UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





x  QUARTERLY
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the
quarter ended March 31, 2009





 ̈ TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the
transition period from _____ to _____





Commission
File Number: 0-52150





FRANKLIN
TOWERS ENTERPRISES, INC.


(Exact
name of small business issuer as specified in its charter)





Nevada
              (State
      of incorporation)
            20-4069588
              (IRS
      Employer ID Number)




88 Julong
Road


Lidu
Economic Development Zone


Fulin,
Chongqing, China


(Address
of principal executive offices)





011-86-2372183330


(Issuer's
telephone number)








(Former
name, former address and former fiscal year, if changed since last
report)





Check
whether the issuer (1) filed all reports required to be filed by Section 13 or
15(d) of the Exchange Act during the past 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 x  No
 ̈





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





Large accelerated filer
             ̈
            Accelerated filer
             ̈Non-accelerated filer
             ̈
            Smaller reporting company
            x(Do
      not check if a smaller reporting company)




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





Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date: 123,484,043 shares as of May 20,
2009











TABLE OF
CONTENTS





2





PART
I





Item
1.  Financial Statements


FRANKLIN
TOWERS ENTERPRISES, INC. AND SUBSIDIARY
 
 INDEX TO
FINANCIAL STATEMENTS
 
 PageCondensed
      Consolidated Balance Sheets
                      As
      of March 31, 2009 (Unaudited) and December 31, 2008
                    F-1Condensed
      Consolidated Statements of Operations
                      For
      the Three Months Ended March 31, 2009 and 2008 (Unaudited)
                    F-2Condensed
      Consolidated Statement of Stockholders’ Deficit
                      For
      the Three Months Ended March 31, 2009 (Unaudited)
                      and
      the Year Ended December 31, 2008
                    F-3Condensed
      Consolidated Statements of Cash Flows
                      For
      the Three Months Ended March 31, 2009 and 2008 (Unaudited)
                    F-4Notes
      to Condensed Consolidated Financial Statements (Unaudited)
                    F-5
      - F-18
  
 FRANKLIN TOWERS ENTERPRISES,
INC. AND SUBSIDIARY
 CONDENSED CONSOLIDATED
BALANCE SHEETS
 
 March 31,
                          2009
                        
                        
                        December 31,
                          2008(Unaudited)ASSETSCurrent
      Assets:Cash
      and cash equivalents
                        
                        $
                        997,952
                        
                        
                        $
                        61,867Accounts
      receivable - net of allowance for doubtful accounts of $3,289 and $2,362
      as of March 31, 2009 and December 31, 2008, respectively
                        
                        
                        57,298
                        
                        
                        
                        68,727Other
      receivables
                        
                        
                        545,388
                        
                        
                        
                        -Inventories
                        
                        
                        2,796,846
                        
                        
                        
                        2,847,009Prepaid
      costs and expenses
                        
                        
                        324,497
                        
                        
                        
                        772,314Total
      Current Assets
                        
                        
                        4,721,981
                        
                        
                        
                        3,749,917Property
      and Equipment, net
                        
                        
                        869,040
                        
                        
                        
                        887,693Other
      Assets:Deposits
                        
                        
                        702,720
                        
                        
                        
                        483,681Deferred
      finance costs - net of accumulated amortization of $357,331 and $325,703
      as of March 31, 2009 and December 31, 2008, respectively
                        
                        
                        25,169
                        
                        
                        
                        56,797Total
      Other Assets
                        
                        
                        727,889
                        
                        
                        
                        540,478TOTAL
      ASSETS
                        
                        $
                        6,318,910
                        
                        
                        $
                        5,178,088LIABILITIES
      AND STOCKHOLDERS' DEFICITCurrent
      Liabilities:Convertible
      notes payable - net of unamortized discounts of $686,607 and $1,078,882 as
      of March 31, 2009 and December 31, 2008, respectively
                        
                        $
                        2,105,568
                        
                        
                        $
                        1,713,293Loans
      payable
                        
                        
                        2,967,032
                        
                        
                        
                        1,866,294Accounts
      payable and accrued expenses
                        
                        
                        767,036
                        
                        
                        
                        707,843Convertible
      notes interest and penalty payables
                        
                        
                        1,565,755
                        
                        
                        
                        1,223,713Loans
      payable - related parties
                        
                        
                        19,391
                        
                        
                        
                        19,391Total
      Current Liabilities
                        
                        
                        7,424,782
                        
                        
                        
                        5,530,534TOTAL
      LIABILITIES
                        
                        
                        7,424,782
                        
                        
                        
                        5,530,534Stockholders'
      Defict:Preferred
      stock, $0.001 par value; 5,000,000 shares authorized, 0 shares issued and
      outstanding as of March 31, 2009 and December 31, 2008
                        
                        
                        -
                        
                        
                        
                        -Common
      stock, $.0001 par value; 1,250,000,000 shares authorized, 123,484,043
      shares issued and outstanding as of March 31, 2009 and December 31,
      2008
                        
                        
                        12,348
                        
                        
                        
                        12,348Deferred
      finance costs
                        
                        
                        (849,693
                        )
                        
                        
                        (1,335,144
                        )Additional
      paid-in capital
                        
                        
                        18,345,012
                        
                        
                        
                        18,345,012Accumulated
      deficit
                        
                        
                        (18,926,857
                        )
                        
                        
                        (17,690,956
                        )Accumulated
      other comprehensive income
                        
                        
                        313,318
                        
                        
                        
                        316,294Total
      Stockholders' Deficit
                        
                        
                        (1,105,872
                        )
                        
                        
                        (352,446
                        )TOTAL
      LIABILITIES AND STOCKHOLDERS' DEFICIT
                        
                        $
                        6,318,910
                        
                        
                        $
                        5,178,088
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  F -
1
 
 FRANKLIN TOWERS ENTERPRISES,
INC. AND SUBSIDIARY
 CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS
 FOR THE THREE MONTHS ENDED
MARCH 31, 2009 AND 2008
 (UNAUDITED)
 
 2009
                    
                    
                    2008Net
      Sales
                    
                    $
                    398,371
                    
                    
                    $
                    1,325,660Cost
      of Sales
                    
                    
                    370,486
                    
                    
                    
                    1,314,861Gross
      Profit
                    
                    
                    27,885
                    
                    
                    
                    10,799Operating
      Expenses:Professional
      fees
                    
                    
                    16,629
                    
                    
                    
                    119,860Depreciation
      and amortization
                    
                    
                    9,625
                    
                    
                    
                    2,322General
      and administrative expenses
                    
                    
                    120,362
                    
                    
                    
                    93,517Total
      Operating Expenses
                    
                    
                    146,616
                    
                    
                    
                    215,699Loss
      From Operations
                    
                    
                    (118,731
                    )
                    
                    
                    (204,900
                    )Other
      Income (Expenses):Subsidy
      income
                    
                    
                    265,458
                    
                    
                    
                    -Interest
      income
                    
                    
                    6,457
                    
                    
                    
                    1,439Interest
      Expense
                    
                    
                    (1,389,085
                    )
                    
                    
                    (1,338,199
                    )Total
      Other (Expense)
                    
                    
                    (1,117,170
                    )
                    
                    
                    (1,336,760
                    )Loss
      Before Income Tax
                    
                    
                    (1,235,901
                    )
                    
                    
                    (1,541,660
                    )Provision
      for Income Tax
                    
                    
                    -
                    
                    
                    
                    -Net
      Loss
                    
                    $
                    (1,235,901
                    )
                    
                    $
                    (1,541,660
                    )Net
      Loss per Share - Basic and Diluted
                    
                    $
                    (0.01
                    )
                    
                    $
                    (0.02
                    )Weighted
      Average Shares Outstanding - Basic and Diluted
                    
                    
                    123,484,043
                    
                    
                    
                    91,958,959Comprehensive
      Loss:Net
      loss
                    
                    $
                    (1,235,901
                    )
                    
                    $
                    (1,541,660
                    )Foreign
      currency translation adjustment
                    
                    
                    (2,976
                    )
                    
                    
                    80,417Comprehensive
      Loss
                    
                    $
                    (1,238,877
                    )
                    
                    $
                    (1,461,243
                    )
  The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  F -
2
  FRANKLIN TOWERS ENTERPRISES,
INC. AND SUBSIDIARY
 CONDENSED CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' DEFICIT
 FOR THE THREE MONTHS ENDED
MARCH 31, 2009 (UNAUDITED) AND THE YEAR ENDED DECEMBER 31,
2008
 
 Preferred
      Stock
                      
                      
                      Common
      Stock
                      
                      
                      Additional
                      
                      
                      
                      
                      
                      
                      
                      
                      Accumulated
                        OtherShares
                      
                      
                      Amount
                      
                      
                      Shares
                      
                      
                      Amount
                      
                      
                      Paid
      - in
                        Capital
                      
                      
                      Deferred
                        Finance
      Costs
                      
                      
                      Accumulated
                        Deficit
                      
                      
                      Comprehensive
                        Income
                      
                      
                      TotalBalance
      - December 31, 2007
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      91,130,000
                      
                      
                      $
                      9,113
                      
                      
                      $
                      15,659,700
                      
                      
                      $
                      (3,415,349
                      )
                      
                      $
                      (11,508,096
                      )
                      
                      $
                      104,224
                      
                      
                      $
                      849,592Common
      stock issued for repayment of convertible notes and accrued
      interest
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      32,354,043
                      
                      
                      
                      3,235
                      
                      
                      
                      665,627
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      668,862Amortization
      of deferred finance costs
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,080,205
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,080,205Repayment
      of nonreciprocal funds transferred to shareholder
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,019,685
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,019,685Net
      loss for the year ended December 31, 2008
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      (6,182,860
                      )
                      
                      
                      -
                      
                      
                      
                      (6,182,860
                      )Foreign
      currency translation adjustment
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      212,070
                      
                      
                      
                      212,070Balance
      - December 31, 2008
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      123,484,043
                      
                      
                      
                      12,348
                      
                      
                      
                      18,345,012
                      
                      
                      
                      (1,335,144
                      )
                      
                      
                      (17,690,956
                      )
                      
                      
                      316,294
                      
                      
                      
                      (352,446
                      )Amortization
      of deferred finance costs
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      485,451
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      485,451Net
      loss for the period
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (1,235,901
                      )
                      
                      
                      -
                      
                      
                      
                      (1,235,901
                      )Foreign
      currency translation adjustment
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (2,976
                      )
                      
                      
                      (2,976
                      )Balance
      - March 31, 2009
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      123,484,043
                      
                      
                      $
                      12,348
                      
                      
                      $
                      18,345,012
                      
                      
                      $
                      (849,693
                      )
                      
                      $
                      (18,926,857
                      )
                      
                      $
                      313,318
                      
                      
                      $
                      (1,105,872
                      )
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  F -
3
 
 FRANKLIN TOWERS ENTERPRISES,
INC. AND SUBSIDIARY
 CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS
 FOR THE THREE MONTHS ENDED
MARCH 31, 2009 AND 2008
 (UNAUDITED)
 
 2009
                              
                              
                              2008Cash
      Flows from Operating Activities:Net
      Loss
                              
                              $
                              (1,235,901
                              )
                              
                              $
                              (1,541,660
                              )Adjustments
      to Reconcile Net Loss to NetCash Provided by (Used in) Operating
      Activities:Depreciation
      expense
                              
                              
                              22,878
                              
                              
                              
                              14,819Bad
      debt expense
                              
                              
                              929
                              
                              
                              
