UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





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





For the
quarter ended September 30, 2010





 ̈ 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 xNo o





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was


required
to submit and post such files). 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
                x(Do
      not check if a smaller reporting company)




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





Indicate
the number of shares outstanding as of November 18,
2010:  123,484,043







TABLE OF
CONTENTS




PART
      IItem
      1.  Financial Statements
              F-1Item
      2.  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations.
              3Forward-Looking
      Statements
              3Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk.
              15Item
      4.  Controls and Procedures.
              15PART
      II  OTHER INFORMATIONItem
      1.  Legal Proceedings.
              16Item
      2.  Unregistered Sales of Equity Securities and Use of
      Proceeds.
              16Item
      3.  Defaults Upon Senior Securities.
              17Item
      4.  Removed and Reserved
              17Item
      5.  Other Information.
              17Item
      6.  Exhibits
              17




1





PART
I




Item
1.  Financial Statements




FRANKLIN
TOWERS ENTERPRISES, INC. AND SUBSIDIARY





INDEX TO
FINANCIAL STATEMENTS





PageCondensed
      Consolidated Balance Sheetsas
      of September 30, 2010 (Unaudited) and December 31, 2009
                              F-1Condensed
      Consolidated Statements of Losses and Comprehensive Lossesfor
      the three months ended September 30, 2010 and 2009
    (Unaudited)
                              F-2Condensed
      Consolidated Statement of Stockholders’ Deficitfor
      the nine months September 30, 2010 (Unaudited) and the year ended December
      31, 2009
                              F-3Condensed
      Consolidated Statements of Cash Flowsfor
      the nine months ended September 30, 2010 and 2009
    (Unaudited)
                              F-4Notes
      to Condensed Consolidated Financial Statements (Unaudited)
                              F-5
      -
F-25




2





FRANKLIN TOWERS ENTERPRISES,
INC. AND SUBSIDIARY


CONDENSED CONSOLIDATED
BALANCE SHEETS





September 30,
                      
                      
                      December 31,2010
                      
                      
                      2009(Unaudited)ASSETSCurrent
      Assets:Cash
      and cash equivalents
                      
                      $
                      11,837
                      
                      
                      $
                      2,788,581Accounts
      receivable - net of allowance for doubtful accounts of $580 and $20,631 as
      of September 30, 2010 and December 31, 2009, respectively
                      
                      
                      28,436
                      
                      
                      
                      20,630Inventories
                      
                      
                      707,528
                      
                      
                      
                      1,441,685Prepaid
      costs and expenses
                      
                      
                      556,775
                      
                      
                      
                      135,314Other
      receivables
                      
                      
                      1,374,423
                      
                      
                      
                      21,232Restricted
      cash relating to bank acceptance payable
                      
                      
                      748,329
                      
                      
                      
                      -Total
      Current Assets
                      
                      
                      3,427,328
                      
                      
                      
                      4,407,442Property
      and Equipment, net
                      
                      
                      711,485
                      
                      
                      
                      796,144Other
      Assets:Deposits
                      
                      
                      -
                      
                      
                      
                      996,200Total
      Other Assets
                      
                      
                      -
                      
                      
                      
                      996,200TOTAL
      ASSETS
                      
                      $
                      4,138,813
                      
                      
                      $
                      6,199,786LIABILITIES
      AND STOCKHOLDERS' DEFICITCurrent
      Liabilities:Bank
      acceptance payable to related party
                      
                      $
                      1,494,700
                      
                      
                      $
                      -Convertible
      notes payable
                      
                      
                      2,792,175
                      
                      
                      
                      2,792,175Loans
      payable - short term
                      
                      
                      20,000
                      
                      
                      
                      2,217,500Accounts
      payable and accrued expenses
                      
                      
                      3,433,786
                      
                      
                      
                      3,260,596Customer
      prepaid
                      
                      
                      174,172
                      
                      
                      
                      536,344Loans
      payable - related parties
                      
                      
                      21,282
                      
                      
                      
                      19,391Total
      Current Liabilities
                      
                      
                      7,936,115
                      
                      
                      
                      8,826,006TOTAL
      LIABILITIES
                      
                      
                      7,936,115
                      
                      
                      
                      8,826,006Stockholders'
      Deficit:Preferred
      stock, $0.001 par value; 5,000,000 shares authorized, 0 shares issued and
      outstanding as of September 30, 2010 and December 31, 2009
                      
                      
                      -
                      
                      
                      
                      -Common
      stock, $.0001 par value; 1,250,000,000 shares authorized, 123,484,043
      shares issued and outstanding as of September 30, 2010 and December 31,
      2009, respectively
                      
                      
                      12,348
                      
                      
                      
                      12,348Additional
      paid-in capital
                      
                      
                      18,345,012
                      
                      
                      
                      18,345,012Accumulated
      deficit
                      
                      
                      (22,508,816
                      )
                      
                      
                      (21,296,442
                      )Accumulated
      other comprehensive income
                      
                      
                      354,154
                      
                      
                      
                      312,862Total
      Stockholders' Deficit
                      
                      
                      (3,797,302
                      )
                      
                      
                      (2,626,220
                      )TOTAL
      LIABILITIES AND STOCKHOLDERS' DEFICIT
                      
                      $
                      4,138,813
                      
                      
                      $
                      6,199,786





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 LOSSES AND COMPREHENSIVE LOSSES


(UNAUDITED)





Three Months Ended September
      30,
                
                
                Nine Months Ended September
    30,2010
                
                
                2009
                
                
                2010
                
                
                2009(Restated)
                
                
                
                
                
                (Restated)Net
      Sales
                
                $
                337,177
                
                
                $
                2,240,449
                
                
                $
                2,160,273
                
                
                $
                5,124,347Cost
      of Sales
                
                
                357,124
                
                
                
                1,647,072
                
                
                
                2,160,584
                
                
                
                4,298,110Gross
      Profit (Loss)
                
                
                (19,947
                )
                
                
                593,377
                
                
                
                (311
                )
                
                
                826,237Operating
      Expenses:Professional
      fees
                
                
                9,718
                
                
                
                14,018
                
                
                
                40,173
                
                
                
                48,012Depreciation
      and amortization
                
                
                9,028
                
                
                
                8,725
                
                
                
                29,223
                
                
                
