “Risks Related To an Investment in Our
Securities” in this report as well as other relevant risks detailed in our
filings with the SEC which may cause our actual results, performance or
achievements to be materially different from any future results, performance or
achievements expressed or implied by the forward-looking statements. The
information set forth in this report on Form 10-Q should be read in light of
such risks and in conjunction with the consolidated financial statements and the
notes thereto included elsewhere in this Form 10-Q.





Overview





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





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





Our solar
cells and modules are sold under the brand name “SolarE”.  Our total
sales for the nine months ended June 30, 2010 was $51.8 million and our end
users are mainly in Europe and Australia.  In anticipation of entering
the US market, we have 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.





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





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




26




•
            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.





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





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.





Environmental,
Health and Safety Regulations





We will
use, generate and discharge toxic, volatile or otherwise hazardous chemicals and
wastes in our manufacturing activities. We are subject to a variety of federal,
state and local governmental laws and regulations related to the purchase,
storage, use and disposal of hazardous materials. We are also subject to
occupational health and safety regulations designed to protect worker health and
safety from injuries and adverse health effects from exposure to hazardous
chemicals and working conditions. If we fail to comply with present or future
environmental laws and regulations, we could be subject to fines, suspension of
production or a cessation of operations. In addition, under some 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.




Solar
Energy Industry





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





Government
Subsidies and Incentives





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




27


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





Critical
Accounting Policies





We
consider our accounting policies related to principles of consolidation, revenue
recognition, inventory reserve, and stock based compensation, fair value of
equity instruments and derivative financial instruments to be critical
accounting policies. A number of significant estimates, assumptions, and
judgments are inherent in determining our consolidation policy, when to
recognize revenue, how to evaluate our equity instruments and derivative
financial instruments, and the calculation of our inventory reserve and
stock-based compensation expense. We base our estimates and judgments on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances. Actual results could differ materially from
these estimates. Management believes that, except for the accounting estimation
related to investment impairment and warranty cost, as described in the
following three paragraphs below, there have been no significant changes during
the three and nine months ended June 30, 2010 to the items that we disclosed as
our critical accounting policies and estimates in Management’s Discussion and
Analysis or Plan of Operations in our Annual Report on Form 10-K filed for the
year ended September 30, 2009 with the Securities and Exchange Commission (the
“SEC”). For a description of those critical accounting policies, please refer to
our 2009 Annual Report on Form 10-K.





Investment





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





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




Warranty
Cost





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





28


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 of this Form 10-Q.




Results
of Operations for the three and nine months ended June 30, 2010 and
2009





The
following discussion of the financial condition, results of operations, cash
flows and changes in financial position of our Company should be read in
conjunction with our audited consolidated financial statements and notes filed
with the SEC on Form 10-K and its subsequent amendments.





Sales,
Cost of Sales and Gross Profit (Loss)





Three
      Months Ended
                June
      30, 2010
              
              
              Three
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeSales
              
              $
              16,355,000
              
              
              
              100.0
              %
              
              $
              10,143,000
              
              
              
              100.0
              %
              
              $
              6,212,000
              
              
              
              61.2
              %Cost
      of sales
              
              
              (15,051,000
              )
              
              
              (92.0
              %)
              
              
              (9,657,000
              )
              
              
              (95.2
              %)
              
              
              (5,394,000
              )
              
              
              55.9
              %Gross
      profit (loss)
              
              $
              1,304,000
              
              
              
              8.0
              %
              
              $
              486,000
              
              
              
              4.8
              %
              
              $
              818,000
              
              
              
              168.3
              %





Nine
      Months Ended
                June
      30, 2010
              
              
              Nine
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeSales
              
              $
              51,799,000
              
              
              
              100.0
              %
              
              $
              19,639,000
              
              
              
              100.0
              %
              
              $
              32,160,000
              
              
              
              163.8
              %Cost
      of sales
              
              
              (47,637,000
              )
              
              
              (92.0
              %)
              
              
              (22,791,000
              )
              
              
              (116.0
              %)
              
              
              (24,846,000
              )
              
              
              109.0
              %Gross
      profit (loss)
              
              $
              4,162,000
              
              
              
              8.0
              %
              
              $
              (3,152,000
              )
              
              
              (16.0
              %)
              
              $
              7,314,000
              
              
              
              (232.0
              %)





For the
three months ended June 30, 2010, we reported total sales of $16.4 million,
representing an increase of $6.2 million, or 61.2%, compared to $10.1 million of
sales in the same period of the prior year.  The increase in sales was
due to the strong organic growth from our existing customers in a growing market
and increased sales orders from new customers as a result of heightened efforts
by our sales and marketing team. Specifically, during the fourth quarter of
fiscal year 2009, we acquired a new key customer, specifically a 10MW contract
with a German system integrator, and in the first quarter of fiscal year 2010,
we signed a 15 MW and a 10MW contracts with existing customers. All of these
events contributed to the increased in sales volume during the three months
ended June 30, 2010.





For the
nine months ended June 30, 2010, we recorded $51.8 million in sales, which
comprised of $44.4 million in solar module sales, $4.9 million in cell
sales and $2.5 million in resale of raw materials, compared to $19.6 million in
sales in the same period of the prior year, which comprised of $15.6 million in
solar module sales and $4.0 million in cell sales. The increase in sales
resulted from increases in solar module shipments from 5.87MW for the nine
months ended June 30, 2009 to 22.74MW for the nine months ended June 30,
2010.