                              9,214Amortization
      of deferred finance costs
                              
                              
                              31,628
                              
                              
                              
                              75,807Amortization
      of debt discount - fair value of warrants and beneficial conversion
      feature
                              
                              
                              392,275
                              
                              
                              
                              437,192Amortization
      of deferred finance costs - consulting
                              
                              
                              485,451
                              
                              
                              
                              541,036Common
      stock issued for accrued interest on convertible notes
    payable
                              
                              
                              -
                              
                              
                              
                              115,000Accrued
      convertible notes interest and penalties
                              
                              
                              342,042
                              
                              
                              
                              -Changes
      in operating assets and liabilities:Decrease
      (increase) in accounts receivable
                              
                              
                              10,502
                              
                              
                              
                              (794,399
                              )Decrease
      in inventories
                              
                              
                              50,163
                              
                              
                              
                              317,889Decrease
      (increase) in prepaid costs and expenses
                              
                              
                              447,817
                              
                              
                              
                              (172,996
                              )Increase
      in accounts payable and accrued liabilities
                              
                              
                              59,193
                              
                              
                              
                              445,286Net
      Cash Provided by (Used in) Operating Activities
                              
                              
                              606,977
                              
                              
                              
                              (552,812
                              )Cash
      Flows from Investing Activities:Capital
      expenditures
                              
                              
                              (5,272
                              )
                              
                              
                              (1,372
                              )Other
      receivables
                              
                              
                              (545,388
                              )
                              
                              
                              -Acquisition
      deposits paid
                              
                              
                              (219,600
                              )
                              
                              
                              (7,131
                              )Net
      Cash (Used in) Investing Activities
                              
                              
                              (770,260
                              )
                              
                              
                              (8,503
                              )Cash
      Flows from Financing Activities:Proceeds
      from (repayment of) short term loans - net
                              
                              
                              1,100,738
                              
                              
                              
                              (891,085
                              )Repayment
      of convertible notes payable
                              
                              
                              -
                              
                              
                              
                              (13,875
                              )Proceeds
      from repayment of nonreciprocal funds transferred to
      shareholder
                              
                              
                              -
                              
                              
                              
                              219,693Net
      Cash Provided by (Used in) Financing Activities
                              
                              
                              1,100,738
                              
                              
                              
                              (685,267
                              )Effect
      of Exchange Rate Changes on Cash and Cash Equivalents
                              
                              
                              (1,370
                              )
                              
                              
                              14,432Net
      Increase (Decrease) in Cash and Cash Equivalents
                              
                              
                              936,085
                              
                              
                              
                              (1,232,150
                              )Cash
      and Cash Equivalents - Beginning of Period
                              
                              
                              61,867
                              
                              
                              
                              1,311,939Cash
      and Cash Equivalents - End of Period
                              
                              $
                              997,952
                              
                              
                              $
                              79,789Supplemental
      Cash Flow Information:Interest
      paid
                              
                              $
                              146,522
                              
                              
                              $
                              17,637Income
      taxes paid
                              
                              $
                              -
                              
                              
                              $
                              -Supplemental
      Disclosure of Non-Cash Investing Activities:Fixed
      assets purchased from related party
                              
                              $
                              -
                              
                              
                              $
                              253,617Supplemental
      Disclosures of Non-Cash Financing
Activities:Common
      stock issued for convertible notes principal payment
                              
                              $
                              -
                              
                              
                              $
                              127,650Common
      stock issued for convertible notes interest payment
                              
                              $
                              -
                              
                              
                              $
                              115,000
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  F -
4
  FRANKLIN TOWERS ENTERPRISES,
INC. AND SUBSIDIARY
 NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
 NOTE 1 –
Description of
Business and Basis of Presentation
 
 Organization
 
 Franklin
Towers Enterprises, Inc. (“Franklin”) was
incorporated on March 23, 2006 under the laws of the State of
Nevada.
 
 On June
19, 2007, Franklin entered into a Share Purchase Agreement with the shareholders
of Chongqing Qiluo Textile Co. Ltd.(“Qiluo”), a limited liability company
organized under the laws of the People’s Republic of China, whereby Franklin
agreed to acquire 100% of the issued and outstanding registered capital of Qiluo
for consideration of 5,000,000 shares of Franklin’s Series A Convertible
Preferred Stock (convertible into 52,880,000 shares of common stock) (see Note
12). Upon consummation of such purchase, Qiluo became a wholly-owned subsidiary
of Franklin.
 
 The
acquisition is accounted for as a “reverse acquisition”, since the stockholders
of Qiluo owned a majority of Franklin’s common stock immediately following the
transaction. The combination of the two companies is recorded as a
recapitalization of Qiluo pursuant to which Qiluo is treated as the continuing
entity although Franklin is the legal acquirer. Accordingly, the Company’s
historical financial statements are those of Qiluo.
 
 Qiluo was
incorporated on December 15, 2006, named “Chongqing Qiluo Industry Ltd.” under
the laws of the People’s Republic of China with the purpose of engaging in the
manufacture and sale of silk and silk products. Qiluo renamed to “Chongqing
Qiluo Textile Co., Ltd.” On May 30, 2008, Qiluo renamed to “Chongqing Fuling
Qiluo Wintus Silk Co., Ltd”.
 
 After the
acquisition, Franklin focused on the production and sale of silk and silk
products. The Company started its test production at the end of June 2007 and
commenced operations from the third quarter of 2007.
 
 Principles of
Consolidation
 
 The
accompanying consolidated financial statements include the accounts of Franklin
(Parent) and its wholly owned subsidiary Qiluo. All significant intercompany
accounts and transactions have been eliminated in consolidation.
 
 Going
Concern
 
 The
Company started its test production at the end of June 2007 and commenced its
manufacturing operations during the third quarter of 2007. The Company has
incurred a net loss of $1,235,901 for the three months ended March 31, 2009 and
has an accumulated deficit of $18,926,857 at March 31,
2009.  Substantial portions of the losses are attributable to the
common stock issued for consulting service, amortization of debt discount,
deferred finance costs and beneficial conversion feature, and accrued interest
and penalties in connection with the default of the Convertible Notes. The
Company had a working capital deficiency of $2,702,801 and $1,780,617 as of
March 31, 2009 and December 31, 2008, respectively. In addition, the Company’s
gross margin rate from its current operations was low.  It was 7% for
the three months ended March 31, 2009 and 5.2% for the year ended December 31,
2008.
  F -
5
 
 Going Concern
(Continued)
 
 Furthermore,
as of July 12, 2008, the Company was in default on its Convertible Notes
payments due July 12, 2008. The Notes provide that, at the option of the holder,
an event of default shall make all sums of principal and interest then remaining
unpaid and all other amounts payable immediately due and payable upon demand. As
of March 31, 2009, the unpaid convertible notes payable balance is $2,792,175;
unpaid accrued interest is $274,937; and unpaid accrued liquidated damages
penalty and default penalty are $1,290,818. The Company is currently negotiating
with investors and seeking ways to resolve the default issue with all
investors.
 
 These
factors raise substantial doubt concerning the Company’s ability to continue as
a going concern.
 
 There can
be no assurance that funds will be generated during the next twelve months or
thereafter from the Company’s current operations, or that funds will be
available from external sources such as debt or equity financings or other
potential sources.  The lack of additional capital could force the
Company to curtail or cease operations and would, therefore, have a material
adverse effect on its business.  Furthermore, there can be no
assurance that any such required funds, if available, will be available on
attractive terms or that they will not have a significant dilutive effect on the
Company's existing stockholders.
 
 During
the three months ended March 31, 2009, the Company received net proceeds of
$1,100,738 from various short term loans.
 
 The
Company has undertaken further steps as part of a plan to improve operations and
to address our lack of liquidity by raising additional funds, either in the form
of debt or equity or some combination thereof. The Company is planning to reduce
its cost of goods sold by purchasing its main raw material directly from farmers
in the local neighbored area and to reduce its overhead cost by fully utilizing
its current manufacture facilities. From the Spring of 2008, the Company began
purchasing its main raw material directly from farmers through the planned
acquisition of “Zhengzhong” (see Note 7), thereby helping the Company to reduce
its raw material - cocoon cost by 14.5% directly and increase its operating
gross margin rate to 5.2% for the year ended December 31, 2008, an increase of
4.5 percentage points, as compared to 0.7% for the year ended December 31, 2007.
During the three months ended March 31, 2009, the gross margin rate was 7%, as
compared to 0.8% for the three months ended March 31, 2008. However, there can
be no assurance that the Company will be able to raise enough funds to complete
the acquisition of “Zhengzhong” and to accomplish these objectives, and it is
uncertain whether the Company will achieve a profitable level of operations or
be able to obtain additional financing.
 
 There can
be no assurance that any additional financings will be available to the Company
on satisfactory terms and conditions, if at all.  In the event we are
unable to continue as a going concern, we may elect or be required to seek
protection from our creditors by filing a voluntary petition in bankruptcy or
may be subject to an involuntary petition in bankruptcy.
 
 The accompanying unaudited condensed
consolidated financial statements do not include any adjustments related to the
recoverability or classification of asset carrying amounts or the amounts and
classifications of liabilities that may result should the Company be unable to
continue as a going concern.
  Reclassifications
 
 Certain
reclassifications have been made to prior year’s consolidated financial
statements and notes thereto for comparative purposes to confirm with current
year’s presentation. These reclassifications have no effect on previously
reported results of operations.
  F -
6
 
 Basis of
presentation
 
 The
unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
(“US GAAP”).
 
 NOTE 2 –
INTERIM FINANCIAL STATEMENTS
 
 The
unaudited condensed consolidated financial statements as of March 31, 2009 and
for the three months ended March 31, 2009 and 2008 have been prepared in
accordance with accounting principles generally accepted in the United States
for interim financial information and with instructions to Form 10 - Q. In the
opinion of management, the unaudited condensed consolidated financial statements
have been prepared on the same basis as the annual consolidated financial
statements and reflect all adjustments, which include only normal recurring
adjustments, necessary to present fairly the financial position as of March 31,
2009 and the results of operations and cash flows for the three months ended
March 31, 2009 and 2008. The financial data and other information disclosed in
these notes to the interim financial statements related to these periods are
unaudited. The results for the three month period ended March 31, 2009 is not
necessarily indicative of the results to be expected for any subsequent quarter
of the entire year ending December 31, 2009. The balance sheet at December 31,
2008 has been derived from the audited consolidated financial statements at that
date.
 
 Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted pursuant to the Securities and
Exchange Commission’s rules and regulations. These unaudited condensed
consolidated financial statements should be read in conjunction with our audited
consolidated financial statements and notes thereto for the year ended December
31, 2008 included in our Form 10 –K/A filed April 15, 2009.
 
 NOTE 3 –
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Use of
Estimates
 
 The
preparation of condensed consolidated financial statements in conformity with US
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 dates of the financial statements and the reported
amounts of revenues and expenses during the reporting periods.  Actual
results could differ from those estimates.
 
 Fair Value of Financial
Instruments
 
 The
Company’s financial instruments consist of cash and cash equivalents, accounts
receivable, net, other receivables, accounts payable and accrued liabilities,
short term loans and convertible notes, net.  The fair value of these
financial instruments approximate their carrying amounts reported in the
condensed consolidated balance sheets due to the short term maturity of these
instruments or by comparison to other instruments with similar
terms.
 
 Foreign Currency
Translation
 
 The
functional currency of Franklin is the United States dollar.  The
functional currency of Qiluo is the Chinese Renminbi (“RMB”).  The
reporting currency of the Company is the United States dollar.
 
