UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





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





For the
quarter ended September 30, 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
            20-4069588(State
      of incorporation)
            (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 o  No o





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
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
             ̈(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  ̈





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 November 18,
2009








TABLE OF
CONTENTS




PART
      I
                  3Item
      1.  Financial Statements
                  3Item
      2.  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations.
                  4Forward-Looking
      Statements
                  4Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk.
                  17Item
      4.  Controls and Procedures.
                  18PART
      II  OTHER INFORMATION
                  18Item
      1.  Legal Proceedings.
                  18Item
      2.  Unregistered Sales of Equity Securities and Use of
      Proceeds.
                  18Item
      3.  Defaults Upon Senior Securities.
                  19Item
      4.  Submission of Matters to a Vote of Security
      Holders.
                  19Item
      5.  Other Information.
                  19Item
      6.  Exhibits
                  19


2




PART
I




Item
1.  Financial Statements


FRANKLIN
TOWERS ENTERPRISES, INC. AND SUBSIDIARY
 
 INDEX TO
FINANCIAL STATEMENTS
 
 PageCondensed
      Consolidated Balance Sheets
                    As
      of September 30, 2009 (Unaudited) and December 31, 2008
      (Restated)
                  
                  
                  F-1Condensed
      Consolidated Statements of Operations
                    For
      the Three and Nine Months Ended September 30, 2009 and 2008
      (Unaudited)
                  
                  
                  F-2Condensed
      Consolidated Statement of Stockholders’ Deficit
                    For
      the Nine Months Ended September 30, 2009 (Unaudited)
                    and
      the Year Ended December 31, 2008 (Restated)
                  
                  
                  F-3Condensed
      Consolidated Statements of Cash Flows
                    For
      the Nine Months Ended September 30, 2009 and 2008
    (Unaudited)
                  
                  
                  F-4Notes
      to Condensed Consolidated Financial Statements (Unaudited)
                  
                  
                  F-5
      - F-20
  3
 FRANKLIN TOWERS ENTERPRISES,
INC. AND SUBSIDIARY
 CONDENSED CONSOLIDATED
BALANCE SHEETS
 
 September 30,
                              2009
                            
                            
                            December 31,
                              2008(Unaudited)
                            
                            
                            (Restated)ASSETSCurrent
      Assets:Cash
      and cash equivalents
                            
                            $
                            70,783
                            
                            
                            $
                            61,867Accounts
      receivable - net of allowance for doubtful accounts of $20,911 and $2,362
      as of September 30, 2009 and December 31, 2008,
    respectively
                            
                            
                            48,425
                            
                            
                            
                            68,727Inventories
                            
                            
                            1,706,485
                            
                            
                            
                            2,847,009Prepaid
      costs and expenses
                            
                            
                            1,405,753
                            
                            
                            
                            772,314Other
      receivables
                            
                            
                            4,298,998
                            
                            
                            
                            -Total
      Current Assets
                            
                            
                            7,530,444
                            
                            
                            
                            3,749,917Property
      and Equipment, net
                            
                            
                            824,882
                            
                            
                            
                            887,693Other
      Assets:Deposits
                            
                            
                            996,200
                            
                            
                            
                            483,681Total
      Other Assets
                            
                            
                            996,200
                            
                            
                            
                            483,681TOTAL
      ASSETS
                            
                            $
                            9,351,526
                            
                            
                            $
                            5,121,291LIABILITIES
      AND STOCKHOLDERS' DEFICITCurrent
      Liabilities:Convertible
      notes payable - as of September 30, 2009 and December 31, 2008,
      respectively
                            
                            $
                            2,792,175
                            
                            
                            $
                            2,792,175Loans
      payable
                            
                            
                            3,012,995
                            
                            
                            
                            1,866,294Accounts
      payable and accrued expenses
                            
                            
                            3,193,386
                            
                            
                            
                            1,931,556Customer
      prepaid
                            
                            
                            939,313
                            
                            
                            
                            -Loans
      payable - related parties
                            
                            
                            1,484,391
                            
                            
                            
                            19,391Total
      Current Liabilities
                            
                            
                            11,422,260
                            
                            
                            
                            6,609,416TOTAL
      LIABILITIES
                            
                            
                            11,422,260
                            
                            
                            
                            6,609,416Stockholders'
      Deficit:Preferred
      stock, $0.001 par value; 5,000,000 shares authorized, 0 shares issued and
      outstanding as of September 30, 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 September 30, 2009 and December 31,
      2008, respectively
                            
                            
                            12,348
                            
                            
                            
                            12,348Additional
      paid-in capital
                            
                            
                            18,345,012
                            
                            
                            
                            18,345,012Accumulated
      deficit
                            
                            
                            (20,743,476
                            )
                            
                            
                            (20,161,779
                            )Accumulated
      other comprehensive income
                            
                            
                            315,382
                            
                            
                            
                            316,294Total
      Stockholders' Deficit
                            
                            
                            (2,070,734
                            )
                            
                            
                            (1,488,125
                            )TOTAL
      LIABILITIES AND STOCKHOLDERS' DEFICIT
                            
                            $
                            9,351,526
                            
                            
                            $
                            5,121,291
 
 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
 (UNAUDITED)
 
 Three Months Ended
                      
                      
                      Nine Months EndedSeptember 30,
                      
                      
                      September 30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Net
      Sales
                      
                      $
                      2,240,449
                      
                      
                      $
                      2,334,638
                      
                      
                      $
                      5,124,347
                      
                      
                      $
                      4,784,776Cost
      of Sales
                      
                      
                      (1,647,072
                      )
                      
                      
                      (2,051,618
                      )
                      
                      
                      (4,298,110
                      )
                      
                      
                      (4,464,228
                      )Gross
      Profit
                      
                      
                      593,377
                      
                      
                      
                      283,020
                      
                      
                      
                      826,237
                      
                      
                      
                      320,548Operating
      Expenses:Selling,
      general and administrative expenses
                      
                      
                      233,068
                      
                      
                      
                      338,687
                      
                      
                      
                      515,474
                      
                      
                      
                      892,451Depreciation
      and amortization
                      
                      
                      8,725
                      
                      
                      
                      -
                      
                      
                      
                      28,438
                      
                      
                      
                      -Total
      Operating Expenses
                      
                      
                      241,793
                      
                      
                      
                      338,687
                      
                      
                      
                      543,912
                      
                      
                      
                      892,451Income
      (Loss) From Operations
                      
                      
                      351,584
                      
                      
                      
                      (55,667
                      )
                      
                      
                      282,325
                      
                      
                      
                      (571,903
                      )Other
      Income (Expenses):Subsidy
      income
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      706,122
                      
                      
                      
                      -Interest
      income
                      
                      
                      324
                      
                      
                      
                      576
                      
                      
                      
                      7,137
                      
                      
                      
                      2,152Interest
      expense
                      
                      
                      (521,263
                      )
                      
                      
                      (1,239,008
                      )
                      
                      
                      (1,577,281
                      )
                      
                      
                      (3,859,226
                      )Total
      Other (Expense)
                      
                      
                      (520,939
                      )
                      
                      
                      (1,238,432
                      )
                      
                      
                      (864,022
                      )
                      
                      
                      (3,857,074
                      )Loss
      Before Income Tax
                      
                      
                      (169,355
                      )
                      
                      
                      (1,294,099
                      )
                      
                      
                      (581,697
                      )
                      
                      
                      (4,428,977
                      )Provision
      for Income Tax
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Net
      Loss
                      
                      $
                      (169,355
                      )
                      
                      $
                      (1,294,099
                      )
                      
                      $
                      (581,697
                      )
                      
                      $
                      (4,428,977
                      )Net
      Loss per Share - Basic and Diluted
                      
                      $
                      (0.00
                      )
                      
                      $
                      (0.01
                      )
                      
                      $
                      (0.00
                      )
                      
                      $
                      (0.04
                      )Weighted
      Average Shares Outstanding - Basic and Diluted
                      
                      
                      123,484,043
                      
                      
                      
                      123,484,043
                      
                      
                      
                      123,484,043
                      
                      
                      
                      107,741,181Comprehensive
      Loss:Net
      loss
                      
                      $
                      (169,355
                      )
                      
                      $
                      (1,294,099
                      )
                      