                28,438Selling,
      general and administrative expenses
                
                
                59,374
                
                
                
                219,050
                
                
                
                310,914
                
                
                
                467,462Total
      Operating Expenses
                
                
                78,120
                
                
                
                241,793
                
                
                
                380,310
                
                
                
                543,912Loss
      From Operations
                
                
                (98,067
                )
                
                
                351,584
                
                
                
                (380,621
                )
                
                
                282,325Other
      Income (Expenses):Subsidy
      income (expense)
                
                
                (2,955
                )
                
                
                -
                
                
                
                170,656
                
                
                
                706,122Interest
      income
                
                
                908
                
                
                
                324
                
                
                
                3,129
                
                
                
                7,137Interest
      expense
                
                
                (272,888
                )
                
                
                (451,458
                )
                
                
                (1,005,538
                )
                
                
                (1,367,867
                )Total
      Other (Expense)
                
                
                (274,935
                )
                
                
                (451,134
                )
                
                
                (831,753
                )
                
                
                (654,608
                )Loss
      Before Income Tax
                
                
                (373,002
                )
                
                
                (99,550
                )
                
                
                (1,212,374
                )
                
                
                (372,283
                )Provision
      for Income Tax
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      Loss
                
                $
                (373,002
                )
                
                $
                (99,550
                )
                
                $
                (1,212,374
                )
                
                $
                (372,283
                )Net
      Loss per Share - Basic and Diluted
                
                $
                (0.00
                )
                
                $
                (0.00
                )
                
                $
                (0.01
                )
                
                $
                (0.00
                )Weighted
      Average Shares Outstanding - Basic and Diluted
                
                
                123,484,043
                
                
                
                123,484,043
                
                
                
                123,484,043
                
                
                
                123,484,043Comprehensive
      Loss:Net
      loss
                
                $
                (373,002
                )
                
                $
                (99,550
                )
                
                $
                (1,212,374
                )
                
                $
                (372,283
                )Foreign
      currency translation adjustment
                
                
                36,423
                
                
                
                2,062
                
                
                
                41,292
                
                
                
                (912
                )Comprehensive
      Loss
                
                $
                (336,579
                )
                
                $
                (97,488
                )
                
                $
                (1,171,082
                )
                
                $
                (373,195
                )





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, 2010 (UNAUDITED) AND THE YEAR ENDED DECEMBER 31,
2009





Preferred Stock
                  
                  
                  Common Stock
                  
                  
                  Additional
                  
                  
                  
                  
                  
                  Accumulated
                    OtherShares
                  
                  
                  Amount
                  
                  
                  Shares
                  
                  
                  Amount
                  
                  
                  Paid - in
                    Capital
                  
                  
                  Accumulated
                    Deficit
                  
                  
                  Comprehensive
                    Income
                  
                  
                  TotalBalance
      - December 31, 2008 (Restated)
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  123,484,043
                  
                  
                  $
                  12,348
                  
                  
                  $
                  18,345,012
                  
                  
                  $
                  (20,022,170
                  )
                  
                  $
                  316,294
                  
                  
                  $
                  (1,348,516
                  )Net
      loss for the year ended December 31, 2009 (Restated)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,274,272
                  )
                  
                  
                  -
                  
                  
                  
                  (1,274,272
                  )Foreign
      currency translation adjustment
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,432
                  )
                  
                  
                  (3,432
                  )Balance
      - December 31, 2009 (Restated)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  123,484,043
                  
                  
                  
                  12,348
                  
                  
                  
                  18,345,012
                  
                  
                  
                  (21,296,442
                  )
                  
                  
                  312,862
                  
                  
                  
                  (2,626,220
                  )Net
      loss for the nine months ended September 30, 2010
    (Unaudited)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,212,374
                  )
                  
                  
                  -
                  
                  
                  
                  (1,212,374
                  )Foreign
      currency translation adjustment (Unaudited)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  41,292
                  
                  
                  
                  41,292Balance
      - September 30, 2010 (Unaudited)
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  123,484,043
                  
                  
                  $
                  12,348
                  
                  
                  $
                  18,345,012
                  
                  
                  $
                  (22,508,816
                  )
                  
                  $
                  354,154
                  
                  
                  $
                  (3,797,302
                  )





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


(UNAUDITED)





Nine Months Ended September 30,2010
                        
                        
                        2009(Unaudited)
                        
                        
                        (Restated)Cash
      Flows from Operating Activities:Net
      Loss
                        
                        $
                        (1,212,374
                        )
                        
                        $
                        (372,283
                        )Adjustments
      to Reconcile Net Loss to NetCash
      Provided by (Used in) Operating Activities:Interest
      earned on restricted cash
                        
                        
                        (979
                        )
                        
                        
                        -Depreciation
      expense
                        
                        
                        79,310
                        
                        
                        
                        68,390(Reduction
      in) provision for doubtful accounts
                        
                        
                        (35,041
                        )
                        
                        
                        18,537Accrued
      convertible notes interest and penalties
                        
                        
                        816,711
                        
                        
                        
                        816,711Changes
      in operating assets and liabilities:Decrease
      in accounts receivable
                        
                        
                        12,245
                        
                        
                        
                        1,753Decrease
      in inventories
                        
                        
                        734,157
                        
                        
                        
                        1,140,524(Increase)
      in prepaid costs and expenses
                        
                        
                        (421,461
                        )
                        
                        
                        (633,439
                        )(Decrease)
      increase in accounts payable and accrued liabilities
                        
                        
                        (643,521
                        )
                        
                        
                        235,704(Decrease)
      increase in customer prepaid
                        
                        
                        (362,172
                        )
                        
                        
                        939,313Net
      Cash (Used in) Provided by Operating Activities
                        
                        
                        (1,033,125
                        )
                        
                        
                        2,215,210Cash
      Flows from Investing Activities:Capital
      expenditures
                        
                        
                        -
                        
                        
                        
                        (5,275
                        )Proceeds
      from sale of property
                        
                        
                        19,704
                        
                        
                        
                        -Acquisition
      deposits paid
                        
                        
                        -
                        
                        
                        
                        (512,750
                        )Advance
      to other entities
                        
                        
                        (30,719
                        )
                        
                        
                        (4,298,998
                        )Advance
      made by Company to related parties
                        
                        
                        (575,122
                        )
                        