 The
assets and liabilities of Qiluo were translated into United States dollars at
period-end exchange rates.  The revenues and expenses were translated
into United States dollars at average exchange rates for the
period.  Resulting translation adjustments are recorded as a component
of accumulated other comprehensive income within stockholders’
deficit.
  F -
7
 
 Transaction
gains or losses arising from exchange rate fluctuation on transactions
denominated in a currency other than the functional currency are included in the
consolidated results of operations.  There is no material foreign
currency transaction gain or loss for the three months ended March 31, 2009 and
2008.
 
 Cash and Cash
Equivalents
 
 Cash and
cash equivalents consist of cash on hand, cash on deposit with banks, and highly
liquid debt investments with a maturity of three months or less when
purchased.
 
 Inventories
 
 Inventories
are stated at the lower of cost (first-in, first-out method) or
market.
 
 Property, Plant and
Equipment, Net
 
 Property,
plant and equipment is stated at cost less accumulated
depreciation.  Depreciation is calculated on a straight-line basis
over the estimated useful lives of the respective assets.
 
 Revenue
Recognition
 
 Sales of
products are recorded when title passes to the customer, which is generally at
time of shipment.  The Company performs ongoing credit evaluations of
its customers’ financial condition, but generally does not require collateral to
support customer receivables.  The credit risk is controlled through
credit approvals, limits and monitoring procedures.  The Company
establishes an allowance for doubtful accounts based upon factors surrounding
the credit risk of specific customers, historical trends and other
factors.  Accounts receivable are charged against the allowance for
doubtful accounts once all collection efforts have been
exhausted.  The Company does not routinely permit customers to return
product.
 
 Stock-Based
Compensation
 
 Stock-based
compensation is accounted for at fair value in accordance with SFAS No. 123(R),
“Accounting for Stock-Based Compensation”.  No stock options have been
granted and none are outstanding.
 
 Advertising
 
 Advertising
costs are expensed as incurred. The Company did not incur significant
advertising costs for the three months ended March 31, 2009 and
2008.
 
 Shipping and Handling
Costs
 
 Shipping
and handling costs, primarily related to outbound freight, are reported in the
consolidated statements of operations as a component of general and
administrative expenses.
 
 Research and
Development
 
 In
accordance with SFAS No. 2, “Accounting For Research and Development Costs”, the
Company expenses all research and development costs as incurred.
 
 Segment
Information
 
 SFAS No.
131, “Disclosure About Segments of and Enterprise and Related Information”,
changed the way public companies report information about segments of their
business in their quarterly reports issued to shareholders. It also requires
entity-wide disclosures about the products and services an entity provides, the
material countries in which it holds assets and reports revenues and its major
customers. The Company operates as a single segment and will evaluate additional
segment disclosure requirements as it expands its operations.
  F -
8
  Income
Taxes
 
 The
Company accounts for income taxes using the asset and liability method described
in SFAS No. 109, “Accounting For Income Taxes”, the objective of which is to
establish deferred tax assets and liabilities for the temporary differences
between the financial reporting and the tax bases of the Company’s assets and
liabilities at enacted tax rates expected to be in effect when such amounts are
realized or settled.  A valuation allowance related to deferred tax
assets is recorded when it is more likely than not that some portion or all of
the deferred tax assets will not be realized.
 
 No
provision has been made for corporation income taxes due to the current loss. In
addition, no future tax benefit has been calculated. According to the tax
regulations of China, the amount of loss that will carry over to the next tax
period should be assessed and approved by the tax regulation agency. The maximum
carry over period is five years.
 
 Net Loss Per Common
Share
 
 The
Company has adopted SFAS No. 128, “Earnings per Share,” (“EPS”) which requires
presentation of basic and diluted EPS on the face of the income statement for
all entities with complex capital structures and requires a reconciliation of
the numerator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation.
 
 Basic
loss per share is computed by dividing net loss by the weighted average number
of common shares outstanding during the period.
 
 Diluted
loss per share is computed similarly to basic loss per share except that it
includes the potential dilution that could occur if dilutive securities were
converted.  Diluted loss per common share is the same as basic loss
per share, as the effect of potentially dilutive securities, convertible debts
and warrants,  are anti-dilutive.
 
 Recently Issued Accounting
Pronouncements
 
 Certain
accounting pronouncements have been issued by the FASB and other standard
setting organizations which are not yet effective and have not yet been adopted
by the Company. The impact on the Company’s financial position and results of
operations from adoption of these standards is not expected to be
material.
  NOTE 4 -
Inventories
 
 Inventories
consist of the following:
 March
      31,
                                
                                
                                December
      31,2009
                                
                                
                                2008(Unaudited)Finished
      Goods
                                
                                $
                                399,078
                                
                                
                                $
                                131,684Processed
      cocoons
                                
                                
                                1,281,073
                                
                                
                                
                                1,857,227Raw
      Materials
                                
                                
                                145,414
                                
                                
                                
                                255,971Work
      in Process
                                
                                
                                971,281
                                
                                
                                
                                602,127Total
                                
                                $
                                2,796,846
                                
                                
                                $
                                2,847,009
  Finished
goods consist of those silks and by products available for sale. There was no
valuation allowance for inventory loss at March 31, 2009 and December 31,
2008.
  F -
9
  NOTE 5 –
Prepaid Costs and
Expenses
 
 Prepaid
costs and expenses consist of:
 
 March 31,
                      2009
                    
                    
                    December 31,
                      2008(Unaudited)Prepayment
      in connection with short term loanobtained
      in January 2009 (see Note 9)
                    
                    $
                    -
                    
                    
                    $
                    439,710Advances
      to personnel for future overhead costs
                    
                    
                    42,467
                    
                    
                    
                    7,423Advances
      to vendors for future overhead costs
                    
                    
                    129,535
                    
                    
                    
                    116,460Value
      added tax credits
                    
                    
                    152,452
                    
                    
                    
                    208,678Other
                    
                    
                    43
                    
                    
                    
                    43Total
                    
                    $
                    324,497
                    
                    
                    $
                    772,314
 
 NOTE 6 -
Property and
Equipment
 
 Property
and equipment is summarized as follows:
 Description
                            
                            Estimated
                              Useful Life
                            
                            
                            March 31,
                              2009
                            
                            
                            December 31,
                              2008(Unaudited)Production
      Equipment
                            
                            
                            10
                            
                            
                            $
                            725,665
                            
                            
                            $
                            726,508Auxiliary
      Equipment
                            
                            
                            10
                            
                            
                            
                            6,939
                            
                            
                            
                            6,947Office
      Equipment
                            
                            
                            3-5
                            
                            
                            
                            28,253
                            
                            
                            
                            23,006Automobile
                            
                            
                            5
                            
                            
                            
                            124,440
                            
                            
                            
                            124,585Furniture
      and Fixtures
                            
                            
                            5-7
                            
                            
                            
                            36,581
                            
                            
                            
                            36,624Construction
      in progress
                            
                            
                            
                            
                            
                            
                            102,463
                            
                            
                            
                            102,5821,024,341
                            
                            
                            
                            1,020,252Less:
      Accumulated Depreciation
                            
                            
                            
                            
                            
                            
                            155,301
                            
                            
                            
                            132,559$
                            869,040
                            
                            
                            $
                            887,693
 
 Depreciation
expense was $22,878 and $14,819 for the three months ended March 31, 2009 and
2008, respectively, of which $13,253 and $12,496 was included in cost of
sales.
  F -
10
 
 NOTE 7 -
Deposits
 
 Deposits
consist of:
 March 31,
                      2009
                    
                    
                    December 31,
                      2008(Unaudited)Down
      payment in connection with Letter Agreement
      dated   November 26, 2007 to acquire cocoon purchase
      stations,   warehouse, and certain other assets from
      Zhengzhong    Silkworm Industrial Development Co. Ltd., a
      state owned   entity ("Zhengzhong")
                    
                    $
                    411,270
                    
                    
                    $
                    411,270Deposit
      paid in connection with agreement dated March 19,   2008 to
      use cocoon purchase stations and warehouse at   no cost
      from March 19, 2008 to March 18, 2009
                    
                    
                    7,329
                    
                    
                    
                    7,329Additional
      payments relating to acquisition of Zhengzhong assets
                    
                    
                    256,243
                    
                    
                    
                    36,643Foreign
      currency translation adjustment
                    
                    
                    27,878
                    
                    
                    
                    28,439Total
                    
                    $
                    702,720
                    
                    
                    $
                    483,681
  The
Letter Agreement dated November 26, 2007 and subsequent amendments provided that
the total purchase price of the Zhengzhong assets was 10,374,800 RMB ($1,518,871
translated at the March 31, 2009 exchange rate). If the Company is unable to pay
the remaining 5,574,800 RMB ($816,151 translated at the March 31, 2009 exchange
rate) due, the Company’s total payments of 4,800,000 RMB ($702,720 translated at
the March 31, 2009 exchange rate) may be forfeited and not recovered (partially
or in full). In February 2009, the due date of the remaining 5,574,800 RMB
($816,151 translated at the March 31, 2009 exchange rate) due was extended to
September 2009.
 
 NOTE 8 –
Other
Receivables
 
 During
the three months ended March 31, 2009, the Company advanced $392,840 and
$152,548 to one unrelated entity and one unrelated individual separately. These
receivables are interest free and receivable on demand.
 
 NOTE 9 -
Loans
Payable
 Loans
      payable consist of:
                    
                    March 31,
                      2009
                    
                    
                    December 31,
                      2008(Unaudited)Qiluo
      loan payable to Chongqing Aikekaer Paint Co., Ltd. interest at 6% per
      annum, due May 31, 2009
                    
                    $
                    -
                    
                    
                    $
                    170,999Qiluo
      loan payable to one individual, interest at 6% per annum, due on
      demand
                    
                    
                    62,952
                    
                    
                    
                    63,025Qiluo
      loan payable to Jin Cheng Small Loans Company, Ltd. - 11,000,000 RMB,
      interest at 18% per annum, due March 23, 2009
                    
                    
                    -
                    
                    
                    
                    1,612,270Franklin
      loans payable to two individuals, interest at 8% per annum, due April 24,
      2008 (past due)
                    
                    
                    20,000
                    
                    
                    
                    20,000Qiluo
      loan payable to Jin Cheng Small Loans Company, Ltd. - 2,000,000 RMB,
      interest at 19.44% per annum, due June 25, 2009
                    
                    
                    292,800
                    
                    
                    
                    -Qiluo
      loan payable to Jin Cheng Small Loans Company, Ltd. - 4,000,000 RMB,
      interest at 21.24% per annum, due November 24, 2009
                    
                    
                    585,600
                    
                    
                    
                    -Qiluo
      loan payable to Shan Xia Bank, net interest at 10% per annum, due January
      19, 2010
                    
                    
                    2,005,680
                    
                    
                    
                    -Total
                    
                    $
                    2,967,032
                    
                    
                    $
                    1,866,294
  F -
11
 
 On
January 20, 2009, Qiluo jointly with Chongqing Guojing Silk Company, Ltd.
(“Guojing Silk”), Mr. Wensheng Chen and Mr. Songbai Zhong, obtained a short term
credit line in the amount of 30,000,000 RMB ($4,392,000 translated at the March
31, 2009 exchange rate) from Shan Xia Bank. The loan is collateralized with the
assets of Guojing Silk and real estate property of Mr. Wensheng Chen and Mr.
Songbai Zhong. From this jointly acquired credit line, Qiluo received 13,700,000
RMB ($2,005,680), Guojing Silk received 13,300,000 RMB ($1,947,120), and Mr.
Chen received 3,000,000 RMB ($439,200).The loan bears interest at 10% per annum
payable monthly and is due in full by January 19, 2010. Guojing Silk is
controlled by the brother-in-law of Mr. Kuang, indirect majority stockholder and
chief executive officer of the Company.
 