For the
three months ended June 30, 2010, we incurred a gross profit of $1.3 million,
representing an increase of $0.8 million, or 168.3%, compared to the gross
profit of $0.5 million in the same period of the prior year.  The
increase in gross profit was partially due to the decrease in raw material
prices, specifically silicon wafer prices which offset the decrease in module
sales prices. Silicon wafer prices decreased approximately 18.8% from RMB
19.6/piece during the three months ended June 30, 2009 to RMB 15.9/piece during
the three months ended June 30, 2010. The increase in gross profit was also due
to economies of scale generated from higher production volume, which lowered per
unit production cost and continued efforts by technical group in improving the
efficiency of our cells. In addition, we have continued with its various cost
cutting programs and renegotiated most of its vendor contracts to reduce
operating expenses.





For the
nine months ended June 30, 2010, we incurred a gross profit of $4.2 million,
representing an increase of $7.3 million, or 232.0%, compared to negative gross
profit of $3.2 million in the same period of the prior year.  The
increase in gross profit was partially 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 44.35% from
RMB 27.89/piece during the nine months ended June 30, 2009 to RMB 15.52/piece
during the nine months ended June 30, 2010. The increase in gross profit was
also due to economies of scale generated from higher production volume, which
lowered per unit production cost and continued efforts by technical group in
improving the efficiency of our cells. In addition, we have continued with its
various cost cutting programs and renegotiated most of its vendor contracts to
reduce operating expenses.





29


Selling,
general and administrative





Three
      Months Ended
                June
      30, 2010
              
              
              Three
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeSelling,
      general and administrative
              
              $
              2,475,000
              
              
              
              15.1
              %
              
              $
              2,577,000
              
              
              
              25.4
              %
              
              $
              (102,000
              )
              
              
              (4.0
              %)





Nine
      Months Ended
                June
      30, 2010
              
              
              Nine
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeSelling,
      general and administrative
              
              $
              7,243,000
              
              
              
              14.0
              %
              
              $
              8,224,000
              
              
              
              41.9
              %
              
              $
              (981,000
              )
              
              
              (11.9
              %)





For the
three months ended June 30, 2010, our selling, general and administrative
expenses were $2.5 million, representing a decrease of $0.1 million, or 4.0%,
from $2.6 million in the three months ended June 30, 2009. Selling, general and
administrative expenses as a percentage of sales for the three months ended June
30, 2010 decreased to 15.1% from 25.4% for the three months ended June 30, 2009.
The decrease in the selling, general and administrative expenses was primarily
due to a decrease of $0.4 million in stock-based compensation expenses related
to employee options and restricted stock from $1.1 million for the three months
ended June 30, 2009 to $0.7 million for the three months ended June 30, 2010.
Excluding stock-based compensation expenses, our selling, general &
administrative expenses increased by approximately $0.3 million primarily due to
increased sales and marketing activities.





For the
nine months ended June 30, 2010, our selling, general and administrative
expenses were $7.2 million, representing a decrease of $1.0 million, or 11.9%,
from $8.2 million in the nine months ended June 30, 2009. Selling, general and
administrative expenses as a percentage of sales for the nine months ended June
30, 2010 decreased to 14.0% from 41.9% for the nine months ended June 30, 2009.
The decrease in the selling, general and administrative expenses was primarily
due to a decrease of $1.3 million in stock-based compensation expenses related
to employee options and restricted stock from $3.4 million for the nine months
ended June 30, 2009 to $2.1 million for the nine months ended June 30, 2010.
Excluding stock-based compensation expenses, our selling, general and
administrative expenses increased by approximately $0.3 million primarily due to
increased sales and marketing activities.





Research
and development





Three
      Months Ended
                June
      30, 2010
              
              
              Three
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeResearch
      and development
              
              $
              54,000
              
              
              
              0.3
              %
              
              $
              463,000
              
              
              
              4.6
              %
              
              $
              (409,000
              )
              
              
              (88.3
              %)





Nine
      Months Ended
                June
      30, 2010
              
              
              Nine
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeResearch
      and development
              
              $
              287,000
              
              
              
              0.6
              %
              
              $
              1,234,000
              
              
              
              6.3
              %
              
              $
              (947,000
              )
              
              
              (76.7
              %)





Research
and development expenses in the three months ended June 30, 2010 were $0.1
million, representing a decrease of $0.4 million, or 88.3%, from $0.5 million
for the three months ended June 30, 2009. Research and development expenses as a
percentage of sales for the three months ended June 30, 2010 decreased to 0.3%
from 4.6% for the three months ended June 30, 2009. The decrease in research and
development expenses was mainly due to a decrease of $0.3 million in stock-based
compensation expenses related to employee options and restricted stock from $0.3
million for the three months ended June 30, 2009 to $13,000 for the three months
ended June 30, 2010.





Research
and development expense in the nine months ended June 30, 2010 of $0.3 million,
representing a decrease of $0.9 million, or 76.7 %, from $1.2 million for the
nine months ended June 30, 2009. Research and development expense as a
percentage of sales for the nine months ended June 30, 2010 decreased to 0.6%
from 6.3% for the nine months ended June 30, 2009. The decrease in research and
development expenses were mainly due to a decrease of $0.8 million in
stock-based compensation expenses related to employee options and restricted
stock from $0.9 million for the nine months ended June 30, 2009 to $0.1 million
for the nine months ended June 30, 2010.