                      $
                      (581,697
                      )
                      
                      $
                      (4,428,977
                      )Foreign
      currency translation adjustment
                      
                      
                      2,062
                      
                      
                      
                      77,477
                      
                      
                      
                      (912
                      )
                      
                      
                      222,521Comprehensive
      Loss
                      
                      $
                      (167,293
                      )
                      
                      $
                      (1,216,622
                      )
                      
                      $
                      (582,609
                      )
                      
                      $
                      (4,206,456
                      )
 
 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 NINE MONTHS ENDED
SEPTEMBER 30, 2009 (UNAUDITED) AND THE YEAR ENDED DECEMBER 31, 2008
(RESTATED)
 
 Preferred Stock
                            
                            
                            Common Stock
                            
                            
                            Additional
                              Paid - in
                            
                            
                            Deferred
                            
                            
                            Accumulated
                            
                            
                            Accumulated
                              Other
                              ComprehensiveShares
                            
                            
                            Amount
                            
                            
                            Shares
                            
                            
                            Amount
                            
                            
                            Capital
                            
                            
                            Finance Costs
                            
                            
                            Deficit
                            
                            
                            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 (Restated)
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            3,415,349
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            3,415,349Repayment
      of nonreciprocal funds transferred to shareholder
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            2,019,685
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            2,019,685Net
      loss for the year ended December 31, 2008 (Restated)
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            
                            -
                            
                            
                            
                            (8,653,683
                            )
                            
                            
                            -
                            
                            
                            
                            (8,653,683
                            )Foreign
      currency translation adjustment
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            212,070
                            
                            
                            
                            212,070Balance
      - December 31, 2008 (Restated)
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            123,484,043
                            
                            
                            
                            12,348
                            
                            
                            
                            18,345,012
                            
                            
                            
                            -
                            
                            
                            
                            (20,161,779
                            )
                            
                            
                            316,294
                            
                            
                            
                            (1,488,125
                            )Unaudited:Net
      loss for the period
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (581,697
                            )
                            
                            
                            -
                            
                            
                            
                            (581,697
                            )Foreign
      currency translation adjustment
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (912
                            )
                            
                            
                            (912
                            )Balance
      - September 30, 2009
                            
                            
                            -
                            
                            
                            $
                            -
                            
                            
                            
                            123,484,043
                            
                            
                            $
                            12,348
                            
                            
                            $
                            18,345,012
                            
                            
                            $
                            -
                            
                            
                            $
                            (20,743,476
                            )
                            
                            $
                            315,382
                            
                            
                            $
                            (2,070,734
                            )
 
 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 NINE MONTHS ENDED
SEPTEMBER 30, 2009 AND 2008
 (UNAUDITED)
 
 2009
                            
                            
                            2008Cash
      Flows from Operating Activities:Net
      Loss
                            
                            $
                            (581,697
                            )
                            
                            $
                            (4,428,977
                            )Adjustments
      to Reconcile Net Loss to NetCash
      Provided by (Used in) Operating Activities:Depreciation
      expense
                            
                            
                            68,390
                            
                            
                            
                            58,750Bad
      debt expense
                            
                            
                            18,537
                            
                            
                            
                            21,220Amortization
      of deferred finance costs
                            
                            
                            -
                            
                            
                            
                            199,378Amortization
      of debt discount - fair value of warrants and beneficial conversion
      feature
                            
                            
                            -
                            
                            
                            
                            1,277,520Amortization
      of deferred finance costs - consulting
                            
                            
                            -
                            
                            
                            
                            1,580,964Common
      stock issued for accrued interest on convertible notes
    payable
                            
                            
                            -
                            
                            
                            
                            174,913Rent
      expense satisfied by reduction of nonreciprocal funds transferred
      balance
                            
                            
                            -
                            
                            
                            
                            36,559Changes
      in operating assets and liabilities:Decrease
      (increase) in accounts receivable
                            
                            
                            1,753
                            
                            
                            
                            (16,364
                            )Decrease
      (increase) in inventories
                            
                            
                            1,140,524
                            
                            
                            
                            (990,428
                            )Increase
      in prepaid costs and expenses
                            
                            
                            (633,439
                            )
                            
                            
                            (676,827
                            )Increase
      in accounts payable and accrued liabilities
                            
                            
                            1,261,830
                            
                            
                            
                            296,103Increase
      in customer prepaid
                            
                            
                            939,313
                            
                            
                            
                            -Net
      Cash Provided by (Used in) Operating Activities
                            
                            
                            2,215,211
                            
                            
                            
                            (2,467,189
                            )Cash
      Flows from Investing Activities:Capital
      expenditures
                            
                            
                            (5,275
                            )
                            
                            
                            (33,606
                            )Other
      receivables
                            
                            
                            (4,298,998
                            )
                            
                            
                            -Acquisition
      deposits (paid) returned
                            
                            
                            (512,750
                            )
                            
                            
                            89,835Net
      Cash (Used in) provided by Investing Activities
                            
                            
                            (4,817,023
                            )
                            
                            
                            56,229Cash
      Flows from Financing Activities:Proceeds
      from short term loans
                            
                            
                            1,146,701
                            
                            
                            
                            148,712Repayment
      of convertible notes payable
                            
                            
                            -
                            
                            
                            
                            (13,875
                            )Proceeds
      (repayment) from related parties
                            
                            
                            1,465,000
                            
                            
                            
                            (1,190
                            )Proceeds
      from repayment of nonreciprocal funds transferred to
      shareholder
                            
                            
                            -
                            
                            
                            
                            1,663,249Net
      Cash Provided by Financing Activities
                            
                            
                            2,611,701
                            
                            
                            
                            1,796,896Effect
      of Exchange Rate Changes on Cash and Cash Equivalents
                            
                            
                            (973
                            )
                            
                            
                            68,962Net
      Increase (Decrease) in Cash and Cash Equivalents
                            
                            
                            8,916
                            
                            
                            
                            (545,102
                            )Cash
      and Cash Equivalents - Beginning of Period
                            
                            
                            61,867
                            
                            
                            
                            1,311,939Cash
      and Cash Equivalents - End of Period
                            
                            $
                            70,783
                            
                            
                            $
                            766,837Supplemental Cash Flow
      Information:Interest
      paid
                            
                            $
                            549,202
                            
                            
                            $
                            12,500Income
      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
                            
                            $
                            -
                            
                            
                            $
                            493,950Common
      stock issued for convertible notes interest payment
                            
                            $
                            -
                            
                            
                            $
                            174,912
 
 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
13). 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 in 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.
 
 Subsequent
Events
 
 The
Company has evaluated subsequent events through the filing date of this Form
10-Q and has determined that there were no subsequent events to recognize or
disclose in these financial statements.
 
 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 $581,697 for the nine months ended September 30, 2009 and
has an accumulated deficit of $20,743,476 at September 30,
2009.  Substantial portions of the losses are attributable to
stock-based compensation, 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 $3,891,816 and $2,859,499 as of September 30, 2009 and
December 31, 2008, respectively.
  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 September 30, 2009, the unpaid convertible notes payable balance is
$2,792,175; unpaid accrued interest is $414,545; and unpaid accrued liquidated
damages penalty and default penalty are $1,835,294. 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 nine months ended September 30, 2009, the Company received net proceeds of
$1,146,701 from various short term loans and net proceeds of $1,465,000 from
related parties.
 
 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 neighboring 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 8), thereby helping the Company to reduce
its raw material - cocoon cost. During the nine months ended September 30, 2009,
the gross margin rate was 16.1%, as compared to 6.7% for the nine months ended
September 30, 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 conform 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 September 30, 2009
and for the three and nine months ended September 30, 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 September 30, 2009 and the results of operations and cash flows
for the nine months ended September 30, 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 nine month period
ended September 30, 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, which have been restated as set
forth in Note 20.
 
 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 and nine months ended September
30, 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 Accounting
Standards Codification (“ASC”) topic 718-10, Stock Compensation (formerly, SFAS
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 and nine months ended September 30, 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 selling, general and
administrative expenses.
 
 Research and
Development
 
 In
accordance with the Accounting Standards Codification subtopic 730-10, Research
and Development (“ASC 730-10”) (formerly, SFAS No. 2, “Accounting For Research
and Development Costs”), the Company expenses all research and development costs
as incurred.
 