                        
                        -Net
      Cash (Used in) Investing Activities
                        
                        
                        (586,137
                        )
                        
                        
                        (4,817,023
                        )Cash
      Flows from Financing Activities:Proceeds
      of short term loan later offset in lieu of return of acquisition
      deposit
                        
                        
                        995,625
                        
                        
                        
                        -(Repayment)
      proceeds of short term loans
                        
                        
                        (2,197,500
                        )
                        
                        
                        1,146,701Deposit
      made by Company into restricted cash account to secure bank acceptances
      payable
                        
                        
                        (747,350
                        )
                        
                        
                        -Advance
      from related party to fund bank acceptances payable
                        
                        
                        747,350
                        
                        
                        
                        -Advance
      from other related party
                        
                        
                        1,891
                        
                        
                        
                        1,465,000Net
      Cash (Used in) Provided by Financing Activities
                        
                        
                        (1,199,984
                        )
                        
                        
                        2,611,701Effect
      of Exchange Rate Changes on Cash and Cash Equivalents
                        
                        
                        42,502
                        
                        
                        
                        (973
                        )Net
      (Decrease) Increase in Cash and Cash Equivalents
                        
                        
                        (2,776,744
                        )
                        
                        
                        8,915Cash
      and Cash Equivalents - Beginning of Period
                        
                        
                        2,788,581
                        
                        
                        
                        61,867Cash
      and Cash Equivalents - End of Period
                        
                        $
                        11,837
                        
                        
                        $
                        70,782Supplemental
      Cash Flow Information:Interest
      paid
                        
                        $
                        186,874
                        
                        
                        $
                        549,202Income
      taxes paid
                        
                        $
                        -
                        
                        
                        $
                        -Noncash
      Investing and Financing ActivitiesLoans
      payable - short term authorized by lender as offset for acquisition
      deposit (Note 9)
                        
                        $
                        995,625
                        
                        
                        $
                        -





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 was 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 was recorded as a
recapitalization of Qiluo pursuant to which Qiluo was treated as the continuing
entity although Franklin was the legal acquirer. Accordingly, the Company’s
historical financial statements were 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”. On November 4, 2009, the Company renamed to current
name “Chongqing Fuling Qiluo Cocoon Silk Company, Ltd.”.





After the
acquisition, Franklin focused on the production and sale of silk and silk
products. The Company started its test production at the end of June 2007 and
commenced operations from the third quarter of 2007.





Going
Concern





The
Company started its test production at the end of June 2007 and commenced its
manufacturing operations during the third quarter of 2007. The Company has
incurred a net loss of $1,212,374 and $372,283 for the nine months ended
September 30, 2010 and 2009, respectively.  The Company has an
accumulated deficit of $22,508,816 at September 30, 2010.  Substantial
portions of the losses are attributable to common stock issued for consulting
services, 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 $4,508,787 and $4,418,564 as of September 30, 2010 and December 31, 2009,
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, 2010, the unpaid convertible notes payable balance is
$2,792,175; unpaid accrued interest is $693,761; and unpaid accrued liquidated
damages penalty and default penalty are $2,296,003.





In an
effort to restructure the Notes and related accrued interest and liquidated
damages due, the Company circulated an Outline of Proposed Restructuring (the
“Term Sheet’) dated April 14, 2010 to the note holders which was agreed to and
signed by 9 of 11 note holders (see Note 12). The 9 note holders who signed the
Term Sheet constituted $2,300,000 of the original $3,300,000 total principal
balance of the convertible Notes. Although the Term Sheet provided that the
parties reserved the right to approve all the terms of the definitive documents,
definitive documents have not yet been prepared. Accordingly, the Company has
not as yet recognized any reduction of the balance of the respective Notes and
related liabilities and consequent gain from this proposed restructuring. Also,
the Company has continued to accrue interest expense and liquidated damages
penalties in accordance with the terms of the original Notes. The Company did
not make any scheduled interest payment and loan repayment per the Term Sheet,
nor has it had further discussion with the investors.


F-5





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
2008, the Company received proceeds from a significant shareholder in the amount
of $1,722,656 as a repayment of nonreciprocal funds transferred to this
shareholder during 2007. The Company also received proceeds of short term loans
totaling $351,206 and $955,209 during 2009 and 2008, respectively.





In May
2010, the Fulin Municipal Government revoked the Company’s right to operate the
Zhengzhong assets. The loan of RMB 6,750,000 ($995,625), which the Company
received from Chongqing Fulin State-Owned-Assets Management Co. (“Fulin Asset
Management”) during the first quarter 2010, was offset against deposits
receivable from Zhengzhong in the same aggregate amount based on Fulin Asset
Management’s authorization to do so.





The
Company has undertaken further steps as part of a plan to improve operations.
The Company planned to reduce its cost of goods sold by purchasing more of its
main raw material – cocoon 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 9), thereby helping the Company to reduce its raw material - cocoon
cost. However, the Fulin Municipal Government revoked the Company’s right to
operate the “Zhengzhong” assets in May 2010. The Company has to purchase cocoon
from third parties with increased price. This will have a material impact on the
profitability of the Company. There can be no assurance that the Company will be
able to re-obtain the rights.





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 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.





NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Basis of
presentation





The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States (“US
GAAP”).





Principles of
Consolidation





The
accompanying condensed 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.


F-6





Use of
Estimates





The
preparation of 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, restricted cash relating to bank acceptance
payable, accounts payable and accrued liabilities, short term loans and
convertible notes.  The fair value of these financial instruments
approximate their carrying amounts reported in the 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 ($0.14947 and $0.14650 at September 30, 2010 and
December 31, 2009, respectively).  The revenues and expenses were
translated into United States dollars at average exchange rates for the
periods.  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.  There were no material foreign
currency transaction gains or losses for the nine  months ended
September 30, 2010 and 2009.





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.





Intangible and Other
Long-Lived Assets, Net





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.


F-7




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”) 718, “Compensation- Stock
Compensation”.





In
addition to requiring supplemental disclosures, FASB ASC 718, Compensation–Stock Compensation,
addresses the accounting for share-based payment transactions in which a company
receives goods or services in exchange for (a) equity instruments of the company
or (b) liabilities that are based on the fair value of the company’s equity
instruments or that may be settled by the issuance of such equity instruments.
FASB ASC 718 focuses primarily on accounting for transactions in which a company
obtains employee services in share-based payment transactions.