 As of
March 31, 2009 and December 31, 2008, the accrued interest payable for short
term loans totaled $22,808 and $29,581, respectively, which was included in
accounts payable and accrued expenses.
 
 NOTE 10 –
Loans Payable –
Related Parties
 
 Loans
      payable – related parties consist of:
                    
                    March 31,
                      2009
                    
                    
                    December 31,
                      2008(Unaudited)Franklin
      loan payable to former chief executive officer, interest at 8% per annum,
      due on demand
                    
                    $
                    12,233
                    
                    
                    $
                    12,233Franklin
      loan payable to former chief executive officer, non-interest bearing, due
      on demand
                    
                    
                    7,158
                    
                    
                    
                    7,158Total
                    
                    $
                    19,391
                    
                    
                    $
                    19,391
  The
accrued interest payable to related party was $2,537 and $2,292 as of March 31,
2009 and December 31, 2008, respectively.
 
 NOTE 11 -
Convertible Notes
Payable
 March
      31,
                      
                      
                      December
      31,Convertible
      notes payable, net consist of:
                      
                      2009
                      
                      
                      2008(Unaudited)Convertible
      notes - initial face amount
                      
                      $
                      3,300,000
                      
                      
                      $
                      3,300,000Less
      unamortized debt discounts:Discount
      on relative fair value of warrants
                      
                      
                      (2,903,247
                      )
                      
                      
                      (2,903,247
                      )Discount
      on beneficial conversion feature
                      
                      
                      (396,753
                      )
                      
                      
                      (396,753
                      )Less
      accumulated amortization
                      
                      
                      2,613,393
                      
                      
                      
                      2,221,118Unamortized
      debt discounts
                      
                      
                      (686,607
                      )
                      
                      
                      (1,078,882
                      )Repayment
      of convertible notes
                      
                      
                      (507,825
                      )
                      
                      
                      (507,825
                      )Convertible
      notes payable, net
                      
                      $
                      2,105,568
                      
                      
                      $
                      1,713,293
  F -
12
 
 On
September 12 and September 20, 2007, the Company entered into Subscription
Agreements (the "Subscription Agreements") with 11 investors ("Purchasers"), for
the purchase and sale of $3,300,000 of Secured Convertible Promissory Notes of
the Company (the “Notes”) for the aggregate purchase price of $3,300,000 (the
“Note Financing”). The Company received net proceeds from the issuance of the
Notes of $2,622,425 after finance costs of $382,500 and other expenses of
$295,075. Pursuant to the terms of the Subscription Agreements, the Company also
issued to the Purchasers warrants to purchase up to 26,400,000 shares of common
stock of the Company, subject to adjustments for certain issuances and
transactions.
 
 The Notes
bear interest at the rate of 10% per annum, payable in either (a) cash or (b)
absent an event of default, in shares of the Company’s common stock at the
lesser of (i) $0.25 per share or (ii) 75% of the average of the closing bid
prices of the Company’s common stock for the 5 trading days preceding the
payment date. Said payments commence on March 12, 2008 and all accrued but
unpaid interest and any other amounts due thereon is due and payable on
September 12, 2009, or earlier upon acceleration following an event of default,
as defined in the Notes.
 
 All
principal and accrued interest on the Notes is convertible into shares of the
Company’s common stock at the election of the Purchasers at any time at the
conversion price of $0.25 per share, subject to adjustment for certain
issuances, transactions or events that would result in “full ratchet” protection
to the holders.
 
 The Notes
contain default events which, if triggered and not timely cured (if curable),
will result in a default interest rate of 15% per annum. The Notes also contain
full ratchet antidilution provisions with respect to certain securities
issuances, including the issuances of stock for less than $.25 per share. In
addition, the Company has to pay the Purchasers an additional amount of
principal plus accrued interest if the Company is no longer listed on the
Bulletin Board or sells substantially all of its assets.
 
 As part
of the financing, the Company also issued to the Purchasers an aggregate of
13,200,000 Class A Common Stock Purchase Warrants and 13,200,000 Class B Common
Stock Purchase Warrants. The Class A Warrants are exercisable at a price of
$0.50 per share at any time until the fifth anniversary from the date the
Registration Statement is declared effective by the Securities and Exchange
Commission (“the Expiration Date”) and the Class B Warrants are exercisable at a
price of $1.00 per share at any time until the Expiration Date. The warrants
include a cashless exercise provision which is triggered after March 12, 2008 as
well as “full ratchet” antidilution provisions with respect to certain
securities issuances.
 
 Absent a
waiver from a Purchaser, conversion of the Notes, or exercise of the Warrants,
is subject to the restriction that such conversion or exercise does not result
in the Purchaser beneficially owning at any one time more than 4.99% of the
Company’s outstanding shares of common stock.
 
 Payment
of the Notes along with the Company’s other obligations to the Purchasers is
secured by all the assets of the Company and of its wholly-owned subsidiary,
Qiluo. Such obligations are also secured by a guaranty and pledge of the
17,100,000 shares of the Company’s common stock held by Xinshengxiang Industrial
Development Co., Ltd., a significant shareholder of the Company. In connection
with the transaction, the Company agreed to prepare and file with the Securities
and Exchange Commission within 60 days following the closing a registration
statement on Form SB-2 for the purpose of registering for resale all of the
shares of common stock underlying the Notes. If the Company failed to file such
registration statement within such time, or if the registration statement is not
declared effective within 120 days from September 12, 2007, the Company must pay
monthly liquidated damages in cash equal to 2% of the principal amount of the
Notes. The Purchasers were also granted standard piggyback registration rights
along with certain demand registration rights. The Company filed a registration
statement on December 26, 2007. The registration statement has not yet been
declared effective (see Note 17).
  F -
13
 
 In
connection with the convertible debt, the Company recorded deferred finance
costs of $4,466,334, of which $382,500 was recorded as an asset and $4,083,834
was recorded as a component of stockholders’ equity. Such deferred finance costs
are being amortized over the life of the related debt. The Company also recorded
a deferred debt discount in the amount of $3,300,000 to reflect the beneficial
conversion feature of the convertible debt and the fair value of the warrants.
The beneficial conversion feature was recorded pursuant to Emerging Issues Task
Force (“EITF”) 00-27: “Application of EITF No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios, to Certain Convertible Instruments”. In accordance with EITF
00-27, the Company evaluated the value of the beneficial conversion feature and
recorded the amount of $396,753 as a reduction to the carrying amount of the
convertible debt and as an addition to paid-in capital. Additionally, the
relative fair value of the warrants of $2,903,247 was calculated and recorded as
a further reduction to the carrying amount of the convertible debt and as an
addition to paid-in capital. The amortization of these deferred finance costs
and debt discounts are reported as a component of the interest expense. The
amortization of the debt discount was $392,275 and $437,192 for the three months
ended March 31, 2009 and 2008, respectively. The amortization of deferred
finance costs was $485,451 and $541,036 for the three months ended March 31,
2009 and 2008, respectively. Such amortizations have been included as interest
expense.
 
 The
Company commenced the repayment of the convertible notes and interest on March
12, 2008 and paid $26,375 in cash to three of the Purchasers, which represented
accrued interest of $12,500 and repayment of principal of $13,875 due on the
convertible promissory notes. Also, the Company issued a total of 32,354,043
shares to seven of the Purchasers during the six months ended June 30, 2008,
which represented accrued interest of $174,912 and repayment of principal of
$493,950. The Company did not make any repayments during the six months ended
December 31, 2008 due to its financing difficulties. The Company is in default
to all eleven investors (see Note 19).
 
 NOTE 12 -
Stockholders’ Equity
and Share Purchase Agreement
 
 On June
19, 2007, Franklin entered into a Share Purchase Agreement (the “Share Purchase
Agreement”) with the following persons: Chongqing Qiluo Textile Co. Ltd., a
limited liability company organized under the laws of the People’s Republic of
China (“Qiluo”); Xinshengxiang Industrial Development Co., Ltd., a limited
liability company organized under the laws of the People’s Republic of China
(“Xinshengxiang”); Mr. Dingliang Kuang (“Dingliang”); and Ms. Yue Kuang (“Yue,”
and together with Xinshengxiang and Dingliang, the "Qiluo Shareholders").
Pursuant to the Share Purchase Agreement, Franklin agreed to acquire Qiluo at a
closing held simultaneously therewith by purchasing from the Qiluo Shareholders
all of their respective shares of Qiluo’s registered capital, which represent
100% of the issued and outstanding registered capital stock of Qiluo. Upon the
consummation of such purchase, Qiluo became a wholly-owned subsidiary of
Franklin. In consideration therefor, Franklin agreed to issue to the Qiluo
Shareholders an aggregate of 5,000,000 shares of Franklin’s Series A Convertible
Preferred Stock (convertible into 52,880,000 shares of common stock), which were
allocated between the Qiluo Shareholders as follows: 4,750,000 shares to
Xinshengxiang; 125,000 shares to Dingliang; and 125,000 shares to Yue. Each
share of Series A Convertible Preferred Stock was convertible, at the option of
the holder thereof, into 10.576 shares of Franklin's common stock.
 
 In
connection with the foregoing transaction, on June 19, 2007, Kelly Fan, the
former President, Chief Executive Officer, Treasurer, and Director of Franklin,
transferred without consideration to the Qiluo Shareholders 18,000,000 shares of
the common stock of Franklin which were issued and outstanding and held by Ms.
Fan. Such shares were allocated between the Qiluo Shareholders as follows:
17,100,000 shares to Xinshengxiang Industrial Development Co., Ltd.; 450,000
shares to Dingliang Kuang; and 450,000 shares to Yue Kuang.
  F -
14
 
 As a
result of the foregoing transactions: (a), Xinshengxiang held approximately 81%
of the total combined voting power of all classes of Franklin’s capital stock
entitled to vote; (b) Diangliang Kuang is the principal owner and manager of
Xinshengxiang and thus has voting, investment, and dispositive control over the
shares of Franklin’s capital stock owned by Xinshengxiang. Accordingly, Mr.
Kuang is also deemed to be the indirect beneficial owner of the shares of
Franklin’s capital stock owned by Xinshengxiang. Mr. Kuang thus directly and
indirectly (by Xinshengxiang) held approximately 83% of the total combined
voting power of all classes of Franklin’s capital stock entitled to vote; and
(c) Yue Kuang, who is the sister of Diangliang Kuang, directly held
approximately 2% of the total combined voting power of all classes of Franklin’s
capital stock who is entitled to vote.
 
 In
September 2007, the Company agreed to issue an aggregate of 8,000,000 shares of
its common stock valued at $9,200,000 to Bonsai Venture Partner, Ltd., a British
Virgin Islands Limited company in consideration for consulting services
rendered. These issuances were offered and sold in reliance upon exemptions from
registration pursuant to Section 4(2) under the Securities Act and the Rule 506
promulgated thereunder. The shares issued in consideration for services rendered
were valued at $9,200,000, based on the price of our stock on the date of
issuance.
 
 The
Company issued a total of 32,354,043 shares to seven of the Purchasers as
repayment of loan and loan interest during the six months ended June 30, 2008,
pursuant to the terms of the Notes (see Note 11).  The issuing price
was calculated at 75% of the average of the closing bid prices of the Company’s
common stock for the 5 days preceding the payment date.
 