 Segment
Information
 
 ASC
280-10 (formerly, SFAS No. 131), “Disclosure About Segments of and Enterprise
and Related Information”, 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 ASC 740-10, (formerly, 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 ASC 260-10, (formerly, 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 share is the same as basic loss per
share, as the effect of potentially dilutive securities, convertible notes
payable 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:
 September
      30,
                          
                          
                          December
      31,2009
                          
                          
                          2008(Unaudited)Finished
      Goods
                          
                          $
                          271,549
                          
                          
                          $
                          131,684Processed
      cocoons
                          
                          
                          680,322
                          
                          
                          
                          1,857,227Raw
      Materials
                          
                          
                          92,600
                          
                          
                          
                          255,971Work
      in Process
                          
                          
                          662,014
                          
                          
                          
                          602,127Total
                          
                          $
                          1,706,485
                          
                          
                          $
                          2,847,009
 
 Finished
goods consist of those silks and by products available for sale. There was no
valuation allowance for inventory loss at September 30, 2009 and December 31,
2008.
  F-9
 
 NOTE 5 –
PREPAID COSTS AND EXPENSES
 
 Prepaid
costs and expenses consist of:
 September 30,
                            2009
                          
                          
                          December 31,
                            2008(Unaudited)Prepayment
      in connection with short term loan obtained in January 2009 (see Note
      10)
                          
                          $
                          -
                          
                          
                          $
                          439,710Advances
      to cocoon station for purchase of cocoon
                          
                          
                          1,178,602
                          
                          
                          
                          -Advances
      to personnel for future overhead costs
                          
                          
                          112,657
                          
                          
                          
                          7,423Advances
      to vendors for future overhead costs
                          
                          
                          114,451
                          
                          
                          
                          116,460Value
      added tax credits
                          
                          
                          -
                          
                          
                          
                          208,678Other
                          
                          
                          43
                          
                          
                          
                          43Total
                          
                          $
                          1,405,753
                          
                          
                          $
                          772,314
 
 NOTE 6 –
OTHER RECEIVABLES
 
 During
the nine months ended September 30, 2009, the Company advanced $4,298,998 to the
following individuals, entities and related party.
 September
      30,
                          
                          
                          December
      31,2009
                          
                          
                          2008(Unaudited)Receivables
      from individualsZhong,
      Songbai
                          
                          $
                          278,350
                          
                          
                          $
                          -Qin,
      Siwen
                          
                          
                          553,667
                          
                          
                          
                          -Du,
      Wenbing
                          
                          
                          68,855
                          
                          
                          
                          -Total
      receivables from individuals
                          
                          
                          900,872
                          
                          
                          
                          -Receivables
      from entitiesChongqing
      Qiao Da Investment, Ltd.
                          
                          
                          1,560,225
                          
                          
                          
                          -Chongqing
      First Capital Investment, Ltd.
                          
                          
                          286,271
                          
                          
                          
                          -Chongqing
      Aikekaer Paint Co., Ltd.
                          
                          
                          1,030,383
                          
                          
                          
                          -Total
      receivables from entities
                          
                          
                          2,876,879
                          
                          
                          
                          -Receivable
      from related partiesXinshengxiang
      Industrial Development Co., Ltd.
                          
                          
                          22,935
                          
                          
                          
                          -Chongqing
      Guojing Silk Company, Ltd.
                          
                          
                          498,312
                          
                          
                          
                          -Total
      Other Receivables
                          
                          $
                          4,298,998
                          
                          
                          $
                          -
 
 These
receivables are interest free and due on demand. The advances may be deemed
violations of various restrictive covenants contained in the various loan
agreements.
  F-10
 
 NOTE 7 -
PROPERTY AND EQUIPMENT
 
 Property
and equipment is summarized as follows:
 Description
                          
                          Estimated
                            Useful Life
                          
                          
                          September 30,
                            2009
                          
                          
                          December 31,
                            2008(Unaudited)Production
      Equipment
                          
                          
                          10
                          
                          
                          $
                          726,161
                          
                          
                          $
                          726,508Auxiliary
      Equipment
                          
                          
                          10
                          
                          
                          
                          6,944
                          
                          
                          
                          6,947Office
      Equipment
                          
                          
                          3-5
                          
                          
                          
                          26,891
                          
                          
                          
                          23,006Automobile
                          
                          
                          5
                          
                          
                          
                          124,525
                          
                          
                          
                          124,585Furniture
      and Fixtures
                          
                          
                          5-7
                          
                          
                          
                          36,606
                          
                          
                          
                          36,624Construction
      in progress
                          
                          
                          
                          
                          
                          
                          104,364
                          
                          
                          
                          102,5821,025,491
                          
                          
                          
                          1,020,252Less:
      Accumulated Depreciation
                          
                          
                          
                          
                          
                          
                          (200,609
                          )
                          
                          
                          (132,559
                          )$
                          824,882
                          
                          
                          $
                          887,693
 
 Depreciation
expense was $68,390 and $58,750 for the nine months ended September 30, 2009 and
2008, respectively, of which $40,500 and $39,926, respectively, were included in
cost of sales.
 
 The
Company changed its estimate of useful life for production equipment and
auxiliary equipment to ten years in 2008 from five years used in
2007.  The change was based on the following: (1) the equipment at
issue is traditional mechanical equipment which has a longer life than
electronic equipment; (2) 10 years useful life for such equipment is used by
similar companies in China and conforms to the estimated life used by the
taxation authorities in China. The effect of this change in estimate for the
nine months ended September 30, 2008 was to decrease depreciation expense, net
loss, and net loss per share by $56,934, $56,934, and $0.00,
respectively.
 
 NOTE 8 -
DEPOSITS
 
 Deposits
      consist of:
                          
                          September 30,
                            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
                          
                          
                          549,375
                          
                          
                          
                          36,643Foreign
      currency translation adjustment
                          
                          
                          28,226
                          
                          
                          
                          28,439Total
                          
                          $
                          996,200
                          
                          
                          $
                          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 ($1,519,908
translated at the September 30, 2009 exchange rate). If the Company is unable to
pay the remaining 3,574,800 RMB ($523,708 translated at the September 30, 2009
exchange rate) due, the Company’s total payments of 6,800,000 RMB ($996,200
translated at the September 30, 2009 exchange rate) may be forfeited and not
recovered (partially or in full). In February 2009, the due date of the
remaining 3,574,800 RMB ($523,708 translated at the September 30, 2009 exchange
rate) due was extended to September 2009.
  F-11
 
 NOTE 9 -
LOANS PAYABLE
 
 Loans
      payable consist of:
                                                  
                                                  September 30,
                                                    2009
                                                  
                                                  
                                                  December 31,
                                                    2008(Unaudited)Qiluo
      loan payable to Chongqing Aikekaer Paint Co., Ltd.1,166,670
      RMB,  interest at 6% per annum, due May 31, 2009
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  170,999Qiluo
      loan payable to Chongqing Shi Bell Technology, Ltd.430,000
      RMB, interest at 6% per   annum, due on
    demand
                                                  
                                                  
                                                  62,995
                                                  
                                                  
                                                  
                                                  63,025Qiluo
      loans payable to Jin Cheng Small Loans Company, Ltd.11,000,000
      RMB, interest at 18% per annum, due March 23, 2009
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  1,612,2705,000,000
      RMB, interest at 19.44% per annum, due September 2009
                                                  
                                                  
                                                  732,500
                                                  
                                                  
                                                  
                                                  -Total
      Qiluo loans payable to Jin Cheng Small Loans Company, Ltd.
                                                  
                                                  
                                                  732,500
                                                  
                                                  
                                                  
                                                  1,612,270Qiluo
      loans payable to Chongqing Shan Xia Bank30,000,000
      RMB, interest at 10% per annum, due January 19, 2010
                                                  
                                                  
                                                  4,395,000
                                                  
                                                  
                                                  
                                                  -Less:
      used by Mr. Chen, Wensheng, 3,000,000 RMB
                                                  
                                                  
                                                  (439,500
                                                  )
                                                  
                                                  
                                                  -Less:
      used by Mr. Zhong, Songbai, 2,000,000 RMB
                                                  
                                                  
                                                  (293,000
                                                  )
                                                  
                                                  
                                                  -Less:
      used by Guojing Silk, 10,000,000 RMB
                                                  
                                                  
                                                  (1,465,000
                                                  )
                                                  
                                                  
                                                  -Qiluo
      loans payable to Chongqing Shan Xia Bank, net
                                                  
                                                  
                                                  2,197,500
                                                  
                                                  
                                                  
                                                  -Franklin
      loans payable to two individualsinterest
      at 8% per annum, due April 24, 2008 (past due)
                                                  
                                                  
                                                  20,000
                                                  
                                                  
                                                  
                                                  20,000Total
      Loans Payable
                                                  
                                                  $
                                                  3,012,995
                                                  
                                                  
                                                  $
                                                  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 ($4,395,000 translated at the
September 30, 2009 exchange rate) from Chongqing 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 15,000,000 RMB ($2,197,500), Guojing Silk received 10,000,000 RMB
($1,465,000), Mr. Chen received 3,000,000 RMB ($439,500), and Mr. Zhong received
2,000,000 RMB ($293,000). Guojing Silk is controlled by the brother-in-law of
Mr. Kuang, indirect majority stockholder and chief executive officer of the
Company.
 