References
to the issuances of restricted stock refer to stock of a public company issued
in private placement transactions to individuals who are eligible to sell all or
some of their shares of restricted Common Stock pursuant to Rule 144,
promulgated under the Securities Act of 1933 (“Rule 144”), subject to certain
limitations. In general, pursuant to Rule 144, a stockholder who is not an
affiliate and has satisfied a six-month holding period may sell all of his
restricted stock without restriction, provided that the Company has current
information publicly available. Rule 144 also permits, under certain
circumstances, the sale of restricted stock, without any limitations, by a
non-affiliate of the Company that has satisfied a one-year holding
period.





Advertising





Advertising
costs are expensed as incurred. The Company did not incur significant
advertising costs for the nine months ended September 30, 2010 and
2009.





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





Research
and development costs related to both present and future products are expensed
as incurred. The Company did not incur significant research and development
costs for the nine months ended September 30, 2010 and 2009.





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 losses incurred
during the periods presented. 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 common share is the same as basic loss
per share for the periods presented, as the effect of the inclusion of
potentially dilutive securities ($2,792,175 convertible debt convertible into
11,168,700 and 11,168,700 shares and warrants exercisable into 30,360,000 and
30,360,000 shares, for the nine months ended September 30, 2010 and 2009,
respectively), was anti-dilutive.





Statement of Cash
Flows





In
accordance with ASC Topic 230, “Statement of Cash Flows,” cash flows from the
Company’s operations are calculated based upon the local currencies using the
average translation rates. As a result, amounts related to assets and
liabilities reported on the consolidated statements of cash flows will not
necessarily agree with changes in the corresponding balances on the consolidated
balance sheets.





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.





Recently Adopted Accounting
Standards




In
February 2010, the Company adopted an amendment to previously adopted accounting
guidance on subsequent event disclosure, which established standards of
accounting for and disclosure of events or transactions that occur after the
balance sheet date but before financial statements are issued or available to be
issued. Under the amended guidance, the Company is no longer required to
disclose the date through which subsequent events have been evaluated. The
adoption of this requirement did not have a material impact on the Company’s
financial condition or results of operations.





We
adopted the accounting principles established by ASU 2009-17, Consolidations: Improvements to
Financial Reporting by Enterprises Involved with Variable Interest
Entities, effective January 1, 2010. This ASU requires an ongoing
reassessment and replaces the quantitative-based risks and rewards calculation
for determining which reporting entity, if any, has a controlling financial
interest in a variable interest entity (“VIE”) with a primarily qualitative
analysis. The qualitative analysis is based on identifying the party that has
the power to direct the activities that most significantly impact the VIE’s
economic performance (the “power criterion”) and the obligation to absorb losses
from or the right to receive benefits of the VIE that could potentially be
significant to the VIE (the “losses/benefit criterion”). The party that meets
both these criteria is deemed to have a controlling financial interest. The
party with the controlling financial interest is considered to be the primary
beneficiary and as a result is required to consolidate the VIE.  The
adoption of this new guidance did not have a material effect on our financial
statements.


F-9





Recently Issued Accounting
Standards





In
January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance
which expands the required disclosures about fair value measurements. This
guidance requires disclosures about transfers of investments between levels in
the fair value hierarchy and disclosures relating to the reconciliation of fair
value measurements using significant unobservable inputs (level 3 investments).
This guidance is effective for the Company as of January 1, 2011. The
adoption of this guidance will not have a material impact on its financial
condition or results of operations.





In April
2010, the FASB issued ASU 2010-13, “Compensation-Stock Compensation (Topic 718)
- Effect of Denominating the Exercise Price of a Share-Based Payment Award in
the Currency of the Market in Which the Underlying Equity Security Trades - a
consensus of the FASB Emerging Issues Task Force,” or ASU 2010-13. ASU 2010-13
provides amendments to Topic 718 to clarify that an employee share-based payment
award with an exercise price denominated in the currency of a market in which a
substantial portion of the entity’s equity securities trades should not be
considered a condition that is not a market, performance, or service condition.
Therefore, an entity would not classify such an award as a liability if it
otherwise qualifies as equity. The amendments in this update do not expand the
recurring disclosures required by Topic 718. Disclosures currently required
under Topic 718 are applicable to a share-based payment award, including the
nature and the term of share-based payment arrangements. The amendments in this
update are effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2010. The Company is currently
evaluating the impact of the adoption of ASU 2010-13 on its financial
statements.





Certain
other accounting pronouncements were 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
3 – INTERIM FINANCIAL STATEMENTS





The
unaudited condensed consolidated financial statements as of September 30, 2010
and for the three and nine months ended September 30, 2010 and 2009 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, 2010 and the results of operations and cash flows
for the three and nine month period ended September 30, 2010 and 2009. The
financial data and other information disclosed in these notes to the interim
financial statements related to these periods are unaudited. The results for the
three and nine month period ended September 30, 2010 is not necessarily
indicative of the results to be expected for any subsequent quarter of the
entire year ending December 31, 2010. The balance sheet at December 31, 2009 has
been derived from the audited consolidated financial statements at that
date.





Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted pursuant to the Securities and
Exchange Commission’s rules and regulations. These unaudited condensed
consolidated financial statements should be read in conjunction with our audited
consolidated financial statements and notes thereto for the year ended December
31, 2009 included in our Form 10 –K filed April 15, 2010.


F-10





NOTE
4 - INVENTORIES





Inventories
at September 30, 2010 and December 31, 2009 consist of the
following:





September 30,
                    
                    
                    December 31,2010
                    
                    
                    2009(Unaudited)Finished
      Goods
                    
                    $
                    25,316
                    
                    
                    $
                    486,334Processed
      cocoons
                    
                    
                    652,780
                    
                    
                    
                    772,211Raw
      Materials
                    
                    
                    71,469
                    
                    
                    
                    154,971Work
      in Process
                    
                    
                    14,804
                    
                    
                    
                    28,169Reserve
      for obsolete inventory
                    
                    
                    (56,841
                    )
                    
                    
                    -Total
                    
                    $
                    707,528
                    
                    
                    $
                    1,441,685




Finished
goods consist of those silks and by products available for sale. The valuation
allowance for inventory loss at September 30, 2010 and December 31, 2009 was
$56,841 and $0, respectively.