30


In
accordance with our joint research and development laboratory agreement with
Shanghai University, dated December 15, 2006 and expiring on December 15,
2016, we are committed to funding an additional $3.7 million in the next 2
years. The delay in the payment of remaining fiscal years 2008 and 2009 total
commitments of $1.7 million could lead to Shanghai University requesting
that we pay the committed amount within a short time frame. If we do not pay and
are unable to correct the breach within the requested time frame,
Shanghai University could seek compensation up to an additional 15% of the
total committed amount for approximately $0.7 million. As of the date of this
report, we have not received any additional compensation requests from
Shanghai University. We expect to increase our funding to research and
development activities as we grow our business.





Loss
on debt extinguishment





Three
      Months Ended
                June
      30, 2010
              
              
              Three
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeLoss
      on debt extinguishment
              
              $
              -
              
              
              
              0.0
              %
              
              $
              36,000
              
              
              
              0.4
              %
              
              $
              (36,000
              )
              
              
              (100.0
              %)





Nine
      Months Ended
                June
      30, 2010
              
              
              Nine
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeLoss
      on debt extinguishment
              
              $
              18,549,000
              
              
              
              35.8
              %
              
              $
              527,000
              
              
              
              2.7
              %
              
              $
              18,022,000
              
              
              
              3,419.7
              %





There was
no loss on debt extinguishment recorded during the three months ended June 30,
2010. During the nine months ended June 30, 2010, we recorded a cumulative loss
on debt extinguishment of approximately $18.5 million as a result of the
Conversion Agreement and the Exchange Agreement.





During
the three and nine months ended June 30, 2009, $0.1 million and $0.9 million of
Series A and B Convertible Notes were converted into shares of our common stock,
respectively. We recorded a loss on debt extinguishment of $36,000 and $0.5
million, respectively for the three and nine months ended June 30, 2009 as a
result of the conversion based on the quoted market closing price of our common
shares on the conversion dates.





Other
income (expense)




Three
      Months Ended
                June
      30, 2010
              
              
              Three
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeInterest
      income
              
              $
              1,000
              
              
              
              0.0
              %
              
              $
              3,000
              
              
              
              0.0
              %
              
              $
              (2,000
              )
              
              
              (66.7
              %)Interest
      expense
              
              
              (59,000
              )
              
              
              (0.4
              %)
              
              
              (1,015,000
              )
              
              
              (10.0
              %)
              
              
              956,000
              
              
              
              (94.2
              %)Gain
      (loss) on change in fair market valueof
      compound embedded derivative
              
              
              717,000
              
              
              
              4.4
              %
              
              
              (238,000
              )
              
              
              (2.3
              %)
              
              
              955,000
              
              
              
              (401.3
              %)Gain
      (loss) on change in fair market valueof
      warrant liability
              
              
              1,393,000
              
              
              
              8.5
              %
              
              
              (3,158,000
              )
              
              
              (31.1
              %)
              
              
              4,551,000
              
              
              
              (144.1
              %)Impairment
      loss on investment
              
              
              (1,000,000
              )
              
              
              (6.1
              %)
              
              
              -
              
              
              
              0.0
              %
              
              
              (1,000,000
              )
              
              
              (100.0
              %)Other
      income (expense)
              
              
              (485,000
              )
              
              
              (3.0
              %)
              
              
              217,000
              
              
              
              2.1
              %
              
              
              (702,000
              )
              
              
              (323.5
              %)Total
      other income (expense)
              
              $
              567,000
              
              
              
              3.5
              %
              
              $
              (4,191,000
              )
              
              
              (41.3
              %)
              
              $
              4,758,000
              
              
              
              (113.5
              %)





Nine
      Months Ended
                June
      30, 2010
              
              
              Nine
      Months Ended
                June
      30, 2009
              
              
              Year-Over-Year
                ChangeAmount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of net sales
              
              
              Amount
              
              
              %
      of changeInterest
      income
              
              $
              5,000
              
              
              
              0.0
              %
              
              $
              13,000
              
              
              
              0.1
              %
              
              $
              (8,000
              )
              
              
              (61.5
              %)Interest
      expense
              
              
              (5,383,000
              )
              
              
              (10.4
              %)
              
              
              (1,938,000
              )
              
              
              (9.9
              %)
              
              
              (3,445,000
              )
              
              
              177.8
              %Gain
      (loss) on change in fair market valueof
      compound embedded derivative
              
              
              1,115,000
              
              
              
              2.2
              %
              
              
              350,000
              
              
              
              1.8
              %
              
              
              765,000
              
              
              
              218.6
              %Gain
      (loss) on change in fair market valueof
      warrant liability
              
              
              4,369,000
              
              
              
              8.4
              %
              
              
              (1,415,000
              )
              
              
              (7.2
              %)
              
              
              5,784,000
              
              
              
              (408.8
              %)Impairment
      loss on investment
              
              
              (1,000,000
              )
              
              
              (1.9
              %)
              
              
              -
              
              
              
              0.0
              %
              
              
              (1,000,000
              )
              
              
              (100.0
              %)Other
      expense
              
              
              (929,000
              )
              
              
              (1.8
              %)
              
              
              3,000
              
              
              
              0.0
              %
              
              
              (932,000
              )
              
              
              (31,066.7
              %)Total
      other income (expense)
              
              $
              (1,823,000
              )
              
              
              (3.5
              %)
              
              $
              (2,987,000
              )
              
              
              (15.2
              %)
              
              $
              1,164,000
              
              
              
              (39.0
              %)





For the
three months ended June 30, 2010, total other income was $0.6 million,
representing an increase of $4.8 million, or 113.5%, compared to total other
expense of $4.2 million for the same period of the prior year. Other income as a
percentage of sales for the three months ended June 30, 2010 was 3.5% compared
to a negative 41.3% for the same period in the prior year. We incurred interest
expenses of $59,000 in the three months ended June 30, 2010 primarily related to
6% interest charges on the Series B-1 Note. In the three months ended June 30,
2009, we incurred interest expense of $1.0 million primarily related to the
amortization of the discount on the convertible notes and deferred financing
cost, and 6% interest charges on Series A and B Convertible Notes.