 The loans
payable to Jin Cheng Small Loans Company, Ltd are past due. The Company is in
negotiations with Jin Cheng to extend and refinance the loan.
 
 As of
September 30, 2009 and December 31, 2008, the accrued interest payable for short
term loans totaled $21,359 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:
                          
                          September 30,
                            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
                          
                          
                          
                          7,1584,000,000
      RMB loan payable to Xin Shengxiang
                          
                          
                          586,000
                          
                          
                          
                          -6,000,000
      RMB loan payable to Dingliang Kuang
                          
                          
                          879,000
                          
                          
                          
                          -Total
                          
                          $
                          1,484,391
                          
                          
                          $
                          19,391
  F-12
 
 On March
25, 2009, Xin Shengxiang Industrial Development Co., Ltd, (“Xinshengxiang”), a
major shareholder of the Company borrowed 4,000,000 RMB from Jin Cheng Small
Loans Company, Ltd. (Jincheng”) and advanced the funds to the Company. The short
term loan is due by November 24, 2009 and bears interest at 21.24% per
annum.
 
 On
September 29, 2009, Mr. Dingliang Kuang (“Mr. Kuang”), the Chief Executive
Officer and a major shareholder of the Company, borrowed 6,000,000 RMB from
Jincheng and advanced the funds to the Company. The short term loan is due by
October 28, 2009 and bears interest at 19.44% per annum. This loan is past due
as of the filing date of this Form 10-Q.
 
 NOTE 11 -
CONVERTIBLE NOTES PAYABLE
 
 September
      30,
                    
                    
                    December
      31,Convertible
      notes payable, net consist of:
                    
                    2009
                    
                    
                    2008(Unaudited)
                    
                    
                    (Restated)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
                    
                    
                    3,300,000
                    
                    
                    
                    3,300,000Unamortized
      debt discounts
                    
                    
                    -
                    
                    
                    
                    -Repayment
      of convertible notes
                    
                    
                    (507,825
                    )
                    
                    
                    (507,825
                    )Convertible
      notes payable, net
                    
                    $
                    2,792,175
                    
                    
                    $
                    2,792,175
 
 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.
  F-13
 
 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 18).
 
 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 ASC 470-20-30
(formerly, 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 ASC 470-20-30, 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
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 nine months ended September 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). Consequently, the Company wrote off the
remaining $56,797 unamortized deferred finance costs, $1,078,882 unamortized
debt discounts (warrants and beneficial conversion feature) and $1,335,144
unamortized deferred finance costs included in the equity section at December
31, 2008 and recognized additional interest expense of $2,470,823 (See Note
20).
  F-14
 
 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.
 
 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 nine months ended September 30,
2008, pursuant to the terms of the Notes (see Note 12).  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:
  F-15
 
 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.
 
 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
      - September 30, 2009 (Unaudited) and December 31, 2008
                          
                          
                          
                          30,360,000
                          
                          
                          $
                          0.68
 
 Warrants
outstanding and exercisable by price range as of September 30, 2009 and December
31, 2008 are:
 
 WarrantsOutstanding
                              
                              
                              WarrantsExercisablePriceRange
                              
                              Number
                                Outstanding
                              
                              
                              WeightedAverage
                                Remaining
                                Contractual
                                LifeinYears*
                              
                              
                              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 from the effective date of the registration statement.
The registration statement filed on
December 26, 2007 is not effective as of the date of filing of this Form
10-Q.
 
 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
  F-16
 
 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 RMB), 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.
 
 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 RMB) at market price from
Xinshengxiang.
 
 Chongqing
Guojing Silk Company, Ltd. (“Guojing Silk”), is controlled by the brother-in-law
of Mr. Kuang, indirect majority stockholder and chief executive officer of the
Company. 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 ($4,395,000 translated at the
September 30, 2009 exchange rate) from Chongqing 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 15,000,000 RMB ($2,197,500), Guojing Silk received 10,000,000 RMB
($1,465,000), Mr. Chen received 3,000,000 RMB ($439,500), and Mr. Zhong received
2,000,000 RMB ($293,000).
 
 In March
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. Under the related
agreement with Shan Xia Bank, use of the 31,500,000 RMB is not permitted while
the bank acceptance is outstanding. Qiluo returned the 31,500,000 RMB in
September 2009.
 
 During
the nine months ended September 30, 2008, the Company received funds from and
advanced funds to Guojing Silk for working capital purposes. As of September 30,
2009, the excess advanced payments to Guojing Silk amounted to $498,312
(3,401,450 RMB), which was reported under the caption of “Other receivables”
(Note 8).
 
 On March
25, 2009, Xin Shengxiang Industrial Development Co., Ltd, (“Xinshengxiang”), a
major shareholder of the Company borrowed 4,000,000 RMB from Jin Cheng Small
Loans Company, Ltd. (Jincheng”) and advanced the funds to the Company. The short
term loan is due by November 24, 2009 and bears interest at 21.24% per
annum.
 
 On
September 29, 2009, Mr. Dingliang Kuang (“Mr. Kuang”), the Chief Executive
Officer and a major shareholder of the Company, borrowed 6,000,000 RMB from
Jincheng  and advanced the funds to the Company. The short term loan
is due by October 28, 2009 and bears interest at 19.44% per annum. This loan is
past due as of the filing date of this Form 10-Q.
  F-17
 
 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, accounts
receivable, and other receivables.
 
 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 $70,783 and $61,867 as of
September 30, 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 ($29,300 translated at the September 30, 2009
exchange rate) plus other occupancy costs.
 
 Future
minimum rentals under this lease are as follows:
 TwelveMonths
                      Ending
                      September30,
                      (Unaudited)
                    
                    FutureMinimum
                      RentPayments2010
                    
                    $
                    29,3002011
                    
                    
                    29,3002012
                    
                    
                    29,3002013
                    
                    
                    29,3002014
                    
                    
                    29,300Thereafter
                    
                    
                    341,600Total
                    
                    $
                    488,100
 
 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 $1,311,760
as of September 30, 2009, which has been recorded as interest expense and
included in accounts payable and accrued expenses.
 
 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.
  F-18
 
 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 nine (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
September 30, 2009, the unpaid convertible notes payable balance is $2,792,175;
unpaid accrued interest is $414,545; and unpaid accrued liquidated damages
penalty and default penalty are $1,835,294. The Company is currently negotiating
with investors and seeking ways to resolve the default issue with all
investors.
 
 NOTE 20 –
RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
 
 The
Company plans to restate its consolidated financial statements at December 31,
2008 and for the year then ended (which were previously included in the
Company’s Form 10-K filed with SEC on April 15, 2009) in order to correct an
error relating to the accounting for the defaulted notes payable (see Notes 11
and 19).
 