 NOTE 13 -
Preferred
Stock
 
 On June
18, 2007, the Company designated a series of Preferred Stock known as the
“Series A Convertible Preferred Stock” (the “Series A Preferred Stock”) by
filing a Certificate of Designation with the Secretary of State of
Nevada.  The number of shares constituting such Series A Preferred
Stock was designated to be 5,000,000 shares, par value $0.001 per
share.  Pursuant to the Certificate of Designation, the principal
rights, preferences, powers, limitations and restrictions of the Series A
Preferred Stock are as follows:
 
 Each
share of Series A Preferred Stock is convertible, at the option of the holder
thereof, without payment of additional consideration, into 10.576 shares of the
Company’s common stock.  Holders of Series A Preferred Stock shall be
entitled to vote, together with holders of common stock as a single class, on
all matters upon which stockholders of the Company are entitled to vote, with
each share of Series A Preferred Stock having one vote.  The Series A
Preferred Stock shall rank senior to the common stock.  In the event
of any liquidation, dissolution or winding up of the Company, the holders of
Series A Preferred Stock shall be entitled to receive, prior and in preference
to any distribution of any of the assets of the Company to the holders of the
common stock of the Company and any other issue of stock, should there be any,
by reason of their ownership thereof, an amount per share equal to $0.001 per
each share of Series A Preferred Stock owned by such shareholder plus any
declared and unpaid dividends on the Series A Preferred Stock.
 
 On
December 10, 2007, the Company issued an aggregate of 52,880,000 shares of
common stock to complete the conversion of the 5,000,000 shares of Series A
Preferred Stock then outstanding.
  F -
15
 
 NOTE 14 -
Warrants
 
 A summary
of the status of the Company’s warrants is presented below:
 Date of
                                Issuance
                              
                              Number of
                                Warrants
                              
                              
                              Weighted Average
                                Exercise PriceOutstanding
      - January 1, 2007
                              
                              
                              
                              -
                              
                              
                              $
                              -Issued,
      Class A Warrants
                              9/12/2007
                              
                              
                              13,200,000
                              
                              
                              
                              0.50Issued,
      Class B Warrants
                              9/12/2007
                              
                              
                              13,200,000
                              
                              
                              
                              1.00Issued,
      Finder's Fees Warrants
                              9/12/2007
                              
                              
                              3,960,000
                              
                              
                              
                              0.25Outstanding
      - March 31, 2009 (Unaudited)and
      December 31, 2008
                              
                              
                              30,360,000
                              
                              
                              $
                              0.68
  Warrants
outstanding and exercisable by price range as of March 31, 2009 and December 31,
2008 are:
 
 Warrants Outstanding
                                                
                                                
                                                Warrants ExercisableRange of
                                                
                                                Number
                                                  Outstanding
                                                
                                                
                                                Weighted Average
                                                  Remaining
                                                  Contractual
                                                  Life in Years *
                                                
                                                
                                                Weighted
                                                  Average
                                                  Exercise
                                                  Price
                                                
                                                
                                                Number
                                                  Exercisable
                                                
                                                
                                                Weighted
                                                  Average
                                                  Exercise
                                                  Price$
                                                0.25
                                                
                                                
                                                3,960,000
                                                
                                                
                                                
                                                5.00
                                                
                                                
                                                $
                                                0.25
                                                
                                                
                                                
                                                3,960,000
                                                
                                                
                                                $
                                                0.25$
                                                0.50
                                                
                                                
                                                13,200,000
                                                
                                                
                                                
                                                5.00
                                                
                                                
                                                
                                                0.50
                                                
                                                
                                                
                                                13,200,000
                                                
                                                
                                                
                                                0.50$
                                                1.00
                                                
                                                
                                                13,200,000
                                                
                                                
                                                
                                                5.00
                                                
                                                
                                                
                                                1.00
                                                
                                                
                                                
                                                13,200,000
                                                
                                                
                                                
                                                1.0030,360,000
                                                
                                                
                                                
                                                
                                                
                                                
                                                $
                                                0.68
                                                
                                                
                                                
                                                30,360,000
                                                
                                                
                                                $
                                                0.68
 
 *
Warrants expire 5 years after effective date of registration statement. The
registration statement filed on December 26, 2007 is not effective as of
May 18, 2009.
 
 The
significant assumptions used to determine the fair values of the warrants, using
a Black-Scholes option pricing model, were as follows:
 
 Significant
      assumptions:Risk-free
      interest rate at grant date
                        
                        
                        4.11%Expected
      stock price volatility
                        
                        
                        93.95%Expected
      dividend payout
                        
                        
                        -Expected
      option life-years
                        
                        
                        5
  NOTE 15 -
Related Party
Transactions
 
 During
2007, the Company received funds from and advanced funds to Xinshengxiang, one
of its significant shareholders (see Note 12) for working capital purposes. As
of December 31, 2007, the excess advanced payments to Xinshengxiang amounted to
$2,019,685. The Company has accounted for this excess as a nonreciprocal
transfer in 2007 and recorded the overpayment as a direct reduction of
additional paid-in capital. Xinshengxiang repaid $1,722,656 in cash during the
year ended December 31, 2008 and the Company recorded the repayments as an
increase in additional paid-in capital.
 
 During
the three months ended March 31, 2008, the Company acquired four silk reeling
machines and an automobile from Xinshengxiang valued at a total of $253,617
(1,850,000 Renminbi), which the parties agreed to be treated as a repayment of
the nonreciprocal funds transferred in 2007. The Company recorded the $253,617
repayment as an increase in additional paid-in capital.
  F -
16
 
 During
the year ended December 31, 2008, the Company and Xinshengxiang agreed to offset
the Company’s $43,412 rent liability to Xinshengxiang and treat the $43,412 as a
repayment of the nonreciprocal funds transferred in 2007. The Company recorded
the $43,412 repayment as an increase in additional paid-in capital.
 
 As of
December 31, 2008, the unpaid balance of the nonreciprocal funds transferred to
Xinshengxiang in 2007 is $0.
 
 During
the three months ended March 31, 2008, the Company purchased approximately 42.3
tons raw material–cocoon for $301,455 (2,198,960 Renminbi) at market price from
Xinshengxiang.
 
 During
the three months ended March 31, 2009, Qiluo borrowed 31,500,000 RMB
($4,611,600) from Chongqing Guojing Silk Company, Ltd.(“Guojing Silk”) and
simultaneously delivered a bank acceptance (from Shan Xia Bank) for the same
amount to Guojing Silk. Guojing Silk is controlled by the brother-in-law of Mr.
Kuang, indirect majority stockholder and chief executive officer of the Company.
Under the related agreement with Shan Xia Bank, use of the 31,500,000 RMB is not
permitted while the bank acceptance is outstanding. Accordingly, the Company has
not reflected the offsetting $4,611,600 asset and liability in the unaudited
condensed consolidated financial statements.
 
 NOTE 16 -
Concentration of
Credit Risk
 
 Financial
instruments that potentially subject the Company to significant concentrations
of credit risk consist principally of cash and cash equivalents and accounts
receivable.
 
 Qiluo
maintains cash balances in various banks in the People’s Republic of China.
Currently, no deposit insurance system has been set up in the People’s Republic
of China. Therefore, the Company will bear a risk if any of these banks become
insolvent. Qiluo’s uninsured cash balance was $997,952 and $61,867 as of March
31, 2009 and December 31, 2008, respectively.
 
 NOTE 17 -
Commitments and
Contingencies
 
 Lease
agreement
 
 On
January 28, 2007, Qiluo signed a twenty (20) years lease with Xinshengxiang, a
related party (see Note 12), for the use of a factory building located in Fulin,
Chongqing. The lease commenced on March 1, 2007 and provides for annual rental
payments of 200,000 Renminbi ($29,280 translated at the March 31, 2009 exchange
rate) plus other occupancy costs.
 
 Future
minimum rentals under this lease are as follows:
  Year
      Ending
                            March
      31,
                            (Unaudited)
                          
                          Future
      Minimum
                            Rent
      Payments2010
                          
                          $
                          29,2802011
                          
                          
                          29,2802012
                          
                          
                          29,2802013
                          
                          
                          29,2802014
                          
                          
                          29,280Thereafter
                          
                          
                          348,920Total
                          
                          $
                          495,320
  F -
17
  Registration Rights
Arrangement
 
 In
connection with the convertible notes payable (see Note 11), the Company agreed
to prepare and file with the Securities and Exchange Commission within 60 days
following the closing a registration statement for the purpose of registering
for resale all of the shares of common stock underlying the Notes. If the
Company fails to file such registration statement within such time, or if the
registration statement is not declared effective within 120 days from September
12, 2007, the Company is to pay monthly liquidated damages in cash equal to 2%
of the principal amount of the Notes. The Company filed a registration statement
on December 26, 2007; the registration statement has not yet been declared
effective. Accordingly, the Company has accrued liquidated damages of $976,698
as of March 31, 2009, which has been recorded as interest expense and included
in convertible notes interest and penalty payables.
 
 Lack of
Insurance
 
 The
Company currently has no insurance in force for its office facilities and
operations and it cannot be certain that it can cover the risks associated with
such lack of insurance or that it will be able to obtain and/or maintain
insurance to cover these risks at economically feasible premiums.
 
 Country
Risk
 
 As the
Company's principal operations are conducted in the People’s Republic of China
(the “PRC”), the Company is subject to special considerations and significant
risks not typically associated with companies in North America and Western
Europe. These risks include, among others, risks associated with the political,
economic and legal environments and foreign currency exchange limitations
encountered in the PRC. The Company's results of operations may be adversely
affected by changes in the political and social conditions in the PRC, and by
changes in governmental policies with respect to laws and regulations, among
other things.
 
 In
addition, all of the Company's transactions undertaken in the PRC are
denominated in Renminbi, which must be converted into other currencies before
remittance out of the PRC may be considered. Both the conversion of Renminbi
into foreign currencies and the remittance of foreign currencies abroad require
the approval of the PRC government.
 
 NOTE 18 –
Legal
Proceeding
 
 On July
28, 2008, Professional Offshore Opportunity Fund Ltd. (the “Plaintiff”) obtained
a default judgment against the Company. On April 21, 2008, the Plaintiff
initiated the action in the United States District Court Southern District of
New York, on a claim of breach of contract and non payment on a promissory note
dated September 12, 2007, made by the Company in favor of the Plaintiff, in the
principal amount of $500,000. The Plaintiff claimed approximately $671,000 in
total relief, which amount includes a 15% principal charge of $75,000, accrued
interest of $48,125, and liquidated damages of $37,000.
 
 NOTE 19 –
Default on Convertible
Notes Payable
 
 As of
June 12, 2008, the Company was in default to six (6) Purchasers on convertible
notes payments due June 12, 2008 and earlier. As of July 12, 2008, the Company
was in default to all eleven (11) Purchasers on convertible notes payments due
July 12, 2008. The Notes provide that, at the option of the holder, an event of
default shall make all sums of principal and interest then remaining unpaid and
all other amounts payable immediately due and payable upon demand. As of March
31, 2009, the unpaid convertible notes payable balance is $2,792,175; unpaid
accrued interest is $274,937; and unpaid accrued liquidated damages penalty and
default penalty are $1,290,818. The Company is currently negotiating with
investors and seeking ways to resolve the default issue with all
investors.
  F -
18




Item
2.  Management’s Discussion and Analysis of Financial Condition and Results
of Operations.