31


In the
three months ended June 30, 2010, we recorded a gain on change in fair market
value of warranty liability of $1.4 million and a gain on change in fair market
value of compound embedded derivative of $0.7 million compared to a loss on
change in fair market value of warrant liability of $3.2 million and a loss on
change in fair market value of compound embedded derivative of $0.2 million
during the three months ended June 30, 2009. The lower conversion price of
the compound embedded derivative and warrant in the three months ended June 30,
2010 compared to that in the three months ended June 30, 2009 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. Other expenses of $0.5 million and other
income of $0.2 million for the three months ended June 30, 2010 and 2009,
respectively, were primarily related to foreign exchange gain
(loss).





The $1.0
million in impairment loss on investment for the three and nine months ended on
June 30, 2010 is related to the write-down of our investment in 21-Century
Silicon, which we consider as unrecoverable.  No write-down of
investment is recorded in the prior period.





For the
nine months ended June 30, 2010, total other expenses was $1.8 million,
representing a decrease of $1.2 million or 39.0% compared to total other
expenses of $3.0 million for the same period of the prior year. Other expenses
as a percentage of sales for the nine months ended June 30, 2010 decreased to a
negative 3.5% from a negative 15.2% for the nine months ended June 30, 2009. In
the nine months ended June 30, 2010, we recorded a gain on change in fair market
value of compound embedded derivative of $1.1 million and a gain on change in
fair market value of warrant liability of $4.4 million compared to a gain on
change in fair market value of compound embedded derivative of $0.4 million and
a loss on change in fair market value of warrant liability of $1.4 million
during the nine months ended June 30, 2009. The lower conversion price of the
compound embedded derivative and warrant in the nine months ended June 30, 2010
compared to that in the nine months ended June 30, 2009, 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 $5.4 million
and $1.9 million in the nine months ended June 30, 2010 and 2009, respectively,
primarily related to the amortization of the discount on the convertible notes
and deferred financing cost, and 6% interest charges on Series A and B, and
Series B-1 Convertible Notes. Other expenses of $0.9 million and other income of
$3,000 for the nine months ended June 30, 2010 and 2009, respectively, were
primarily related to foreign exchange gain (loss).




Liquidity
and Capital Resources





June
      30,
                2010
              
              
              September
      30,
                2009
              
              
              ChangeCash
      and cash equivalents
              
              $
              2,662,000
              
              
              $
              1,719,000
              
              
              $
              943,000





As of June 30, 2010, we had cash and
cash equivalents of $2.7 million as compared to $1.7 million at September 30,
2009. We will require a significant amount of cash to fund our operations.
Changes in our operating plans, an increase in our inventory, increased
expenses, or other events, may cause us to seek additional equity or debt
financing in the future. In order to continue as a going concern, we will need
to continue to generate new sales while controlling our costs.  If we
are unable to successfully generate enough sales to cover our costs, we only
have limited cash resources to bear operating losses.  To the extent
our operations are not profitable, we may not continue as a going
concern.




Our
liquidity is impacted to a large extent based on both the nature of the products
we sell and also the geographical location of our customers, as our payment
terms on sale vary greatly depending on both factors.  With respect to
the products we sell, while in the past we have engaged in transactions
where we have resold our raw materials due to our overstock of materials
relative to our then limited production capacity, as our production capacity has
increased over the years, our sales now consist primarily of solar modules to
solar panel installers in Europe and Australia who incorporate our
modules into their power generating systems that are sold to
end-customers.  Payment terms for the sale of our modules are generally
longer than payment terms where we resell our raw materials in China and as a
result, our payment terms have lengthened relative to prior years.  In
addition, with respect to the geographic location of our customers, the
payment terms for the sale of our solar modules are generally longer for our
customers in the United States than for our customers in Europe and
Australia.  While our current sales to customers in the United
States are limited, if we are able to increase our sales in the
U.S. market or in other markets that may have longer payment terms, our
payment terms may lengthen.  If we have more sales of products or in
geographies with longer payment terms, the longer payment terms will impact the
timing of our cash flows.


32




Nine
      Months Ended
                June
      30,2010
              
              
              2009
              
              
              ChangeNet
      cash provided by (used in):Operating
      activities
              
              $
              653,000
              
              
              $
              369,000
              
              
              $
              284,000Investing
      activities
              
              
              (454,000
              )
              
              
              (289,000
              )
              
              
              (165,000
              )Financing
      activities
              
              
              729,000
              
              
              
              -
              
              
              
              729,000Effect
      of exchange rate changes on cash and cash equivalents
              
              
              15,000
              
              
              
              5,000
              
              
              
              10,000Net
      increase in cash and cash equivalents
              
              $
              943,000
              
              
              $
              85,000
              
              
              $
              858,000


Net cash
provided by operating activities were $0.7 million and $0.4 million for the nine
months ended June 30, 2010 and 2009, respectively. Cash flow from operating
activities reflected a net loss of $23.7 million adjusted for non-cash items,
including depreciation of property and equipment, stock-based compensation, the
change in the fair market value of the compound derivative liabilities and
warrants liabilities, impairment loss on investment, amortization of note
discount and deferred financing cost, and loss on debt extinguishment. The
increase of $0.3 million in cash flow from operating activities from June 30,
2009 to June 30, 2010 was mainly attributable to the improved cash generating
ability resulting from enlarged sales and positive gross margin. The net loss
excluding non-cash expenses for nine months ended June 30, 2010 decreased
compared to the same period in 2009, partially offset by higher balances of
accounts receivable, inventories, VAT receivables, and a lower accounts payable
balance outstanding in the current period.