 In the
Form 10-K filed April 15, 2009, the consolidated balance sheet at December 31,
2008 included unamortized deferred finance costs of $1,391,941 ($56,797 in
assets, $1,335,144 as contra equity in stockholders’ deficit) and unamortized
debt discounts of $1,078,882 (as a reduction of convertible notes payable in
current liabilities) relating to these notes, which reflected amortization of
these costs over the two year life of the notes. Since the Company had defaulted
on the notes, thus making the obligations immediately due and payable on demand,
the Company should have accelerated the amortization of the remaining
unamortized deferred finance costs and debt discounts at such time. Accordingly,
the consolidated balance sheet at December 31, 2008 included in this Form 10-Q
has been restated to reflect such amortization.
 
 The
effect of the restatement adjustments on the consolidated balance sheet at
December 31, 2008 follows:
  F-19
 
 As
      PreviouslyReported
                      
                      
                      Adjustments
                      
                      
                      As RestatedASSETSCurrent
      assets
                      
                      $
                      3,749,917
                      
                      
                      $
                      -
                      
                      
                      $
                      3,749,917Property
      and equipment, net
                      
                      
                      887,693
                      
                      
                      
                      -
                      
                      
                      
                      887,693Deposits
                      
                      
                      483,681
                      
                      
                      
                      -
                      
                      
                      
                      483,681Deferred
      finance costs
                      
                      
                      56,797
                      
                      
                      
                      (56,797
                      )
                      
                      
                      -Total
      Assets
                      
                      $
                      5,178,088
                      
                      
                      $
                      (56,797
                      )
                      
                      $
                      5,121,291LIABILITIES
      AND STOCKHOLDERS' DEFICITConvertible
      notes payable
                      
                      $
                      1,713,293
                      
                      
                      $
                      1,078,882
                      
                      
                      $
                      2,792,175Other
      current liabilities
                      
                      
                      3,817,241
                      
                      
                      
                      -
                      
                      
                      
                      3,817,241Total
      Current Liabilities
                      
                      
                      5,530,534
                      
                      
                      
                      1,078,882
                      
                      
                      
                      6,609,416Common
      stock
                      
                      
                      12,348
                      
                      
                      
                      -
                      
                      
                      
                      12,348Additional
      paid-in capital
                      
                      
                      18,345,012
                      
                      
                      
                      -
                      
                      
                      
                      18,345,012Deferred
      finance costs
                      
                      
                      (1,335,144
                      )
                      
                      
                      1,335,144
                      
                      
                      
                      -Accumulated
      deficit
                      
                      
                      (17,690,956
                      )
                      
                      
                      (2,470,823
                      )
                      
                      
                      (20,161,779
                      )Accumulated
      other comprehensive income
                      
                      
                      316,294
                      
                      
                      
                      -
                      
                      
                      
                      316,294Total
      Stockholders' (Deficit)
                      
                      
                      (352,446
                      )
                      
                      
                      (1,135,679
                      )
                      
                      
                      (1,488,125
                      )Total
      Liabilities and Stockholders' deficit
                      
                      $
                      5,178,088
                      
                      
                      $
                      (56,797
                      )
                      
                      $
                      5,121,291
 
 The
effect of the restatement adjustments on the consolidated statement of
operations for the year ended December 31, 2008 follows:
 
 As
      PreviouslyReported
                            
                            
                            Adjustments
                            
                            
                            As RestatedLoss
      from operations
                            
                            $
                            (751,854
                            )
                            
                            $
                            -
                            
                            
                            $
                            (751,854
                            )Interest
      income
                            
                            
                            2,564
                            
                            
                            
                            -
                            
                            
                            
                            2,564Interest
      expense
                            
                            
                            (5,433,570
                            )
                            
                            
                            (2,470,823
                            )
                            
                            
                            (7,904,393
                            )Net
      Loss
                            
                            $
                            (6,182,860
                            )
                            
                            $
                            (2,470,823
                            )
                            
                            $
                            (8,653,683
                            )Net
      Losss per Share - Basic and Diluted
                            
                            $
                            (0.06
                            )
                            
                            $
                            (0.02
                            )
                            
                            $
                            (0.08
                            )
  F-20




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. Although Qiluo is a subsidiary of Franklin,
the acquisition of Qiluo by Franklin that was consummated on June 19, 2007 has
been treated as a reverse merger of Qiluo. This means that Qiluo is the
continuing entity for financial reporting purposes.




We
and our representatives may, from time to time, make written or verbal
forward-looking statements, including statements contained in our filings with
the United States Securities and Exchange Commission and in our reports to
shareholders. Generally, the inclusion of the words “believe”, “expect”,
“intend”, “estimate”, “anticipate”, “will”, and similar expressions or the
converse thereof, identify statements that constitute “forward-looking
statements”.




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.




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 ($1,519,908
translated at the September 30, 2009 exchange rate). If the Company is unable to
pay the remaining 3,574,800 RMB ($523,708 translated at the September 30, 2009
exchange rate) due, the Company’s total payments of 6,800,000 RMB ($996,200
translated at the September 30, 2009 exchange rate) may be forfeited and not
recovered (partially or in full). In February 2009, the due date of the
remaining 3,574,800 RMB ($523,708 translated at the September 30, 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. Nevertheless, the Company started to use those cocoon
stations and to purchase cocoon directly from local farmers commenced on the
second quarter of 2008. However, there is no assurance that the Company will
raise enough fund to complete this acquisition.


4





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 has not
taken 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 may 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, and we have given no contemplation with respect to
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.




Results
of Operations





Comparison of Sales for the
Three Months Ended September 30, 2009 and 2008





Three
      Months EndedSeptember
      30,Sales
      in US dollars
                              
                              2009
                              
                              
                              2008Silk
                              
                              $
                              1,235,169
                              
                              
                              $
                              786,308Cocoons
                              
                              
                              593,338
                              
                              
                              
                              1,083,621By
      products and others
                              
                              
                              411,942
                              
                              
                              
                              464,709Total
      sales
                              
                              $
                              2,240,449
                              
                              
                              $
                              2,334,638





Net
Sales





Our net
sales were $2,240,449 for the three months ended September 30, 2009, decreased
by $94,189, or 4%, as compared to $2,334,638 for the three months ended
September 30, 2008.





The
Company sold 51.24 tons of silk during the three months ended September 30,
2009, an increase of 17.24 tons, or 51% as compared to 34.00 tons during the
three months ended September 30, 2008. The revenue from sale of silk was
$1,235,169 during the three months ended September 30, 2009, an increase of
$448,861, or 57% as compared to $786,308 for the same period of
2008.





The
cocoon is a raw material for production of silk. The sales of cocoon were 100.26
tons for the three months ended September 30, 2009, decreased by 105.32 tons, or
52% as compared to 202.58 tons sold in the same period of 2008. The revenue from
sale of cocoon was $593,338 for the three months ended September 30, 2009,
decreased by $490,283, or 45%, as compared to $1,083,621 for the three months
ended September 30, 2008.




5




Gross
Profit





Comparison of Gross Profit
for the Three Months Ended September 30, 2009 and 2008





Three
      Months EndedSeptember
      30,2009
                          
                          
                          2008Net
      sales
                          
                          $
                          2,240,449
                          
                          
                          $
                          2,334,638Cost
      of sales
                          
                          
                          (1,647,072
                          )
                          
                          
                          (2,051,618
                          )Gross
      profit
                          
                          $
                          593,377
                          
                          
                          $
                          283,020Gross
      profit margin rate
                          
                          
                          26.48
                          %
                          
                          
                          12.12
                          %





Gross
profit for the three months end September 30, 2009 and 2008 was $593,377 and
$283,020, respectively. The gross profit margin rate for the three months ended
September 30, 2009 increased 14.36 percentage points from 12.12% during the
three months ended September 30, 2008 to 26.48% for the three months ended
September 30, 2009. This improvement reflects the improvement of silk market
condition and is also the result of our acquisition of Zhengzhong (see Plan of
Operation). The Company started to use its exclusive right through acquired
assets of Zhengzhong 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.