NOTE
5 – PREPAID COSTS AND EXPENSES





Prepaid
costs and expenses at September 30, 2010 and December 31, 2009 consist
of:





September 30,
                      2010
                    
                    
                    December 31,
                      2009(Unaudited)Advances
      to personnel for future overhead costs
                    
                    $
                    83,982
                    
                    
                    $
                    14,245Advances
      to vendors for future overhead costs
                    
                    
                    472,793
                    
                    
                    
                    118,339Other
                    
                    
                    -
                    
                    
                    
                    2,730Total
                    
                    $
                    556,775
                    
                    
                    $
                    135,314




NOTE
6 – OTHER RECEIVABLES





Other
receivables at September 30, 2010 and December 31, 2009 consist of:





September30,
                      2010
                    
                    
                    December31,
                      2009(Unaudited)Chongqing
      Guojing Silk Company, Ltd.
                    
                    $
                    1,322,472
                    
                    
                    $
                    -Chongqing
      Aikekaer Paint Co., Ltd.
                    
                    
                    49,166
                    
                    
                    
                    21,232Chongqing
      First Capital Investment Co., Ltd.
                    
                    
                    2,785
                    
                    
                    
                    -Total
                    
                    $
                    1,374,423
                    
                    
                    $
                    21,232





As of
September 30, 2010, the net amount that Qiluo loaned to Chongqing Guojing Silk
Company, Ltd. (“Guojing Silk”), an entity that has pledged its assets as
collateral for the Company’s bank borrowing (see Notes 7 and 10) was $1,322,472.
The receivable bears interest at 10% per annum and is due by December 31, 2010.
Guojing Silk is controlled by the brother-in-law of Mr. Kuang, indirect majority
stockholder and chief executive officer of the Company.


F-11





The
receivables from Chonqing Aikekaer Paint Co., Ltd. and Chongqing First Capital
Investment Co., Ltd. are interest free and due on demand.





NOTE
7 - RESTRICTED CASH RELATING TO BANK ACCEPTANCE AND BANK ACCEPTANCE PAYABLE TO
RELATED PARTY





On May
13, 2010, Qiluo borrowed $747,350 (5,000,000 RMB) from Guojing Silk and
simultaneously delivered a bank acceptance (from Chongqing Shan Xia Bank) for
$1,494,700 (10,000,000 RMB) to Guojing Silk due by November 13, 2010. The
Company deposited $747,350 into the Shan Xia Bank to secure the payment of the
bank acceptance. The use of the $747,350 deposit was not permitted while the
bank acceptance was outstanding.  Accordingly, $747,350 together with
interest income of $979 was reported under the caption “restricted cash relating
to bank acceptance payable” in the current assets and $1,494,700 was reported
under the caption “bank acceptance payable to related party” in the current
liabilities, respectively.  The purpose of this arrangement was to
encourage and nurture the Company’s relationship with Chongqing Shan Xia Bank.
As
discussed in Note 22, the bank acceptance was repaid on November 15, 2010 and
replaced by another due in 60 days in the same amount on November 15, 2010. The
restricted cash of $748,329 was released to the Company on November 15, 2010
coincident to the repayment of the acceptance obligation, and a similar amount
was deposited when the new acceptance was established on November 16,
2010.




NOTE
8 - PROPERTY AND EQUIPMENT





Property
and equipment at September 30, 2010 and December 31, 2009 is summarized as
follows:





Fixed Assets
                          
                          Estimated
                            Useful Life
                          
                          
                          September 30,
                            2010
                          
                          
                          December 31,
                            2009(Unaudited)Production
      Equipment
                          
                          10
                          
                          
                          $
                          740,883
                          
                          
                          $
                          726,161Auxiliary
      Equipment
                          
                          10
                          
                          
                          
                          7,085
                          
                          
                          
                          6,944Office
      Equipment
                          
                          3-5
                          
                          
                          
                          27,436
                          
                          
                          
                          26,891Automobiles
                          
                          5
                          
                          
                          
                          127,050
                          
                          
                          
                          124,525Furniture
      and Fixtures
                          
                          5-7
                          
                          
                          
                          37,348
                          
                          
                          
                          36,606Construction
      in progress
                          
                          
                          
                          
                          
                          94,275
                          
                          
                          
                          112,1061,034,077
                          
                          
                          
                          1,033,233Less:
      Accumulated Depreciation
                          
                          
                          
                          
                          
                          322,592
                          
                          
                          
                          237,089$
                          711,485
                          
                          
                          $
                          796,144





Depreciation
expense was $79,310 and $68,390 for the nine months ended September 30, 2010 and
2009, respectively, of which $50,087 and $39,952 was included in cost of
sales.





In
January 2010, the Company returned unusable materials (included in construction
in progress at December 31, 2009) at their cost of $19,704.


F-12





NOTE
9 - DEPOSITS





Deposits
at September 30, 2010 and December 31, 2009 consist of:





September 30,
                      2010
                    
                    
                    December 31,
                      2009(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
                    
                    
                    549,393
                    
                    
                    
                    549,393Offset
      of loan from Chongqing Fulin State-Owned Assets
      Management   (see Note 10) against amount due from
      Zhengzhong
                    
                    
                    (995,625
                    )
                    
                    
                    -Foreign
      currency translation adjustment
                    
                    
                    27,633
                    
                    
                    
                    28,208Total
                    
                    $
                    -
                    
                    
                    $
                    996,200





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), of which 6,800,000 RMB ($996,200) was paid through December 31,
2009. In February 2009, the due date of the remaining 3,574,800 RMB ($523,708)
due was extended to September 2009.  In May 2010, the Fulin Municipal
Government revoked the Company’s right to operate the Zhengzhong assets. The
loan of RMB 6,750,000 ($995,625), which the Company received from Chongqing
Fulin State-Owned-Assets Management Co. (“Fulin Asset Management”) during the
first quarter 2010, was offset against deposits receivable from Zhengzhong in
the same aggregate amount based on Fulin Asset Management’s authorization to do
so.





The
Company is currently in negotiation with the Fulin Government for the return of
the rights related to the Zhengzhong cocoon station operations. However, there
can be no assurance that the Company will be able to re-obtain the
right.