Net cash
used in investing activities were $0.5 million and $0.3 million in the nine
months ended June 30, 2010 and 2009, respectively. The increase of $0.2 million
in net cash used in investing activities was primarily due to higher property
and equipment acquisitions during the nine months ended June 30, 2010 compared
to the nine months ended June 30, 2009.





Net cash
provided by financing activities was $0.7 million in the nine months ended June
30, 2010 due to we borrowed the fund from a credit facility with Industrial Bank
Co., Ltd (“IBC”). There was no cash provided by financing activities for the
nine months ended June 30, 2009.





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





After
consummating the transactions contemplated under the Conversion Agreement and
Exchange Agreement, our only outstanding convertible note is the Series
B-1-Note. As of June 30, 2010, the principal outstanding and the carrying value
of the Series B-1 Note were $1.8 million and 1.5 million, respectively. The
Series B-1 Note bears interest at 6% per annum and is due on March 19, 2012. The
holders of the Series B-1 Note can demand repayment from us upon the occurrence
of any of the triggering events detailed in the Series B-1 Note. It is uncertain
whether we will be able to satisfy this claim if it comes due. In addition, we
have certain commitments as disclosed in the “Off-Balance Sheet Arrangements”
section below.





If we
experience a material shortfall versus our operating plans, we have a range of
actions we can take to remediate the cash shortage, including but not limited to
raising additional funds through debt financing, securing a credit facility,
entering into secured or unsecured bank loans, or undertaking equity offerings
such 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.




33





Off-Balance
Sheet Arrangements





Pursuant
to a joint research and development laboratory agreement with
Shanghai University, dated December 15, 2006 and expiring on
December 15, 2016, we are committed to funding the establishment of
laboratories and completion of research and development activities. We have
committed to invest no less than RMB5 million each year for the first three
years and no less than RMB30 million cumulatively for the first five years.
The following table summarizes the commitments in U.S. dollars based upon a
translation of the RMB amounts into U.S. dollars at an exchange rate of 6.7909
as of June 30, 2010.




Year
              
              Amount2010
              
              $
              2,604,0002011
              
              
              1,119,000Total
              
              $
              3,723,000


We intend
to increase research and development spending as we grow our business. The
payment to Shanghai University will be used to fund program expenses and
equipment purchase. Due to the delay in the progress of research and development
activities, the amount of $1.7 million originally committed to be paid during
fiscal years 2009 and 2008 has not been paid as of June 30, 2010, (included in
the total amount of $3.7 million above), as Shanghai University has not
incurred the additional costs to meet its research and development milestones
and therefore has not made the request for payments. If we fail to make
payments, when requested, we will be deemed to be in breach of the agreement. If
we are unable to correct the breach within the requested time frame,
Shanghai University could seek compensation up to an additional 15% of the
total committed amount for approximately $0.7 million. As of June 30, 2010, we
are not in breach as we have not received any additional compensation requests
from Shanghai University.





On August
21, 2008, we 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.
 See “Note 3 — Summary of Significant Accounting Policies” in the
Notes to Consolidated Financial Statements of this Form 10-Q.





On
September 22, 2008, the registered capital of Solar EnerTech (Shanghai) Co., Ltd
was increased from $25 million to $47.5 million, which was approved by our Board
of Directors and authorized by Shanghai Municipal Government (the “Shanghai
Government”). The paid-in capital as of June 30, 2010 was $31.96 million, with
an outstanding remaining balance of $15.54 million to be originally funded by
September 21, 2010. In August 2010, we received the approval of the Shanghai
Government to extend the funding requirement date by nine months to June 2011.
We plan to raise funds to meet this capital requirement through participation in
the capital markets, such as undertaking equity offerings. If external financing
is not available, we will file an application with the Shanghai Government to
reduce the capital requirement, which is legally permissible under PRC
law.





On
January 15, 2010, we incorporated a wholly-owned subsidiary in Yizheng, Jiangsu
Province of China to supplement our existing production facilities to meet
increased sales demands.  The subsidiary was formed with a registered
capital requirement of $33 million, of which $23.4 million is to be funded by
October 16, 2011.  In order to fund the registered capital
requirement, we will have to raise funds or otherwise obtain the approval of
local authorities to reduce the amount of registered capital for the subsidiary.
The registered capital requirement outstanding as of June 30, 2010, is $23.4
million.





On
February 8, 2010, we acquired land use rights of a parcel of land at the price
of approximately $0.7 million. This piece of land is 68,025 square meters and is
located in Yizheng, Jiangsu Province of China, which will be used to house our
second manufacturing facility. As part of the acquisition of the land use right,
we are required to complete construction of the facility by February 8,
2012.





ITEM 3. 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 3.