Income
(Loss) from Operations





Comparison of Income (Loss)
from Operations for the Three Months Ended September 30, 2009 and
2008





Three
      Months EndedSeptember
      30,2009
                                  
                                  
                                  2008Gross
      profit
                                  
                                  $
                                  593,377
                                  
                                  
                                  $
                                  283,020Professional
      fees
                                  
                                  
                                  14,018
                                  
                                  
                                  
                                  15,454Depreciation
      and amortization
                                  
                                  
                                  8,725
                                  
                                  
                                  
                                  8,332Selling
      expenses
                                  
                                  
                                  19,251
                                  
                                  
                                  
                                  24,490Other
      general and administrative expenses
                                  
                                  
                                  199,799
                                  
                                  
                                  
                                  290,411Income
      (Loss) from operations
                                  
                                  $
                                  351,584
                                  
                                  
                                  $
                                  (55,667
                                  )





Income
from operations for the three months ended September 30, 2009 were $351,584, an
improvement of $407,251, as compared to loss from operations of $55,667 for the
three months ended September 30, 2008.





Total
operating expenses was $241,793, decreased by $96,894, or 29%, as compared to
$338,687 for the nine months ended September 30, 2008. Other general and
administrative expenses consist of expenses relating to our back office and
general and administrative expenses relating to our cocoon stations. Other
general and administrative expenses decreased $90,612 from $290,411 for the
three months ended September 30, 2008 to $199,799 for the three months ended
September 30, 2009. The decrease of other general and administrative expenses
was primarily due to the decrease in expenses on new acquired cocoon stations.
The expenses in connection with cocoon stations decreased $98,179 from $115,807
for the three months ended September 30, 2008 to $17,628 for the three months
ended September 30, 2009.




6




Other
Expenses, Net





Comparison of Other
Expenses, net for the Three Months Ended September 30, 2009 and
2008





Three
      Months EndedSeptember
      30,2009
                                
                                
                                2008Subsidy
      income
                                
                                $
                                -
                                
                                
                                $
                                -Interest
      income
                                
                                
                                324
                                
                                
                                
                                576Interest
      expense
                                
                                
                                (521,263
                                )
                                
                                
                                (1,239,008
                                )Other
      Expenses, net
                                
                                $
                                (520,939
                                )
                                
                                $
                                (1,238,432
                                )





Total
other expenses, net was $520,939 for the three months ended September 30, 2009,
a decrease of $717,493 as compared to $1,238,432 for the three months ended
September 30, 2008.





Interest
expenses consist of interest paid for short term loans and amortization of
deferred financing cost and debt discount in connection with the convertible
debt issuances in September 2007. Interest paid to various loans was $178,570
and $0 for the three months ended September 30, 2009 and 2008, respectively.
Interest paid and accrued to convertible notes was $69,804 and $69,804 for the
three months ended September 30, 2009 and 2008, respectively. We have incurred
and recorded $0 and $983,483 amortization expenses of deferred finance costs and
debt discount and cash discount for the three months ended September 30, 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 $272,238 and $167,531 for the three months ended
September 30, 2009 and 2008, respectively.





Comparison of Sales for the
Nine Months Ended September 30, 2009 and 2008





Nine
      Months EndedSeptember
      30,Sales
      in US dollars
                            
                            2009
                            
                            
                            2008Silk
                            
                            $
                            3,004,709
                            
                            
                            $
                            2,104,648Cocoons
                            
                            
                            1,350,853
                            
                            
                            
                            1,926,241By
      products and others
                            
                            
                            768,785
                            
                            
                            
                            753,887Total
      sales
                            
                            $
                            5,124,347
                            
                            
                            $
                            4,784,776





Net
Sales





Our net
sales were $5,124,347 for the nine months ended September 30, 2009, an increase
of $339,571, or 7%, as compared to $4,784,776 for the nine months ended
September 30, 2008.  The increase of our sales was primarily
attributable to the improvement of the commodity market and increased
demand.





The
Company sold 136.49 tons of silk during the nine months ended September 30,
2009, an increase of 42.72 tons, or 46% as compared to 93.77 tons during the
nine months ended September 30, 2008. The revenue from sale of silk was
$3,004,709 during the nine months ended September 30, 2009, an increase of
$900,061, or 43% as compared to $2,104,648 for the same period of
2008.





The
cocoon is a raw material for production of silk. The sales of cocoon were 253.43
tons for the nine months ended September 30, 2009, decreased by 76.73 tons, or
23% as compared to 330.16 tons sold in the same period of 2008. The revenue from
sale of cocoon was $1,350,853 for nine months ended September 30, 2009, a
decrease of $575,388, or 30%, as compared to $1,926,241 for the nine months
ended September 30, 2008.


7





Gross
Profit





Comparison of Gross Profit
for the Nine Months Ended September 30, 2009 and 2008





Nine
      Months EndedSeptember
      30,2009
                          
                          
                          2008Net
      sales
                          
                          $
                          5,124,347
                          
                          
                          $
                          4,784,776Cost
      of sales
                          
                          
                          (4,298,110
                          )
                          
                          
                          (4,464,228
                          )Gross
      profit
                          
                          $
                          826,237
                          
                          
                          $
                          320,548Gross
      profit margin rate
                          
                          
                          16.12
                          %
                          
                          
                          6.70
                          %





Gross
profit for the nine months end September 30, 2009 and 2008 was $826,237 and
$320,548, respectively. The gross profit margin rate for the nine months ended
September 30, 2009 increased 9.42 percentage points from 6.70% during the nine
months ended September 30, 2008 to 16.12% for the nine months ended September
30, 2009. This improvement is mainly the result of our acquisition of Zhengzhong
(see Plan of Operation). The Company started to use its exclusive right through
acquired assets of Zhengzhong 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.





Loss
from Operations





Comparison of Loss from
Operations for the Nine Months Ended September 30, 2009 and
2008





Nine
      Months EndedSeptember
      30,2009
                            
                            
                            2008Gross
      profit
                            
                            $
                            826,237
                            
                            
                            $
                            320,548Professional
      fees
                            
                            
                            48,012
                            
                            
                            
                            222,422Depreciation
      and amortization
                            
                            
                            28,438
                            
                            
                            
                            18,824Selling
      expenses
                            
                            
                            49,546
                            
                            
                            
                            53,254Other
      general and administrative expenses
                            
                            
                            417,916
                            
                            
                            
                            597,951Loss
      from operations
                            
                            $
                            282,325
                            
                            
                            $
                            (571,903
                            )





Income
from operations for the nine months ended September 30, 2009 were $282,325, an
improvement of $854,228, as compared to loss from operations of $571,903 for the
nine months ended September 30, 2008. Total operating expenses was $543,912,
decreased by $348,539, or 39%, as compared to $892,451 for the nine months ended
September 30, 2008. The decrease of operating expenses was primarily due to the
decrease of professional fees. Professional fees totaled $48,012 for the nine
months ended September 30, 2009, a decrease of $174,410, or 78%, as compared to
professional fees of $222,422 for the nine months ended September 30, 2008. We
incurred significant cost in connection with professional services associated
with the legal and accounting reporting obligations of being a public company in
2008.


8


Other
general and administrative expenses consist of expenses relating to our back
office and general and administrative expenses relating to our cocoon stations.
Other general and administrative expenses decreased $180,035 from $597,951 for
the nine months ended September 30, 2008 to $417,916 for the nine months ended
September 30, 2009. The decrease of other general and administrative expenses
was primarily due to the decrease in expenses on new acquired cocoon stations.
The expenses in connection with cocoon stations decreased $191,441 from $235,826
for the nine months ended September 30, 2008 and to $44,385 for the nine months
ended September 30, 2009.





Other
Expenses, Net





Comparison of Other
Expenses, net for the Nine Months Ended September 30, 2009 and
2008





Nine
      Months EndedSeptember
      30,2009
                            
                            
                            2008Subsidy
      income
                            
                            $
                            706,122
                            
                            
                            $
                            -Interest
      income
                            
                            
                            7,137
                            
                            
                            
                            2,152Interest
      expense
                            
                            
                            (1,577,281
                            )
                            
                            
                            (3,859,226
                            )Other
      Expenses, net
                            
                            $
                            (864,022
                            )
                            
                            $
                            (3,857,074
                            )





Total
other expenses, net was $864,022 for the nine months ended September 30, 2009,
decreased by $2,993,052 as compared to $3,857,074 for the nine months ended
September 30, 2008. The Company received subsidy of $706,122 from various
Chinese government during the nine months ended September 30, 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.