F-13





NOTE
10 - LOANS PAYABLE – SHORT TERM





Loans payable consist of:
                    
                    September 30,
                      2010
                    
                    
                    December 31,
                      2009((Unaudited)Qiluo
      loans payable to Chongqing Shan Xia Bank30,000,000
      RMB, interest at 10% per annum, due January 19, 2010
                    
                    $
                    -
                    
                    
                    $
                    4,395,000Less:
      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
                    )25,000,000
      RMB, interest at 7.965% per annum, due January 29, 2011
                    
                    
                    3,687,500
                    
                    
                    
                    -5,000,000
      RMB, interest at 7.965% per annum, due February 9, 2011
                    
                    
                    737,500
                    
                    
                    
                    -Less:
      used by Mr. Chen, Wensheng, 3,000,000 RMB
                    
                    
                    (442,500
                    )
                    
                    
                    -Less:
      used by Mr. Zhong, Songbai, 2,000,000 RMB
                    
                    
                    (295,000
                    )
                    
                    
                    -Less:
      used by Guojing Silk, 20,000,000 RMB
                    
                    
                    (2,950,000
                    )
                    
                    
                    -Less:
      used by Mr. Jingshi Kuang, 5,000,000 RMB
                    
                    
                    (737,500
                    )
                    
                    
                    -Qiluo
      loans payable to Chongqing Shan Xia Bank, net
                    
                    
                    -
                    
                    
                    
                    2,197,500Franklin
      loans payable to two individualsinterest
      at 8% per  annum, due April 24, 2008 (past due)
                    
                    
                    20,000
                    
                    
                    
                    20,000Total
                    
                    $
                    20,000
                    
                    
                    $
                    2,217,500





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
December 31, 2009 exchange rate) from Chongqing Shan Xia Bank. The loan was
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.





On
January 22, 2010, the Company jointly with Chongqing Guojing Silk Company, Ltd.,
Mr. Wensheng Chen and Mr. Songbai Zhong, returned RMB 30,000,000 ($4,395,000) to
Shanxia Bank.





Pursuant
to a Loan Agreement that provides for a 40,000,000 RMB ($5,900,000) Line of
Credit that expires November 26, 2011 (30,000,000 RMB - $4,425,000 for working
capital; and 10,000,000 RMB - $1,475,000 acceptance financing/requiring 50%
collateral security) on January 29, 2010, the Company jointly with Chongqing
Guojing Silk Company, Ltd., Mr. Wensheng Chen, Mr. Songbai Zhong and Mr. Jingshi
Kuang, obtained a short term secured loan of RMB 25,000,000 ($3,662,500) from
Shanxia Bank. The loan bears interest at 7.965% per annum payable monthly. The
loan provides for a 50% penalty increase in the interest rate on a daily basis
while the Company is in default on payment of principal. It also provides for a
100% penalty increase in interest rate if the loan proceeds are not used for the
purpose stated in the loan. The maturity date of this loan is January 29, 2011,
and it is secured by the assets of Guojing Silk and real estate of Mr. Wenshen
Chen, Mr. Songbai Song and Mr. Jingshi Kuang.





On
February 9, 2010, the Company jointly with Chongqing Guojing Silk Company, Ltd.,
Mr. Wensheng Chen Mr. Songbai Zhong and Mr. Jingshi Kuang, obtained a short term
loan of RMB 5,000,000 ($732,500) for working capital. The loan bears interest at
7.965% per annum payable monthly. The loan provides for a 50% penalty increase
in the interest rate on a daily basis while the Company is in default on payment
of principal. It also provides for a 100% penalty increase in interest rate if
the loan proceeds are not used for the purpose stated in the loan. The maturity
date of this loan is February 9, 2011, and it is secured by the assets of
Guojing Silk and real estate of Mr. Wenshen Chen, Mr. Songbai Song and Mr.
Jingshi Kuang.


F-14





During
the second quarter 2010, the Company reached agreement with Guojing Silk, in
principle, to transfer $1,475,000 (10,000,000 RMB), its remaining allocated
portion of the line of credit, effective July 1, 2010 to Guojing. The purpose of
making the transfer was due to significant reductions in the Company’s business
caused by a recession in the Silk industry. According to the terms of the Loan
Agreement, the Company remains primarily responsible to the lender for the loans
taken under the Line of Credit, which aggregated 40,000,000 RMB ($5,989,600) at
September 30, 2010, no matter how the proceeds of the loans have been allocated
among the Company and the other parties/guarantors of the loan.





During
the first quarter 2010, the Company received a RMB 6,750,000 ($988,875) loan
from Chongqing Fulin State-Owned-Assets Management Co. The loan was interest
free and due by December 31, 2010. In May 2010, the Fulin Municipal Government
revoked the Company’s right to operate the Zhengzhong assets. The loan of RMB
6,750,000 ($995,625) was offset against deposits receivable from Zhengzhong in
the same aggregate amount based on Fulin Asset Management’s authorization to do
so in the second quarter of 2010.





As of
September 30, 2010 and December 31, 2009, the accrued interest payable for short
term loans totaled $7,220 and $22,634, respectively, which was included in
accounts payable and accrued expenses.





NOTE
11 – LOANS PAYABLE – RELATED PARTIES





Loans
      payable – related parties consist of:
                      
                      September 30,
                        2010
                      
                      
                      December 31,
                        2009(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
                      
                      
                      
                      7,158Due
      to Xin Shengxiang, non-interest bearing, due on demand
                      
                      
                      1,891
                      
                      
                      
                      -Total
                      
                      $
                      21,282
                      
                      
                      $
                      19,391





The
accrued interest payable to related party was $4,008 and $3,272 as of September
30, 2010 and December 31, 2009, respectively.





NOTE
12 - CONVERTIBLE NOTES PAYABLE





September
      30,
                    
                    
                    December
      31,Convertible
      notes payable, net consist of:
                    
                    2010
                    
                    
                    2009(Unaudited)Convertible
      notes - initial face amount
                    
                    $
                    3,300,000
                    
                    
                    $
                    3,300,000Less
      unamortized debt discounts:Discount
      on relative fair value of warrants
                    
                    
                    (2,903,247
                    )
                    
                    
                    (2,903,247
                    )Discount
      on beneficial conversion feature
                    
                    
                    (396,753
                    )
                    
                    
                    (396,753
                    )Less
      accumulated amortization
                    
                    
                    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




F-15





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 commenced on March 12, 2008 and all accrued but
unpaid interest and any other amounts due thereon was 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
contained default events which, if triggered and not timely cured (if curable),
would result in a default interest rate of 15% per annum. The Notes also contain
full ratchet anti-dilution 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 was triggered after March 12, 2008
as well as “full ratchet” anti-dilution 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 was
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 Company withdrew the
registration statement on Form S-1 on August 27, 2010.