34




ITEM
4. CONTROLS AND PROCEDURES




Disclosure
Controls and Procedures




As
required by Rule 13a-15 of the Securities Exchange Act of 1934, our Chief
Executive Officer and Chief Financial Officer evaluated our company's disclosure
controls and procedures (as defined in Rules 13a-15(e) of the Securities
Exchange Act of 1934) as of the end of the period covered by this report. Based
on this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that as of the end of the period covered by this report, these
disclosure controls and procedures were not effective to ensure that the
information required to be disclosed by our company in reports we file or submit
under the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported, within the time periods specified in the rules and
forms of the Securities Exchange Commission, and to ensure that such information
required to be disclosed by our company in the reports that we file or submit
under the Securities Exchange Act of 1934, as amended, is accumulated and
communicated to our company's management, including our Chief Executive Officer
and Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure. The conclusion that our disclosure controls and procedures
were not effective was due to the lack of finance and accounting personnel with
an appropriate level of knowledge, experience and training in the application of
U.S. GAAP. Our fiscal 2009 financial reporting close process was ineffective in
recording certain transactions according to the applicable accounting
pronouncement, preventing amounts from being incorrectly classified in our
statement of cash flows and preparing certain critical financial statement
disclosures. Our plan to remediate the material weakness primarily consisted of
hiring finance and accounting personnel with an appropriate level of knowledge,
experience and training in the application of U.S. GAAP and training, educating
and equipping our existing personnel on U.S. GAAP accounting matters.  We
have improved the training, education and equipment of our accounting personnel
in U.S. GAAP, hired a new accounting supervisor and engaged a consulting firm to
provide us with professional advice on how to improve our disclosure controls
and procedures.  We are, however, still looking to hire additional finance
and accounting personnel.  Accordingly, management has determined that this
control deficiency continues to constitute a material weakness. Management
anticipates that such disclosure controls and procedures will not be effective
until the material weaknesses are remediated.




We are in
the process of implementing the following measures to remediate these material
weaknesses: (a) hire additional financial reporting and accounting personnel
with relevant account experience, skills, and knowledge in the preparation of
financial statements under the requirements of U.S. GAAP; and (b) continue to
work with internal and external consultants to improve the process for
collecting and reviewing information required for the preparation of financial
statements.




Changes
in Internal Control over Financial Reporting




Our
management, with the participation of our Chief Executive Officer and our Chief
Financial Officer, has concluded there were no changes in our internal controls
over financial reporting that occurred during the three months ended June 30,
2010 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.







35




PART
II - OTHER INFORMATION




ITEM
1. LEGAL PROCEEDINGS




None





ITEM
1A. RISK FACTORS




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. In assessing these
risks, investors should also refer to the other information contained or
incorporated by reference in this periodic report on Form 10-Q, including our
June 30, 2010 consolidated financial statements and related notes.




RISKS
RELATED TO OUR BUSINESS AND OUR INDUSTRY




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





As of June 30, 2010, we had cash and
cash equivalents of $2.7 million. We will require a significant amount of cash
to fund our operations.  In order to continue as a going concern, we
will need to continue to generate new sales while controlling our
costs.  If we are unable to successfully generate enough revenues to
cover our costs, we only have limited cash resources to bear operating
losses.  To the extent our operations are not profitable, we may not
continue as a going concern.




We may be
adversely affected by volatile market and industry trends and, in particular,
the demand or pricing for our solar power products may decline, which may reduce
oursales and
earnings.




We are
affected by solar power market and industry trends. Beginning in the fourth
fiscal quarter 2008, many of our key markets, including Belgium, Germany, and
Australia, experienced a period of economic contraction and significantly slower
economic growth. In particular, from late 2008 through mid 2009, the credit
crisis, weak consumer confidence and diminished consumer and business spending
contributed to a significant slowdown in market demand for solar power products.
Meanwhile, manufacturing capacity for solar power products increased during the
same period. This resulted in prices for solar power products declining
significantly.   These same trends continued for the remainder of
2009 and caused prices for solar power products to continue to
decline.




36


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




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




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




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




A
significant reduction in the scope or discontinuation of government incentive
programs, especially those in our target overseas markets, could cause demand
for our products and our sales to decline, and have a material adverse effect on
our business, financial condition, results of operations and prospects.
Governments may decide to reduce or eliminate these economic incentives for
political, financial or other reasons. Reductions in, or eliminations of
government subsidies and economic incentives before the solar power industry
reaches a sufficient scale to be cost-effective in a non-subsidized marketplace
could reduce demand for our products and adversely affect our business prospects
and results of operations. A significant reduction in the scope or
discontinuation of government incentive programs, especially those in the target
markets of our major customers, could cause demand for our products and our
sales to decline and have a material adverse effect on our business, financial
condition, results of operations and prospects.




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




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




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




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




37




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




We expect
that our results of operations will, for the foreseeable future, continue to
depend on the sale of our products to a relatively small number of customers.
For the nine fiscal months ended June 30, 2010 and the fiscal years ended
September 30, 2009 and 2008, sales to three, four and one customers,
respectively, exceeded 10% of our sales and accounted for approximately 76.28%,
70.74% and 38.15%, respectively, of our sales. Consequently, any one of the
following events may cause material fluctuations or declines in our sales and
have a material adverse effect on our results of operations:




·
            reduction,
      delay or cancellation of orders from one or more significant
      customers;·
            loss
      of one or more significant customers and failure to identify additional or
      replacement customers;




·
            failure
      of any significant customers to make;
and




·
            timely
      payment for products.