Interest
expenses consist of interest paid for short term loans and amortization of
deferred financing cost and debt discount in connection with the convertible
debt issuances in September 2007. Interest paid to various loans was $549,202
and $0 for the nine months ended September 30, 2009 and 2008, respectively.
Interest paid and accrued to convertible notes was $209,412 and $223,968 for the
nine months ended September 30, 2009 and 2008, respectively. We have incurred
and recorded $0 and $3,057,862 amortization expenses of deferred finance costs
and debt discount and cash discount for the nine months ended September 30, 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 $816,714 and $542,637 for the nine months ended
September 30, 2009 and 2008, respectively.





Liquidity
and Capital Resources





As of
September 30, 2009 and December 31, 2008, we had $70,783 and $61,867 in cash,
respectively. We believe that such funds will not be sufficient to effectuate
our plans with respect to the business over the next twelve months. We will need
to seek additional capital for our operations.





The major
sources of Company’s liquidity for the nine months ended September 30, 2009 and
2008 were cash generated from operations and short term loans from banks and
other entities.




9




Net cash
provided by operating activities during the nine months ended September 30, 2009
was $2,215,211, compared to -$2,467,189 net cash used for the nine months ended
September 30, 2008. This was mainly due to that the Company commenced its
operation after third quarter of 2007, which required more upfront payments
during 2008.  The Company also received $939,313 in advance from
customers during the nine months ended September 30, 2009, as compared to $0
during the same period of 2008.





Net cash
used in investing activities was $4,817,023 during nine months ended September
30, 2009, as compared to net cash provided by investing activities of $56,229
during the nine months ended September 30, 2008. It was the results of paid
additional acquisition deposit of $512,750 and lent $4,298,998 to various
entities and individuals (see Note 8 to Financial Statements).


Net cash
provided by financing activities was $2,611,701 and $1,796,896 for the nine
months ended September 30, 2009 and 2008, respectively. During nine months ended
September 30, 2009, the company received net proceeds of $1,146,701 from various
short term loans and $1,465,000 from related parties. For the nine months ended
September 30, 2008, the Company received net proceeds from various short term
loans of $148,712, and received net proceeds of $1,662,059 from related
parties.





Loans Payable to various
Banks and Entities





September
      30,
                                              
                                              
                                              December
      31,Loans
      payable consist of:
                                              
                                              2009
                                              
                                              
                                              2008(Unaudited)Qiluo
      loan payable to Chongqing Aikekaer Paint Co., Ltd.1,166,670
      RMB, interest at 6% per annum, due May 31, 2009
                                              
                                              $
                                              -
                                              
                                              
                                              $
                                              170,999Qiluo
      loan payable to Chongqing Shi Bell Technology, Ltd.430,000
      RMB, interest at 6% per annum, due on demand
                                              
                                              
                                              62,995
                                              
                                              
                                              
                                              63,025Qiluo
      loans payable to Jin Cheng Small Loans Company, Ltd.11,000,000
      RMB, interest at 18% per annum, due March 23, 2009
                                              
                                              
                                              -
                                              
                                              
                                              
                                              1,612,2705,000,000
      RMB, interest at 19.44% per annum, due September 2009
                                              
                                              
                                              732,500
                                              
                                              
                                              
                                              -Total
      Qiluo loans payable to Jin Cheng Small Loans Company, Ltd.
                                              
                                              
                                              732,500
                                              
                                              
                                              
                                              1,612,270Qiluo
      loans payable to Chongqing Shan Xia Bank30,000,000
      RMB, interest at 10% per annum, due January 19, 2010
                                              
                                              
                                              4,395,000
                                              
                                              
                                              
                                              -Less:
      used by Mr. Chen, Wensheng, 3,000,000 RMB
                                              
                                              
                                              (439,500
                                              )
                                              
                                              
                                              -Less:
      used by Mr. Zhong, Songbai, 2,000,000 RMB
                                              
                                              
                                              (293,000
                                              )
                                              
                                              
                                              -Less:
      used by Guojing Silk, 10,000,000 RMB
                                              
                                              
                                              (1,465,000
                                              )
                                              
                                              
                                              -Qiluo
      loans payable to Chongqing Shan Xia Bank, net
                                              
                                              
                                              2,197,500
                                              
                                              
                                              
                                              -Franklin
      loans payable to two individualsinterest
      at 8% per annum, due April 24, 2008 (past due)
                                              
                                              
                                              20,000
                                              
                                              
                                              
                                              20,000Total
      Loans Payable
                                              
                                              $
                                              3,012,995
                                              
                                              
                                              $
                                              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 ($4,395,000 translated at the
September 30, 2009 exchange rate) from Chongqing 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 15,000,000 RMB ($2,197,500), Guojing Silk received 10,000,000 RMB
($1,465,000), Mr. Chen received 3,000,000 RMB ($439,500), and Mr. Zhong received
2,000,000 RMB ($293,000). Guojing Silk is controlled by the brother-in-law of
Mr. Kuang, indirect majority stockholder and chief executive officer of the
Company.





The loans
payable to Jin Cheng Small Loans Company, Ltd are past due. The Company is in
negotiations with Jin Cheng to extend and refinance the loan.





10





Loans Payable to Related
Parties





September
      30,
                                            
                                            
                                            December
      31,Loans
      payable – related parties consist of:
                                            
                                            2009
                                            
                                            
                                            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
                                            
                                            
                                            
                                            7,1584,000,000
      RMB loan payable to Xin Shengxiang
                                            
                                            
                                            586,000
                                            
                                            
                                            
                                            -6,000,000
      RMB loan payable to Dingliang Kuang
                                            
                                            
                                            879,000
                                            
                                            
                                            
                                            -Total
                                            
                                            $
                                            1,484,391
                                            
                                            
                                            $
                                            19,391





On March
25, 2009, Xin Shengxiang Industrial Development Co., Ltd, (“Xinshengxiang”), a
major shareholder of the Company borrowed 4,000,000 RMB from Jin Cheng Small
Loans Company, Ltd. (Jincheng”) and advanced the funds to the Company. The short
term loan is due by November 24, 2009 and bears interest at 21.24% per
annum.





On
September 29, 2009, Mr. Dingliang Kuang (“Mr. Kuang”), the Chief Executive
Officer and a major shareholder of the Company borrowed 6,000,000 RMB from
Jincheng and advanced the funds to the Company. The short term loan is due by
October 28, 2009 and bears interest at 19.44% per annum. This loan is past due
as of the filing date of this Form 10-Q.





Convertible Notes
Payable





September
      30,
                                                    
                                                    
                                                    December
      31,Convertible
      notes payable, net consist of:
                                                    
                                                    2009
                                                    
                                                    
                                                    2008(Unaudited)
                                                    
                                                    
                                                    (Restated)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
                                                    
                                                    
                                                    3,300,000
                                                    
                                                    
                                                    
                                                    3,300,000Unamortized
      debt discounts
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -Repayment
      of convertible notes
                                                    
                                                    
                                                    (507,825
                                                    )
                                                    
                                                    
                                                    (507,825
                                                    )Convertible
      notes payable, net
                                                    
                                                    $
                                                    2,792,175
                                                    
                                                    
                                                    $
                                                    2,792,175





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.




11




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 18).





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 ASC 470-20-30
(formerly, 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 ASC 470-20-30, 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.


12


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 nine months ended September 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). Consequently, the Company wrote off the
remaining $56,797 unamortized deferred finance costs, $1,078,882 unamortized
debt discounts (warrants and beneficial conversion feature) and $1,335,144
unamortized deferred finance costs included in the equity section at December
31, 2008 and recognized additional interest of $2,470,823. (See Note
20)




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 $581,697 for the nine months ended September 30, 2009 and
has an accumulated deficit of $20,743,476 at September 30,
2009.  Substantial portions of the losses are attributable to
stock-based compensation, 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 $3,891,816 and $2,859,499 as of September 30, 2009 and
December 31, 2008, respectively.





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 September 30, 2009, the unpaid convertible notes payable balance is
$2,792,175; unpaid accrued interest is $414,545; and unpaid accrued liquidated
damages penalty and default penalty are $1,835,294. 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 nine months ended September 30, 2009, the Company received net proceeds of
$1,146,701 from various short term loans and net proceeds of $1,465,000 from
related parties.