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
were 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.


F-16





The
Company commenced the repayment of the convertible notes and interest on March
12, 2008 and paid $26,375 in cash to three of the Purchasers, which represented
accrued interest of $12,500 and repayment of principal of $13,875 due on the
convertible promissory notes. Also, the Company issued a total of 32,354,043
shares to seven of the Purchasers during the six months ended June 30, 2008,
which represented accrued interest of $174,912 and repayment of principal of
$493,950. The Company did not make any repayments during the six months ended
December 31, 2008 due to its financing difficulties. The Company has been in
default to all eleven investors (see Note 19) since then. 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 during the year ended December 31, 2008.





In an
effort to restructure the Notes and related accrued interest and liquidated
damages due, the Company circulated an Outline of Proposed Restructuring (the
“Term Sheet’) dated April 14, 2010 to the note holders which was agreed to and
signed by 9 of 11 note holders. The 9 note holders who signed the Term Sheet
constituted $2,300,000 of the original $3,300,000 total principal balance of the
convertible Notes. Although the Term Sheet provided that the parties reserved
the right to approve all the terms of the definitive documents, definitive
documents have not yet been prepared. Accordingly, the Company has not as yet
recognized any reduction of the balance of the respective Notes and related
liabilities and consequent gain from this proposed restructuring. Also, the
Company has continued to accrue interest expense and liquidated damages
penalties in accordance with the terms of the original Notes.





Among
other things, the Term Sheet provides for the reduction of the balance of the
Notes ($2,792,175 at September 30, 2010) to $2,500,000 and the waiver of the
related accrued interest ($693,761 at September 30, 2010) and penalties
($2,296,003 at September 30, 2010). The restated Notes are to bear interest at
6%, payable monthly in cash or, at the option of the Company, in registered
common stock valued at a 20% discount to the market price. The principal of the
restated Notes are to be repaid in 21 monthly installments commencing 3 months
following the amendment, payable in cash or, at the option of the Company, in
registered common stock valued at a 20% discount to the market price. Also, the
Term Sheet provides for the reduction of the exercise price of the 13,200,000
class A Common Stock Purchase Warrants from $0.50 per share to $0.10 per share.
If effectuated, the gain from the restructuring will be reduced by any increase
in the fair value of the warrants. The Company did not make any scheduled
repayment per the Term Sheet, nor has it had further discussion with the
investors.





NOTE
13 - 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 therefore, 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. Excluding the
18,000,000 shares of common stock, there were 12,250,000 shares of common stock
outstanding in the preexisting public entity prior to the Share Purchase
Agreement that remained outstanding in the newly constituted
company.


F-17





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 there under. The shares issued in consideration for services
rendered were valued at $9,200,000, based on the price of our stock on the date
of issuance.





The
Company issued a total of 32,354,043 shares to seven of the Purchasers as
repayment of loan and loan interest during the six months ended June 30, 2008,
pursuant to the terms of the Notes (see Note 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
14 - PREFERRED STOCK





On June
18, 2007, the Company designated a series of Preferred Stock known as the
“Series A Convertible Preferred Stock” (the “Series A Preferred Stock”) by
filing a Certificate of Designation with the Secretary of State of
Nevada.  The number of shares constituting such Series A Preferred
Stock was designated to be 5,000,000 shares, par value $0.001 per
share.  Pursuant to the Certificate of Designation, the principal
rights, preferences, powers, limitations and restrictions of the Series A
Preferred Stock are as follows:





Each
share of Series A Preferred Stock is convertible, at the option of the holder
thereof, without payment of additional consideration, into 10.576 shares of the
Company’s common stock.  Holders of Series A Preferred Stock shall be
entitled to vote, together with holders of common stock as a single class, on
all matters upon which stockholders of the Company are entitled to vote, with
each share of Series A Preferred Stock having one vote.  The Series A
Preferred Stock shall rank senior to the common stock.  In the event
of any liquidation, dissolution or winding up of the Company, the holders of
Series A Preferred Stock shall be entitled to receive, prior and in preference
to any distribution of any of the assets of the Company to the holders of the
common stock of the Company and any other issue of stock, should there be any,
by reason of their ownership thereof, an amount per share equal to $0.01 per
each share of Series A Preferred Stock owned by such shareholder plus any
declared and unpaid dividends on the Series A Preferred Stock.





On
December 10, 2007, the Company issued an aggregate of 52,880,000 shares of
common stock to complete the conversion of the 5,000,000 shares of Series A
Preferred Stock then outstanding.


F-18





NOTE
15 - 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, 2010 (Unaudited),December 31, 2009  and
      2008
                              
                              
                              
                              
                              30,360,000
                              
                              
                              $
                              0.68




Warrants
outstanding and exercisable by price range as of September 30, 2010
are:





Warrants Outstanding
                                                                        
                                                                        
                                                                        Warrants ExercisableExercise
                                                                          Price
                                                                        
                                                                        
                                                                        Number
                                                                          Outstanding
                                                                        
                                                                        
                                                                        WeightedAverage
                                                                          Remaining
                                                                          Contractual
                                                                          Life in Years*
                                                                        
                                                                        
                                                                        Weighted
                                                                          Average
                                                                          Exercise
                                                                          Price
                                                                        
                                                                        
                                                                        Number
                                                                          Exercisable
                                                                        
                                                                        
                                                                        Weighted
                                                                          Average
                                                                          Exercise
                                                                          Price$
                                                                        0.25
                                                                        
                                                                        
                                                                        
                                                                        3,960,000
                                                                        
                                                                        
                                                                        
                                                                        5.00
                                                                        
                                                                        
                                                                        $
                                                                        0.25
                                                                        
                                                                        
                                                                        
                                                                        3,960,000
                                                                        
                                                                        
                                                                        $
                                                                        0.25$
                                                                        0.50
                                                                        