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




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




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




·
            in
      order to finance our production capacity expansion, we will need to raise
      additional capital beyond what is raised by this offering through bank
      borrowings or the issuance of our equity or debt securities, which may not
      be available on reasonable terms or at all, and which could be dilutive to
      our existing stockholders;




·
            we
      will be required to obtain government approvals, permits or documents of
      similar nature with respect to any acquisitions or new expansion projects,
      and we cannot assure you that such approvals, permits or documents will be
      obtained in a timely manner or at
all;




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




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




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




38




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




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




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




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




We
currently do not have sufficient funds to meet the registered capital
requirement for our Yizheng subsidiary and Shanghai subsidiary.
  On
January 15, 2010, we incorporated a wholly-owned subsidiary in Yizheng, Jiangsu
Province of China to supplement our existing production facilities to meet
increased sales demands.  The subsidiary was formed with a registered
capital requirement of $33 million, of which $23.4 million is to be funded by
October 16, 2011.  As of June 30, 2010, the outstanding registered
capital requirement for the Yizheng subsidiary was $23.4 million.  In
addition, our wholly-owned subsidiary in Shanghai, China has a registered
capital requirement of $47.5 million and as of June 30, 2010, our
paid-in-capital was approximately $31.96 million, with the remaining balance of
$15.54 million to be originally funded by September 21, 2010. In August 2010,
the Company received the approval of the Shanghai government to extend the
funding requirement date by nine months to June 2011. In order to fund the
registered capital requirement, we will have to raise funds or otherwise obtain
the approval of local authorities to reduce the amount of registered capital for
each of our subsidiaries. We cannot assure you that we will be able to raise
funds or obtain local authority approval to reduce the amount of registered
capital. See “Note 12 —Commitments and Contingencies”, in the Notes to Consolidated Financial
Statements of this Form 10-Q.
 
 We
may not have sufficient funds to complete construction of a manufacturing
facility in Yizheng as required.
 
 On
February 8, 2010, we acquired land use rights of a parcel of land at the price
of approximately $0.7 million. This piece of land is 68,025 square meters and is
located in Yizheng, Jiangsu Province of China, which will be used to house
our second manufacturing facility. As part of the acquisition of the land use
right, we are required to complete construction of the facility by February 8,
2012. We cannot assure you that we will have sufficient funds to complete
construction of the facility by the required date or obtain local authority
approval to delay such required date. See “Note 12 —Commitments and
Contingencies”, in the Notes to Consolidated Financial Statements of this Form
10-Q.
  We
have not fully funded our research and development commitments with Shanghai
University
 
 Pursuant
to a joint research and development laboratory agreement with Shanghai
University, dated December 15, 2006 and expiring on December 15, 2016, we
committed to fund the establishment of laboratories and completion of research
and development activities. We committed to invest no less than RMB 5 million
each year for the first three years and no less than RMB 30 million cumulatively
for the first five years. Due to the delay in the progress of research and
development activities, the amount of $1.7 million originally committed to be
paid during fiscal years 2009 and 2008 has not been paid as of June 30, 2010, as
Shanghai University has not incurred the additional costs to meet its research
and development milestones and therefore has not made the request for payments.
If we fail to make such payments when requested, we may be deemed to be in
breach of the agreement. If we are unable to correct the breach within the
requested time frame, Shanghai University could seek compensation of up to an
additional 15% of the total committed amount for approximately $0.7 million. As
of June 30, 2010, the Company is not in breach as it has not received any
additional compensation requests from Shanghai University. We, however, cannot
assure you that we will be able to fund our commitments to Shanghai University
when requested to do so. See “Note 12 —Commitments and
Contingencies”, in the Notes to Consolidated Financial Statements of this Form
10-Q.
  39
 The
terms of one of our debt instruments contains certain requirements and
covenants which limit our ability to raise funds. In addition, if we fail to
comply with our covenants, our debt may be accelerated.
  Our Series B-1 Note
containscertain
provisions which, under certain circumstances, require us to redeem certain
amounts of the indebtedness in an equity financing. In connection with
certain future equity financings that we may pursue, we would be required to
utilize a portion of the proceeds towards redemption of our
Series B-1 Note, which may make it more difficult for us to raise
capital.In
addition, our credit facility with Industrial Bank Co., Ltd. (“IBC”) contains provisionswherebyIBCcandemand repayment of outstanding
debt if we do not comply
with any of the covenants, including but not limited to, maintaining our
creditworthiness, complying with all our contractual obligations, providing true
and accurate records as requested by IBC, fulfillment of other indebtedness
(ifany), maintaining our business license
and continuing operations, ensuring our financial condition does not
deteriorate, remaining solvent, and other conditions, as defined in the credit
facility agreement.
Since certain of the covenants
are broadly constructed and subjective in nature, IBC may have the right to
demand repayment of any outstanding debt as it may determine in its own
discretion.




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




In 2008
and 2009, our five largest suppliers supplied in the aggregate approximately
90.1% and 70.76%, respectively, of our total silicon wafer material purchases by
value. If we fail to develop or maintain our relationships with these or our
other suppliers, we may be unable to manufacture our products, our products may
only be available at a higher cost or after a long delay, or we could be
prevented from delivering our products to our customers in the required
quantities, at competitive prices and on acceptable terms of delivery. Problems
of this kind could cause us to experience order cancellations, decreased sales
and loss of market share. In general, the failure of a supplier to supply
silicon wafer materials that meet our quality, quantity and cost requirements in
a timely manner due to lack of supplies or other reasons could impair our
ability to manufacture our products or could increase our costs, particularly if
we are unable to obtain these materials and components from alternative sources
in a timely manner or on commercially reasonable terms. Some of our suppliers
have a limited operating history and limited financial resources, and the
contracts we entered into with these suppliers do not clearly provide for
remedies to us in the event any of these suppliers is not able to, or otherwise
does not, deliver, in a timely manner or at all, any materials it is
contractually obligated to deliver. Any disruption in the supply of silicon
wafer materials to us may adversely affect our business, financial condition and
results of operations.