Forward-Looking
Statements





The
following discussion should be read in conjunction with our financial
statements, which are included elsewhere in this Form 10-Q (the “Report”) and
Form 10-K/A filed on April 15, 2009. This Report contains forward-looking
statements which relate to future events or our future financial performance. In
some cases, you can identify forward-looking statements by terminology such as
“may,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,”
“predicts,” “potential” or “continue” or the negative of these terms or other
comparable terminology. These statements are only predictions and involve known
and unknown risks, uncertainties, and other factors that may cause our or our
industry’s actual results, levels of activity, performance or achievements to be
materially different from any future results, levels of activity, performance or
achievements expressed or implied by these forward-looking
statements.





While
these forward-looking statements, and any assumptions upon which they are based,
are made in good faith and reflect our current judgment regarding the direction
of our business, actual results will almost always vary, sometimes materially,
from any estimates, predictions, projections, assumptions or other future
performance suggested herein. Except as required by applicable law, including
the securities laws of the United States, we do not intend to update any of the
forward-looking statements to conform these statements to actual
results.




These
forward-looking statements are subject to uncertainties and other factors that
could cause actual results to differ materially from such statements as a result
of a number of risks and uncertainties including: (a) those risks and
uncertainties related to general economic conditions, (b) whether we are able to
manage our planned growth efficiently and operate profitable operations, (c)
whether we are able to generate sufficient revenues or obtain financing to
sustain and grow our operations, and (d) whether we are able to successfully
fulfill our primary requirements for cash.





3





Plan of
Operation





In an
effort to obtain a stable raw material supply and to maximize both output and
quality of our silk production through Qiluo, we are contemplating the
acquisition of various other silk worm farms. On November 26, 2007, we entered
into a letter of intent with Chongqing Fulin Municipal Government to acquire
certain assets from Zhengzhong Silkworm Industrial Development Co., Ltd., a
state owned entity, pursuant to which we intend to acquire the assets of cocoon
purchase stations from Zhengzhong and exclusive right of those purchase stations
to purchase cocoons produced from approximately 15,000 acres of mulberry farms
in the local area.





The
Letter Agreement dated November 26, 2007 and subsequent amendments provided that
the total purchase price of the Zhengzhong assets was 10,374,800 RMB ($1,518,871
translated at the March 31, 2009 exchange rate). If the Company is unable to pay
the remaining 5,574,800 RMB ($816,151 translated at the March 31, 2009 exchange
rate) due, the Company’s total payments of 4,800,000 RMB ($702,720 translated at
the March 31, 2009 exchange rate) may be forfeited and not recovered (partially
or in full). In February 2009, the due date of the remaining 5,574,800 RMB
($816,151 translated at the March 31, 2009 exchange rate) due was extended
to September 2009.





The
acquisition of certain assets of Zhengzhong Silkworm Industrial Development Co.,
Ltd. from Fuling Municipal Government will not be consummated until the Company
has made the full payment of 10,374,800 RMB ($1,518,871 translated at the March
31, 2009 foreign exchange rate). Nevertheless, the Company started to use those
cocoon stations and to purchase cocoon directly from local
farmers commencing in the second quarter of 2008. However, there is no
assurance that the Company will raise enough funds to complete this
acquisition.




Furthermore,
in an effort to expand silk production and subsequent processing ability, on
November 28, 2007, we entered into a binding letter agreement with Chongqing
Wintus, pursuant to which we intend to acquire certain assets of Wintus,
including the stock of their seven wholly owned Chinese subsidiaries. The
business of Wintus is focused on the production of raw silk and the subsequent
processing and sales of various silk products. As consideration for the assets,
we agreed to pay a combination of cash and stock, in amounts to be mutually
agreed upon after we have completed our due diligence investigation of Wintus’
and its assets.  As of the date of this filing, the Company did not
take any further steps for this planned acquisition. We will not be able to
complete this acquisition until we secure additional funds.





Should
our initiatives to maximize both output and quality of silk production move
forward, additional funds will be required. However, there can be no assurance
that additional capital will be available to us. Although we may seek to raise
additional funds, we have no specific plans, understandings or agreements with
respect to such an offering, the securities to be offered or any other issue
with respect to any offering. We may have to issue debt or equity or enter into
a strategic arrangement with a third party.





4





Results of
Operations




Net Sales





Comparison of Sales for the
Three Months Ended March 31, 2009 and 2008




Sales
      in US dollars
                      
                      2009
                      
                      
                      2008Silk
                      
                      $
                      257,961
                      
                      
                      $
                      688,516Cocoons
                      
                      
                      33,565
                      
                      
                      
                      528,391By
      products and others
                      
                      
                      106,845
                      
                      
                      
                      108,753Total
      sales
                      
                      $
                      398,371
                      
                      
                      $
                      1,325,660


Our net
sales were $398,371 during the three months ended March 31, 2009, a decrease of
$927,289, or 70%, as compared to $1,325,660 for the three months ended March 31,
2008.  The decrease in our sales was primarily attributable to the
deterioration of commodity market and lack of demand due to deteriorating
economic conditions throughout the world.





The
Company sold 12.76 tons of silk during the three months ended March 31, 2009, a
decrease of 17.61 tons, or 58% as compared to 30.37 tons during the same quarter
of 2008. The revenue from sale of silk was $257,961 during the three months
ended March 31, 2009, a decrease of $430,555, or 63% as compared to $688,516 in
the same period of 2008.





The
cocoon is a raw material for production of silk. Sales of cocoons were 6.6 tons,
a decrease of 76.80 tons, or 92% as compared to 83.40 tons sold in the same
period of 2008. The revenue from sale of cocoons was $33,565, a decrease of
$494,826, or 94%, as compared to $528,391 for the three months ended March 31,
2008. The decrease is that the reduced demand due to economic conditions and
also a resulting drop in the silk sales.





Gross
Profit





Comparison of Gross Profit
for the Three Months Ended March 31, 2009 and 2008





2009
                      
                      
                      2008Net
      sales
                      
                      $
                      398,371
                      
                      
                      $
                      1,325,660Cost
      of sales
                      
                      
                      370,486
                      
                      
                      
                      1,314,861Gross
      profit
                      
                      $
                      27,885
                      
                      
                      $
                      10,799Gross
      profit margin rate
                      
                      
                      7.00
                      %
                      
                      
                      0.81
                      %





5





Gross
profit for the three months end March 31, 2009 and 2008 was $27,885 and $10,799,
respectively. The gross profit margin rate for the three months ended March 31,
2009 increased 6.19 percentage points to 7%, as compared to 0.81% for the three
months ended March 31, 2008. This improvement is mainly the result of our use of
Zhengzhong assets (see Plan of Operation). The Company started to use its
exclusive right to purchase cocoons directly from local farmers commencing in
the spring cocoon season of 2008. As a result, the Company had better quality
and lower cost cocoons. The average cost of cocoons purchased from our local
farmers was $4,512 per ton in 2008, a decrease of $1,663, or 27% as compared to
the average $6,175 per ton purchased from the market.





Loss from
Operations





Comparison of Loss from
Operations for the Three Months Ended March 31, 2009 and
2008





2009
                      
                      
                      2008Gross
      profit
                      
                      $
                      27,885
                      
                      
                      $
                      10,799Professional
      fees
                      
                      
                      16,629
                      
                      
                      
                      119,860Depreciation
      and amortization
                      
                      
                      9,625
                      
                      
                      
                      2,322Other
      general and administrative expenses
                      
                      
                      120,362
                      
                      
                      
                      93,517Loss
      from operations
                      
                      $
                      (118,731
                      )
                      
                      $
                      (204,900
                      )





The
loss from operations for the three months ended March 31, 2009 was
$118,731, a decrease of $86,169, or 42%, as compared to $204,900 for the three
months ended March 31, 2008. The decrease was primarily due to the decrease in
professional fees. Professional fees totaled $16,629 for the three months ended
March 31, 2009, a decrease of $103,231, or 86%, as compared to professional fees
of $119,860 for the three months ended March 31, 2008. We incurred significant
cost in connection with professional services associated with the legal and
accounting reporting obligations of being a public company in the early stages
of becoming a reporting company during the three months ended March 31,
2008.





Other
general and administrative expenses consist of selling, general and
administrative expenses relating to our office and the cocoon stations. The
increase of other general and administrative expenses in the three months ended
March 31, 2009 was primarily due to expenses of the cocoon stations. The
expenses in connection with cocoon stations totaled $19,049 in the three months
ended March 31, 2009 and such expense was $0 in the same period of
2008.





6





Other Expenses,
Net





Comparison of Other
Expenses, net for the Three Months Ended March 31, 2009 and
2008





2009
                    
                    
                    2008Subsidy
      income
                    
                    $
                    265,458
                    
                    
                    $
                    -Interest
      income
                    
                    
                    6,457
                    
                    
                    
                    1,439Interest
      expense
                    
                    
                    (1,389,085
                    )
                    
                    
                    (1,338,199
                    )Other
      Expenses, net
                    
                    $
                    (1,117,170
                    )
                    
                    $
                    (1,336,760
                    )





Total
other expenses, net decreased by $219,590 to $1,117,170 for the three months
ended March 31, 2009, as compared to $1,336,760 for the three months ended March
31, 2008. The decrease was primarily attributable to the net proceeds of
$265,458 received from various Chinese government subsidies during the first
quarter of 2009. These government subsidies were in connection with the purchase
of cocoon and incentive of technology innovation. Part of these subsidies will
pass through to the farmers who produced the cocoons when we purchase the
cocoons from farmers, which will be reflected in a higher purchase price. These
were one time subsidies. The gross amount received was 2,614,480 RMB ($382,498),
the cost in connection with the application was 800,000 RMB ($117,040), and the
net amount was $265,458.




Interest
expense consists of interest on short term loans and amortization of deferred
financing costs and debt discount in connection with the convertible debt
issuances in September 2007. We have incurred and recorded $909,354 and
$1,054,035 amortization expense of deferred finance costs and debt discounts for
the three months ended March 31, 2009 and 2008, respectively.  In
addition, we also recorded accrued interest expense and penalties in connection
with the default of convertible notes. Such expenses totaled $342,042 and
$196,743 for the three months ended March 31, 2009 and 2008,
respectively.





Liquidity and Capital
Resources





The major
sources of the Company’s liquidity for the three months ended March 31, 2009
were cash generated from operating activities and short term loans from
banks and other entities.





Net cash
provided by operating activities during the three months ended March 31, 2009
was $606,977, compared to ($552,812) for the three months ended March 31, 2008.
The
$606,977 provided by operating activities in 2009 was due primarily to the
$909,354 amortization of deferred finance costs and debt discounts, the $342,042
increase in accrued convertible notes interest and penalties, and the $447,817
decrease in prepaid costs and expenses, offset partially by the $1,235,901 net
loss.





Net cash
used in investing activities was $770,260 during the  three months ended
March 31, 2009, which was the result of $219,600 additional payments in
connection with the acquisition of Zhengzhong assets and the $545,388 in loans
to two unrelated parties.





7





Net cash
provided by (used in) financing activities was $1,100,738 and
($685,267) for the three months ended March 31, 2009 and 2008, respectively.
During the first quarter of 2009, the Company received net proceeds of
$1,100,738 from various short term loans.