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 neighboring 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 8 of consolidated financial statements),
thereby helping the Company to reduce its raw material - cocoon cost. During the
nine months ended September 30, 2009, the gross margin rate was 16.1%, as
compared to 6.7% for the nine months ended September 30, 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.




13




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.





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 $2,192,698 for the nine months ended September 30, 2009
and has an accumulated deficit of $19,883,654 at September 30,
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 $3,440,745 and $1,780,617 as of
September 30, 2009 and December 31, 2008, respectively. In addition, the
Company’s gross margin rate from its current operations was low.  It
was 8% for the nine months ended September 30, 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. 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 September 30, 2009, the unpaid convertible notes payable balance is
$2,792,175; unpaid accrued interest is $344,741; and unpaid accrued liquidated
damages penalty and default penalty are $1,563,056. 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 nine months ended September 30, 2009, the Company received net proceeds of
$2,023,058 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. During the nine months ended September 30, 2009,
the gross margin rate was 8%, as compared to 1.5% for the nine months ended
September 30, 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.





14





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.





Intangible and Other
Long-Lived Assets





Intangible
and other long-lived assets are stated at cost, less accumulated amortization
and impairments.





The
Company reviews its long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may no longer be
recoverable.  When these events occur, the Company measures impairment
by comparing the carrying value of the long-lived assets to the estimated
undiscounted future cash flows expected to result from the use of the assets and
their eventual disposition.  If the sum of the expected undiscounted
cash flow is less than the carrying amount of the assets, the Company would
recognize an impairment loss based on the fair value of the assets.




15




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 Accounting
Standards Codification (“ASC”) topic 718-10, Stock Compensation (formerly, SFAS
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 ASC 740-10, (formerly, 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





ASC
280-10 (formerly, SFAS No. 131), “Disclosure About Segments of and Enterprise
and Related Information”, 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.





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.





The
Company has restated its consolidated financial statement at December 31, 2008
and for the year then ended (which were previously included in the Company’s
Form 10-K filed with SEC on April 15, 2009) in order to correct an error
relating to the accounting for a defaulted notes payable (see Note
19).





Restatement of Previously
Issued Financial Statements





The
Company plans to restate its consolidated financial statements at December 31,
2008 and for the year then ended (which were previously included in the
Company’s Form 10-K filed with SEC on April 15, 2009) in order to correct an
error relating to the accounting for the defaulted notes payable (see Note 11
and 19).




16




In the
form 10-K filed April 15, 2009, the consolidated balance sheet at December 31,
2008 included unamortized deferred finance costs of $1,391,941 ($56,797 in
assets, $1,335,144 as contra equity in stockholders’ deficit) and unamortized
debt discounts of $1,078,882 (as a reduction of convertible notes payable in
current liabilities) relating to these notes, which reflected amortization of
these costs over the two year life of the notes. Since the Company had defaulted
on the notes, thus making the obligations immediately due and payable on demand,
the Company should have accelerated the amortization of the remaining
unamortized deferred finance costs and debt discounts at such time. Accordingly,
the consolidated balance sheet at December 31, 2008 included in this Form 10-Q
has been restated to reflect such amortization.


The
effect of the restatement adjustments on the consolidated balance sheet at
December 31, 2008 follows:





As
      PreviouslyReported
                                      
                                      
                                      Adjustments
                                      
                                      
                                      As
      RestatedASSETSCurrent
      assets
                                      
                                      $
                                      3,749,917
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      3,749,917Property
      and equipment, net
                                      
                                      
                                      887,693
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      887,693Deposits
                                      
                                      
                                      483,681
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      483,681Deferred
      finance costs
                                      
                                      
                                      56,797
                                      
                                      
                                      
                                      (56,797
                                      )
                                      
                                      
                                      -Total
      Assets
                                      
                                      $
                                      5,178,088
                                      
                                      
                                      $
                                      (56,797
                                      )
                                      
                                      $
                                      5,121,291LIABILITIES
      AND STOCKHOLDERS' DEFICITConvertible
      notes payable
                                      
                                      $
                                      1,713,293
                                      
                                      
                                      $
                                      1,078,882
                                      
                                      
                                      $
                                      2,792,175Other
      current liabilities
                                      
                                      
                                      3,817,241
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      3,817,241Total
      Current Liabilities
                                      
                                      
                                      5,530,534
                                      
                                      
                                      
                                      1,078,882
                                      
                                      
                                      
                                      6,609,416Common
      stock
                                      
                                      
                                      12,348
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      12,348Additional
      paid-in capital
                                      
                                      
                                      18,345,012
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      18,345,012Deferred
      finance costs
                                      
                                      
                                      (1,335,144
                                      )
                                      
                                      
                                      1,335,144
                                      
                                      
                                      
                                      -Accumulated
      deficit
                                      
                                      
                                      (17,690,956
                                      )
                                      
                                      
                                      (2,470,823
                                      )
                                      
                                      
                                      (20,161,779
                                      )Accumulated
      other comprehensive income
                                      
                                      
                                      316,294
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      316,294Total
      Stockholders' (Deficit)
                                      
                                      
                                      (352,446
                                      )
                                      
                                      
                                      (1,135,679
                                      )
                                      
                                      
                                      (1,488,125
                                      )Total
      Liabilities and Stockholders' deficit
                                      
                                      $
                                      5,178,088
                                      
                                      
                                      $
                                      (56,797
                                      )
                                      
                                      $
                                      5,121,291





The
effect of the restatement adjustments on the consolidated statement of
operations for the year ended December 31, 2008 follows:





As
      PreviouslyReported
                            
                            
                            Adjustments
                            
                            
                            As
      RestatedLoss
      from operations
                            
                            $
                            (751,854
                            )
                            
                            $
                            -
                            
                            
                            $
                            (751,854
                            )Interest
      income
                            
                            
                            2,564
                            
                            
                            
                            -
                            
                            
                            
                            2,564Interest
      expense
                            
                            
                            (5,433,570
                            )
                            
                            
                            (2,470,823
                            )
                            
                            
                            (7,904,393
                            )Net
      Loss
                            
                            $
                            (6,182,860
                            )
                            
                            $
                            (2,470,823
                            )
                            
                            $
                            (8,653,683
                            )Net
      Losss per Share - Basic and Diluted
                            
                            $
                            (0.06
                            )
                            
                            $
                            (0.02
                            )
                            
                            $
                            (0.08
                            )





Item
3. Quantitative and Qualitative Disclosures About Market Risk.





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





17




Item
4.  Controls and Procedures.





Evaluation
of Disclosure Controls and Procedures


We
carried out an evaluation, under the supervision and with the participation of
our management, including our principal executive officer and principal
financial officer, of the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act
(defined below)). Based upon that evaluation, our principal executive officer
and principal financial officer concluded that, as of the end of the period
covered in this report, our disclosure controls and procedures were effective to
ensure that information required to be disclosed in reports filed under the
Securities Exchange Act of 1934, as amended (the "Exchange Act") is recorded,
processed, summarized and reported within the required time periods and is
accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure.




Our
management, including our principal executive officer and principal financial
officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all error or fraud.  A control system,
no matter how well conceived and   operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Further, the design of a control system must reflect the fact that
there are resource constraints and the benefits of controls must be considered
relative to their costs.  Due to the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, have been detected.
Accordingly, management believes that the financial statements included in this
report fairly present in all material respects our financial condition, results
of operations and cash flows for the periods presented.





Changes
in Internal Control Over Financial Reporting





There
were no changes in our internal controls over financial reporting that occurred
during the last fiscal quarter covered by this report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.




PART
II  OTHER INFORMATION




Item
1.  Legal Proceedings.




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 July 12, 2008, the Company was in default on its Convertible Notes payments
due July 12, 2008. As of June 30, 2009, the unpaid convertible notes payable
balance is $2,792,175; unpaid accrued interest is $344,741; and unpaid accrued
liquidated damages penalty and default penalty are $1,563,056. The Company is
currently negotiating with investors and 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




18




Purchases of equity
securities by the issuer and affiliated purchasers





None.





Use of
Proceeds





None




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 September 30, 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:
      November 18, 2009
              By:
              /s/  Dingliang
      KuangName:
              Dingliang
      KuangTitle:
              President,
      Chief Executive Officer,
                Treasurer
      and Director(Principal
      Executive, Financial and
                Accounting
      Officer)


19