We
face intense competition in solar power product markets. If we fail to adapt to
changing market conditions and to compete successfully with existing or new
competitors, our business prospects and results of operations would be
materially and adversely affected.




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




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


40


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




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




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




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




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




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




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




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




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




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




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




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




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




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




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;




41




·
            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




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




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




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




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




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




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




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


42


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




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




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




·
            the
      state of global credit markets;




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




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




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




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




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




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




The
production of solar cells and solar modules involves complex processes.
Deviations in the manufacturing process can cause a substantial decrease in
output and, in some cases, disrupt production significantly or result in no
output. We have from time to time experienced lower-than-anticipated
manufacturing output during the ramp-up of production lines. This often occurs
during the introduction of new products, the installation of new equipment or
the implementation of new process technologies. As we bring additional lines or
facilities into production, we may operate at less than intended capacity during
the ramp-up period. This would result in higher marginal production costs and
lower than expected output, which could have a material adverse effect on our
results of operations.




Because
a majority of our products are sold with warranties extending for 25 years,
problems with product quality or product performance may cause us to incur
warranty expenses. If these expenses are significant, they could have a material
adverse affect on our business and results of operations.




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




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




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




43




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




As of
June 30, 2010, our director, president and chief executive officer, Leo Shi
Young, beneficially owns 15,284,286 shares of our common stock, or approximately
9%, of our common stock. As of June 30, 2010, The Quercus Trust, which nominated
David Anthony and David Field to our Board of Directors, beneficially owns
82,119,691 shares of our common stock, or approximately 48.36%, of our common
stock. Therefore, our CEO and the Quercus Trust have substantial control over
our business, including decisions regarding mergers, consolidations and the sale
of all or substantially all of our assets, election of directors, dividend
policy and other significant corporate actions. They may take actions that are
not in the best interest of our company or our securities holders. For example,
this concentration of ownership may discourage, delay or prevent a change in
control of our company, which could deprive our stockholders of an opportunity
to receive a premium for their shares as part of a sale of our company and might
reduce the price of our common stock. On the other hand, if our chief executive
officer and the Quercus Trust are in favor of any of these actions, these
actions may be taken even if they are opposed by our other stockholders,
including you and those who invest in our common stock.




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




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




Our
lack of sufficient patent protection in and outside of China may undermine our
competitive position and subject us to intellectual property disputes with third
parties, both of which may have a material adverse effect on our business,
results of operations and financial condition.




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




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




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




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




44




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




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




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




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




We
are subject to 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
corporate governance requirements under the Sarbanes-Oxley Act of 2002, as well
as 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 SEC
rules, we are required to include management’s report on internal controls as
part of our annual reports pursuant to Section 404 of the Sarbanes-Oxley
Act. 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 our lack of a
sufficient number of finance personnel with an appropriate level of knowledge,
experience and training in the application of U.S. generally accepted accounting
principles, or 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.




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.




45




RISKS
RELATED TO DOING BUSINESS IN CHINA




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




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




·
            the
      amount of government involvement;




·
            the
      level of development;




·
            the
      growth rate;




·
            the
      control of foreign exchange; and




·
            the
      allocation of resources.




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




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




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




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




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




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




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




46




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




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




RISKS
RELATED TO AN INVESTMENT IN OUR SECURITIES




Our
stock price is volatile. There is no guarantee that 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.




47




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




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




ITEM 2. UNREGISTERED SALES
OF EQUITY SECURITIES AND USE OF PROCEEDS





On July
1, 2010, we issued 209,549 shares of our common stock as accrued interest to the
holder of our Series B-1 convertible note. These shares were exempt from any
registration requirement under the Securities Act pursuant to Section 3(a)(9) of
the Securities Act and Rule 144 promulgated under the Securities
Act.





On June
16, 2010, we issued 168,749 shares of our common stock as accrued interest to
the holder of our Series B-1 convertible note. These shares were exempt from any
registration requirement under the Securities Act pursuant to Section 3(a)(9) of
the Securities Act and Rule 144 promulgated under the Securities
Act.




ITEM
3. DEFAULTS UPON SENIOR SECURITIES




None




ITEM
4. REMOVED AND RESERVED




None





ITEM
5. OTHER INFORMATION




On August
12, 2010, the Board of Directors confirmed the removal of Mr. Shi Jian Yin from
the position of Chief Operating Officer of the Company.




48





ITEM
6. EXHIBITS




(a)
Pursuant to Rule 601 of Regulation S-K, the following exhibits are included
herein or incorporated by reference.




2.1
            Agreement
      and Plan of Merger with Solar EnerTech Corp., a Nevada corporation and our
      predecessor in interest, dated August 13, 2008, incorporated by reference
      from Exhibit 2.1 to our Form 8-K filed on August 14,
  2008.3.1
            Certificate
      of Incorporation, incorporated by reference from Exhibit 3.1 to our Form
      8-K filed on August 14, 2008.3.2
            By-laws,
      incorporated by reference from Exhibit 3.2 to our Form 8-K filed on August
      14, 2008.31.1
            Section
      302 Certification - Chief Executive Officer*31.2
            Section
      302 Certification - Chief Financial Officer*32.1
            Certification
      Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 - Chief Executive
  Officer.*32.2
            Certification
      Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 - Chief Financial
  Officer.*





* Filed
herewith.





49




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.




SOLAR ENERTECH
      CORP.Date:
      August 16, 2010
            By:
            /s/
      Steve YeSteve
      YeChief
      Financial Officer




50