Loans
Payable




Loans
      payable consist of:
                              
                              March
      31,
                                2009
                              
                              
                              December
      31,
                                2008Qiluo
      loan payable to Chongqing Aikekaer Paint Co., Ltd.interest
      at 6% per annum, due May 31, 2009
                              
                              $
                              -
                              
                              
                              $
                              170,999Qiluo
      loan payable to one individual, interest at 6% perannum,
      due on demand
                              
                              
                              62,952
                              
                              
                              
                              63,025Qiluo
      loan payable to Jin Cheng Small Loans Company, Ltd. -11,000,000
      RMB, interest at 18% per annum, due March 23, 2009
                              
                              
                              -
                              
                              
                              
                              1,612,270Franklin
      loans payable to two individuals, interest at 8% perannum,
      due April 24, 2008 (past due)
                              
                              
                              20,000
                              
                              
                              
                              20,000Qiluo
      loan payable to Jin Cheng Small Loans Company, Ltd. -2,000,000
      RMB, interest at 19.44% per annum, due June 25, 2009
                              
                              
                              292,800
                              
                              
                              
                              -Qiluo
      loan payable to Jin Cheng Small Loans Company, Ltd. -4,000,000
      RMB, interest at 21.24% per annum, due November 24, 2009
                              
                              
                              585,600
                              
                              
                              
                              -Qiluo
      loan payable to Shan Xia Bank, netinterest
      at 10% per annum, due January 19, 2010
                              
                              
                              2,005,680
                              
                              
                              
                              -Total
                              
                              $
                              2,967,032
                              
                              
                              $
                              1,866,294







On
January 20, 2009, Qiluo jointly with Chongqing Guojing Silk Company, Ltd.
(“Guojing Silk”), Mr. Wensheng Chen and Mr. Songbai Zhong, obtained a short term
credit line in the amount of 30,000,000 RMB ($4,392,000 translated at the March
31, 2009 exchange rate) from Shan Xia Bank. The loan is collateralized with the
assets of Guojing Silk and real estate property of Mr. Wensheng Chen and Mr.
Songbai Zhong. From this jointly acquired credit line, Qiluo received 13,700,000
RMB ($2,005,680), Guojing Silk received 13,300,000 RMB ($1,947,120), and Mr.
Chen received 3,000,000 RMB ($439,200).The loan bears interest at 10% per annum
payable monthly and is due in full by January 19, 2010. Guojing Silk is
controlled by the brother-in-law of Mr. Kuang, indirect majority stockholder and
chief executive officer of the Company.





8





As of
March 31, 2009 and December 31, 2008, the accrued interest payable for short
term loans totaled $22,808 and $29,581, respectively, which was included in
accounts payable and accrued expenses.





Convertible Notes
Payable


March
      31,
                  
                  
                  December
      31,Convertible
      notes payable, net consist of:
                  
                  2009
                  
                  
                  2008Convertible
      notes - initial face amount
                  
                  $
                  3,300,000
                  
                  
                  $
                  3,300,000Less
      unamortized debt discounts:Discount
      on relative fair value of warrants
                  
                  
                  (2,903,247
                  )
                  
                  
                  (2,903,247
                  )Discount
      on beneficial conversion feature
                  
                  
                  (396,753
                  )
                  
                  
                  (396,753
                  )Less
      accumulated amortization
                  
                  
                  2,613,393
                  
                  
                  
                  2,221,118Unamortized
      debt discounts
                  
                  
                  (686,607
                  )
                  
                  
                  (1,078,882
                  )Repayment
      of convertible notes
                  
                  
                  (507,825
                  )
                  
                  
                  (507,825
                  )Convertible
      notes payable, net
                  
                  $
                  2,105,568
                  
                  
                  $
                  1,713,293





On
September 12 and September 20, 2007, the Company entered into Subscription
Agreements (the "Subscription Agreements") with 11 investors ("Purchasers"), for
the purchase and sale of $3,300,000 of Secured Convertible Promissory Notes of
the Company (the “Notes”) for the aggregate purchase price of $3,300,000 (the
“Note Financing”). The Company received net proceeds from the issuance of the
Notes of $2,622,425 after finance costs of $382,500 and other expenses of
$295,075. Pursuant to the terms of the Subscription Agreements, the Company also
issued to the Purchasers warrants to purchase up to 26,400,000 shares of common
stock of the Company, subject to adjustments for certain issuances and
transactions.





The Notes
bear interest at the rate of 10% per annum, payable in either (a) cash or (b)
absent an event of default, in shares of the Company’s common stock at the
lesser of (i) $0.25 per share or (ii) 75% of the average of the closing bid
prices of the Company’s common stock for the 5 trading days preceding the
payment date. Said payments commence on March 12, 2008 and all accrued but
unpaid interest and any other amounts due thereon is due and payable on
September 12, 2009, or earlier upon acceleration following an event of default,
as defined in the Notes.





All
principal and accrued interest on the Notes is convertible into shares of the
Company’s common stock at the election of the Purchasers at any time at the
conversion price of $0.25 per share, subject to adjustment for certain
issuances, transactions or events that would result in “full ratchet” protection
to the holders.





9





The Notes
contain default events which, if triggered and not timely cured (if curable),
will result in a default interest rate of 15% per annum. The Notes also contain
full ratchet antidilution provisions with respect to certain securities
issuances, including the issuances of stock for less than $.25 per share. In
addition, the Company has to pay the Purchasers an additional amount of
principal plus accrued interest if the Company is no longer listed on the
Bulletin Board or sells substantially all of its assets.





As part
of the financing, the Company also issued to the Purchasers an aggregate of
13,200,000 Class A Common Stock Purchase Warrants and 13,200,000 Class B Common
Stock Purchase Warrants. The Class A Warrants are exercisable at a price of
$0.50 per share at any time until the fifth anniversary from the date the
Registration Statement is declared effective by the Securities and Exchange
Commission (“the Expiration Date”) and the Class B Warrants are exercisable at a
price of $1.00 per share at any time until the Expiration Date. The warrants
include a cashless exercise provision which is triggered after March 12, 2008 as
well as “full ratchet” antidilution provisions with respect to certain
securities issuances.





Absent a
waiver from a Purchaser, conversion of the Notes, or exercise of the Warrants,
is subject to the restriction that such conversion or exercise does not result
in the Purchaser beneficially owning at any one time more than 4.99% of the
Company’s outstanding shares of common stock.





Payment
of the Notes along with the Company’s other obligations to the Purchasers is
secured by all the assets of the Company and of its wholly-owned subsidiary,
Qiluo. Such obligations are also secured by a guaranty and pledge of the
17,100,000 shares of the Company’s common stock held by Xinshengxiang Industrial
Development Co., Ltd., a significant shareholder of the Company. In connection
with the transaction, the Company agreed to prepare and file with the Securities
and Exchange Commission within 60 days following the closing a registration
statement on Form SB-2 for the purpose of registering for resale all of the
shares of common stock underlying the Notes. If the Company failed to file such
registration statement within such time, or if the registration statement is not
declared effective within 120 days from September 12, 2007, the Company must pay
monthly liquidated damages in cash equal to 2% of the principal amount of the
Notes. The Purchasers were also granted standard piggyback registration rights
along with certain demand registration rights. The Company filed a registration
statement on December 26, 2007. The registration statement has not yet been
declared effective (see Note 17).





In
connection with the convertible debt, the Company recorded deferred finance
costs of $4,466,334, of which $382,500 was recorded as an asset and $4,083,834
was recorded as a component of stockholders’ equity. Such deferred finance costs
are being amortized over the life of the related debt. The Company also recorded
a deferred debt discount in the amount of $3,300,000 to reflect the beneficial
conversion feature of the convertible debt and the fair value of the warrants.
The beneficial conversion feature was recorded pursuant to Emerging Issues Task
Force (“EITF”) 00-27: “Application of EITF No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios, to Certain Convertible Instruments”. In accordance with EITF
00-27, the Company evaluated the value of the beneficial conversion feature and
recorded the amount of $396,753 as a reduction to the carrying amount of the
convertible debt and as an addition to paid-in capital. Additionally, the
relative fair value of the warrants of $2,903,247 was calculated and recorded as
a further reduction to the carrying amount of the convertible debt and as an
addition to paid-in capital. The amortization of these deferred finance costs
and debt discounts are reported as a component of the interest expense. The
amortization of the debt discount was $392,275 and $437,192 for the three months
ended March 31, 2009 and 2008, respectively. The amortization of deferred
finance costs was $485,451 and $541,036 for the three months ended March 31,
2009 and 2008, respectively. Such amortizations have been included as interest
expense.





10





As of
July 12, 2008, the Company was in default to all eleven (11) Purchasers on
convertible notes payments due July 12, 2008. The Notes provide that, at the
option of the holder, an event of default shall make all sums of principal and
interest then remaining unpaid and all other amounts payable immediately due and
payable upon demand. As of March 31, 2009, the unpaid convertible notes payable
balance is $2,792,175; unpaid accrued interest is $274,937; and unpaid accrued
liquidated damages penalty and default penalty are $1,290,818. The Company is
currently negotiating with investors and seeking ways to resolve the default
issue with all investors.





On July
28, 2008, Professional Offshore Opportunity Fund Ltd. (the “Plaintiff”) obtained
a default judgment against the Company. On April 21, 2008, the Plaintiff
initiated the action in the United States District Court Southern District of
New York, on a claim of breach of contract and non payment on a promissory note
dated September 12, 2007, made by the Company in favor of the Plaintiff, in the
principal amount of $500,000. The Plaintiff claimed approximately $671,000 in
total relief, which amount includes a 15% principal charge of $75,000, accrued
interest of $48,125, and liquidated damages of $37,000.





Going Concern
Consideration





The
Company started its test production at the end of June 2007 and commenced its
manufacturing operations during the third quarter of 2007. The Company has
incurred a net loss of $1,235,901 for the three months ended March 31, 2009 and
has an accumulated deficit of $18,926,857 at March 31,
2009.  Substantial portions of the losses are attributable to the
common stock issued for consulting service, amortization of debt discount,
deferred finance costs and beneficial conversion feature, and accrued interest
and penalties in connection with the default of the Convertible Notes. The
Company had a working capital deficiency of $2,702,801 and $1,780,617 as of
March 31, 2009 and December 31, 2008, respectively. In addition, the Company’s
gross margin rate from its current operations was low.  It was 7% for
the three months ended March 31, 2009 and 5.2% for the year ended December 31,
2008.





Furthermore,
as of July 12, 2008, the Company was in default on its Convertible Notes
payments due July 12, 2008 as described above.





11




Our
independent auditor has stated that these factors raise substantial doubt
concerning the Company’s ability to continue as a going concern.





There can
be no assurance that funds will be generated during the next twelve months or
thereafter from the Company’s current operations, or that funds will be
available from external sources such as debt or equity financings or other
potential sources.  The lack of additional capital could force the
Company to curtail or cease operations and would, therefore, have a material
adverse effect on its business.  Furthermore, there can be no
assurance that any such required funds, if available, will be available on
attractive terms or that they will not have a significant dilutive effect on the
Company's existing stockholders.





During
the three months ended March 31, 2009, the Company received net proceeds of
$1,100,738 from various short term loans.





The
Company has undertaken further steps as part of a plan to improve operations and
to address our lack of liquidity by raising additional funds, either in the form
of debt or equity or some combination thereof. The Company is planning to reduce
its cost of goods sold by purchasing its main raw material directly from farmers
in the local neighbored area and to reduce its overhead cost by fully utilizing
its current manufacture facilities. From the Spring of 2008, the Company began
purchasing its main raw material directly from farmers through the planned
acquisition of “Zhengzhong” (see Note 7), thereby helping the Company to reduce
its raw material - cocoon cost by 14.5% directly and increase its operating
gross margin rate to 5.2% for the year ended December 31, 2008, an increase of
4.5 percentage points, as compared to 0.7% for the year ended December 31, 2007.
During the three months ended March 31, 2009, the gross margin rate was 7%, as
compared to 0.8% for the three months ended March 31, 2008. However, there can
be no assurance that the Company will be able to raise enough funds to complete
the acquisition of “Zhengzhong” and to accomplish these objectives, and it is
uncertain whether the Company will achieve a profitable level of operations or
be able to obtain additional financing.





There can
be no assurance that any additional financings will be available to the Company
on satisfactory terms and conditions, if at all.  In the event we are
unable to continue as a going concern, we may elect or be required to seek
protection from our creditors by filing a voluntary petition in bankruptcy or
may be subject to an involuntary petition in bankruptcy.





12





Critical Accounting Policies
and Estimates





General





The
Company’s Condensed Consolidated Financial Statements are prepared in accordance
with U.S. generally accepted accounting principles, which require management to
make estimates, judgments and assumptions that affect the reported amounts of
assets, liabilities, net revenue and expenses, and the disclosure of contingent
assets and liabilities. Management bases its estimates on historical experience
and on various other assumptions that it believes to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Senior management has discussed the development, selection and
disclosure of these estimates with the Board of Directors. Management believes
that the accounting estimates employed and the resulting balances are
reasonable; however, actual results may differ from these estimates under
different assumptions or conditions.





Basis of
Presentation





The
condensed consolidated financial statements have been prepared on the going
concern basis, which assumes the realization of assets and liquidation of
liabilities in the normal course of operations. If we were not to continue as a
going concern, we would likely not be able to realize on our assets at values
comparable to the carrying value or the fair value estimates reflected in the
balances set out in the preparation of the consolidated financial statements.
There can be no assurances that we will be successful in generating additional
cash from equity or other sources to be used for operations. The consolidated
financial statements do not include any adjustments relating to the
recoverability of assets and classification of assets and liabilities that might
be necessary should the Company be unable to continue as a going
concern.





Foreign Currency
Translation





The
functional currency of Franklin is the United States dollar.  The
functional currency of Qiluo is the Chinese Renminbi (“RMB”).  The
reporting currency of the Company is the United States dollar.





The
assets and liabilities of Qiluo were translated into United States dollars at
period-end exchange rates The revenues and expenses were translated into United
States dollars at average exchange rates for the period.  Resulting
translation adjustments are recorded as a component of accumulated other
comprehensive income within stockholders’ equity.





Transaction
gains or losses arising from exchange rate fluctuation on transactions
denominated in a currency other than the functional currency are included in the
consolidated results of operations.





13





Revenue
Recognition





Sales of
products are recorded when title passes to the customer, which is generally at
time of shipment.  The Company performs ongoing credit evaluations of
its customers’ financial condition, but generally does not require collateral to
support customer receivables.  The credit risk is controlled through
credit approvals, limits and monitoring procedures.  The Company
establishes an allowance for doubtful accounts based upon factors surrounding
the credit risk of specific customers, historical trends and other
factors.  Accounts receivable are charged against the allowance for
doubtful accounts once all collection efforts have been
exhausted.  The Company does not routinely permit customers to return
product.





Stock-Based
Compensation





Stock-based
compensation is accounted for at fair value in accordance with SFAS No. 123(R),
“Accounting for Stock-Based Compensation”.  No stock options have been
granted and none are outstanding.





Income
Taxes





The
Company accounts for income taxes using the asset and liability method described
in SFAS No. 109, “Accounting For Income Taxes”, the objective of which is to
establish deferred tax assets and liabilities for the temporary differences
between the financial reporting and the tax bases of the Company’s assets and
liabilities at enacted tax rates expected to be in effect when such amounts are
realized or settled.  A valuation allowance related to deferred tax
assets is recorded when it is more likely than not that some portion or all of
the deferred tax assets will not be realized.





No
provision has been made for corporation income taxes due to the current loss. In
addition, no future tax benefit has been calculated. According to the tax
regulations of China, the amount of loss that will carry over to the next tax
period should be assessed and approved by the tax regulation agency. The maximum
carry over period is five years.





Segment
Information





SFAS No.
131, “Disclosure About Segments of and Enterprise and Related Information”,
changed the way public companies report information about segments of their
business in their quarterly reports issued to shareholders. It also requires
entity-wide disclosures about the products and services an entity provides, the
material countries in which it holds assets and reports revenues and its major
customers. The Company operates as a single segment and will evaluate additional
segment disclosure requirements as it expands its operations.





14





Recently Issued Accounting
Pronouncements





Certain
accounting pronouncements have been issued by the FASB and other standard
setting organizations which are not yet effective and have not yet been adopted
by the Company. The impact on the Company’s financial position and results of
operations from adoption of these standards is not expected to be
material.





Commitments and
Contingencies





Lease
agreement





On
January 28, 2007, Qiluo signed a twenty (20) years lease with Xinshengxiang, a
related party (see Note 12), for the use of a factory building located in Fulin,
Chongqing. The lease commenced on March 1, 2007 and provides for annual rental
payments of 200,000 Renminbi ($29,280 translated at the March 31, 2009 exchange
rate) plus other occupancy costs.





Future
minimum rentals under this lease are as follows:




Year
      Ending
                    March
      31,
                    (Unaudited)
                  
                  Future
      Minimum
                    Rent
      Payments2010
                  
                  $
                  29,2802011
                  
                  
                  29,2802012
                  
                  
                  29,2802013
                  
                  
                  29,2802014
                  
                  
                  29,280Thereafter
                  
                  
                  348,920Total
                  
                  $
                  495,320





Registration Rights
Arrangement





In
connection with the convertible notes payable, the Company agreed to prepare and
file with the Securities and Exchange Commission within 60 days following the
closing a registration statement for the purpose of registering for resale all
of the shares of common stock underlying the Notes. If the Company fails to file
such registration statement within such time, or if the registration statement
is not declared effective within 120 days from September 12, 2007, the Company
is to pay monthly liquidated damages in cash equal to 2% of the principal amount
of the Notes. The Company filed a registration statement on December 26, 2007;
the registration statement has not yet been declared effective. Accordingly, the
Company has accrued liquidated damages of $976,698 as of March 31, 2009, which
has been recorded as interest expense and included in convertible notes interest
and penalty payables.





15





Lack of
Insurance





The
Company currently has no insurance in force for its office facilities and
operations and it cannot be certain that it can cover the risks associated with
such lack of insurance or that it will be able to obtain and/or maintain
insurance to cover these risks at economically feasible premiums.





Country
Risk





As the
Company's principal operations are conducted in the People’s Republic of China
(the “PRC”), the Company is subject to special considerations and significant
risks not typically associated with companies in North America and Western
Europe. These risks include, among others, risks associated with the political,
economic and legal environments and foreign currency exchange limitations
encountered in the PRC. The Company's results of operations may be adversely
affected by changes in the political and social conditions in the PRC, and by
changes in governmental policies with respect to laws and regulations, among
other things.





In
addition, all of the Company's transactions undertaken in the PRC are
denominated in Renminbi, which must be converted into other currencies before
remittance out of the PRC may be considered. Both the conversion of Renminbi
into foreign currencies and the remittance of foreign currencies abroad require
the approval of the PRC government.





Item
3. Quantitative and Qualitative Disclosures About Market Risk.





Smaller
reporting companies are not required to provide the information required by Item
305.





Item
4.  Controls and Procedures.





Evaluation
of Disclosure Controls and Procedures





As of
March 31, 2009, under the direction of our Chief Executive Officer/Chief
Financial Officer, we evaluated our disclosure controls and procedures as of
March 31, 2009 and concluded that our disclosure controls and procedures were
ineffective as of March 31, 2009 due to material weaknesses. A material weakness
is a deficiency, or a combination of control deficiencies, in internal control
over financial reporting such that there is a reasonable possibility that a
material misstatement of the Company’s annual or interim financial statements
will not be prevented or detected on a timely basis.  The material
weakness relates to the lack of segregation of duties in that our CEO and CFO
are the same person.  In the preparation of audited financial
statements, footnotes and financial data all of our financial reporting is
carried out by our Chief Financial Officer, and we do not have an audit
committee or independent CEO to monitor or review the work
performed.   The lack of segregation of duties results
from lack of a separate Chief Financial Officer with accounting technical
expertise necessary for an effective system of internal control.  In
addition, we lack sufficient resources to perform the internal audit
function.  In order to mitigate this material weakness to the fullest
extent possible, all financial reports are reviewed by an outside accountant
that is not our audit firm. All unexpected results are investigated. At any
time, if it appears that any control can be implemented to continue to mitigate
such weaknesses, it is immediately implemented. The Company is in the process of
complying with SOX 404 during 2009 and will be implementing additional internal
controls over accounting and financial reporting.





16





There
were no changes in our internal control over financial reporting during the
fiscal quarter ended March 31, 2009, that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.





PART
II  OTHER INFORMATION





Item
1.  Legal Proceedings.





As of
June 12, 2008, the Company was in default to six (6) Purchasers on convertible
notes payments due June 12, 2008 and earlier. As of July 12, 2008, the Company
is in default to all eleven (11) Purchasers on convertible notes payments due
July 12, 2008. The Notes provide that, at the option of the holder, an event of
default shall make all sums of principal and interest then remaining unpaid and
all other amounts payable immediately due and payable upon demand. As of March
31, 2009, the unpaid convertible notes payable balance is $2,792,175; unpaid
accrued interest is $135,329; and unpaid accrued liquidated damages is $641,636.
The Company is seeking ways to resolve the default issue with all
investors.





On June
30, 2008, Professional Offshore Opportunity Fund Ltd. (the “Plaintiff”) filed a
motion for default judgment against the Company. On April 21, 2008, the
Plaintiff initiated the action in the United States District Court Southern
District of New York, on a claim of breach of contract and non payment on a
promissory note dated September 12, 2007, made by the Company in favor of the
Plaintiff, in the principal amount of $500,000. The Plaintiff claimed
approximately $671,000 in total to relief. The Company is in the process of
retaining an attorney to defend this litigation. Any adverse outcome of this
litigation could materially harm the financial condition of the Company and
could cause it to cease operations.





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





Unregistered Sales of Equity
Securities





None





Purchases of equity
securities by the issuer and affiliated purchasers





None.





Use of
Proceeds





None





17





Item
3.  Defaults Upon Senior Securities.





See Part
II – Item 1. above.





Item
4.  Submission of Matters to a Vote of Security Holders.





There was
no matter submitted to a vote of security holders during the fiscal quarter
ended March 31, 2009.





Item
5.  Other Information.





None





Item
6.  Exhibits





Exhibit
                No.
              
              Description31.1
              
              Rule
      13a-14(a)/15d14(a) Certifications of Dingliang Kuang, the President, Chief
      Executive Officer, Treasurer and Director (Attached
  Hereto)32.1
              
              Section
      1350 Certifications of Dingliang Kuang, the President, Chief Executive
      Officer, Treasurer and Director (Attached
  Hereto)




SIGNATURES





In
accordance with to requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.





FRANKLIN
      TOWERS ENTERPRISES, INC.Dated:
      May 20, 2009
                By:
                /s/  Dingliang
      KuangName:
                Dingliang
      KuangTitle:
                President,
      Chief Executive Officer,
                  Treasurer
      and Director(Principal
      Executive, Financial and
                  Accounting
      Officer)





18