                                                                        
                                                                        
                                                                        13,200,000
                                                                        
                                                                        
                                                                        
                                                                        5.00
                                                                        
                                                                        
                                                                        
                                                                        0.50
                                                                        
                                                                        
                                                                        
                                                                        13,200,000
                                                                        
                                                                        
                                                                        
                                                                        0.50$
                                                                        1.00
                                                                        
                                                                        
                                                                        
                                                                        13,200,000
                                                                        
                                                                        
                                                                        
                                                                        5.00
                                                                        
                                                                        
                                                                        
                                                                        1.00
                                                                        
                                                                        
                                                                        
                                                                        13,200,000
                                                                        
                                                                        
                                                                        
                                                                        1.0030,360,000
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        0.68
                                                                        
                                                                        
                                                                        
                                                                        30,360,000
                                                                        
                                                                        
                                                                        $
                                                                        0.68* Warrants expire 5 years after
      effective date of registration statement. The registration
      statement was filed
      on December 26, 2007 and was withdrawn on August 27,
      2010




The
significant assumptions used to determine the fair values of the warrants, using
a Black-Scholes option pricing model, were as follows:





Significant
      assumptions:Risk-free
      interest rate at grant date
                    
                    
                    4.11
                    %Expected
      stock price volatility
                    
                    
                    93.95
                    %Expected
      dividend payout
                    
                    
                    -Expected
      option life-years
                    
                    
                    5





NOTE
16 - RELATED PARTY TRANSACTION





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) from Chongqing
Shan Xia Bank. The loan was 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).


F-19





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 was not permitted while
the bank acceptance was 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 “Other receivable”. During
the fourth quarter of 2009, Guojing Silk repaid this receivable. As of December
31, 2009, the receivable from Guojing was $0.





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 was due by November 24, 2009 and bore interest at 21.24% per annum.
This loan was paid in full as of December 31, 2009.





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
was due by October 28, 2009 and bore interest at 19.44% per annum. This loan was
paid in full as of December 31, 2009.





On
January 22, 2010, the Company jointly with Chongqing Guojing Silk Company, Ltd.,
Mr. Wensheng Chen and Mr. Songbai Zhong, returned RMB 30,000,000 ($4,395,000) to
Shanxia Bank.





On
January 29, 2010, the Company jointly with Chongqing Guojing Silk Company, Ltd.,
Mr. Wensheng Chen, Mr. Songbai Zhong and Mr. Jingshi Kuang, obtained a short
term loan of RMB 25,000,000 ($3,662,500) from Shanxia Bank. The loan bears
interest at 7.965% per annum payable monthly. The maturity date of this loan is
January 29, 2011.





On
February 9, 2010, the Company jointly with Chongqing Guojing Silk Company, Ltd.,
Mr. Wensheng Chen, Mr. Songbai Zhong and Mr. Jingshi Kuang, obtained a short
term loan of RMB 5,000,000 ($732,500) for working capital. The loan bears
interest at 7.965% per annum payable monthly. The maturity date of this loan is
February 9, 2011.





On May
13, 2010, Qiluo borrowed $747,350 (5,000,000 RMB) from Guojing Silk and
simultaneously delivered a bank acceptance (from Chongqing Shan Xia Bank) for
$1,494,700 (10,000,000 RMB) to Guojing Silk due by November 13,
2010.





During
the second quarter 2010, the Company reached agreement with Guojing Silk, in
principle, to transfer $1,475,000 (10,000,000 RMB), its remaining allocated
portion of the line of credit from Shanxia Bank, effective July 1, 2010, to
Guojing Silk. The purpose of making the transfer was due to significant
reductions in the Company’s business caused by a recession in the Silk industry.
According to the terms of the Loan Agreement, the Company remains primarily
responsible to the lender for the loans taken under the Line of Credit, which
aggregated 40,000,000 RMB ($5,989,600) at September 30, 2010, no matter how the
proceeds of the loans have been allocated among the Company and the other
parties/guarantors of the loan.





During
the third quarter 2010, the Company received net proceeds of $121,585 from
Guojing Silk.





NOTE
17 - CONCENTRATION OF CREDIT RISK





Financial
instruments that potentially subject the Company to significant concentrations
of credit risk consist principally of cash and cash equivalents and accounts
receivable.





Qiluo
maintains cash balances in various banks in the People’s Republic of China.
Currently, no deposit insurance system has been set up in the People’s Republic
of China. Therefore, the Company will bear a risk if any of these banks become
insolvent. Qiluo’s uninsured cash balance was $760,166 and $2,788,581 as of
September 30, 2010 and December 31, 2009, respectively.


F-20





NOTE
18 - COMMITMENTS AND CONTINGENCIES





Lease
agreement





On
January 28, 2007, Qiluo signed a twenty (20) years lease with Xinshengxiang, a
related party (see Note 16), 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 RMB 200,000 ($29,894 translated at the September 30, 2010 exchange
rate) plus other occupancy costs.





Future
minimum rentals under this lease are as follows:





Year
      Ending
                            September
      30 ,
                          
                          Future Minimum
                            Rent Payments2011
                          
                          $
                          29,8942012
                          
                          
                          29,8942013
                          
                          
                          29,8942014
                          
                          
                          29,8942015
                          
                          
                          29,894Thereafter
                          
                          
                          341,290Total
                          
                          $
                          490,760




Rent
expense incurred under the lease during the nine months ended September 30, 2010
and 2009 charged to Selling, General and Administrative Expenses was $$24,322
and $21,970, respectively.





Registration Rights
Arrangement





In
connection with the convertible notes payable (see Note 12), 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 and withdrew the registration statement with SEC on August
27, 2010. Accordingly, the Company has accrued liquidated damages of $1,981,884
and $1,479,241 at September 30, 2010 and December 31, 2009,
respectively.





Lack of
Insurance





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





Country
Risk





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


F-21




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
19 – 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 secured
convertible 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
20 – DEFAULT ON CONVERTIBLE NOTES PAYABLE





As of
June 12, 2008, the Company was in default to six (6) Purchasers on convertible
notes payments due June 12, 2008 and earlier. As of July 12, 2008, the Company
was in default to all eleven (11) Purchasers on convertible notes payments due
July 12, 2008. The Notes provide that, at the option of the holder, an event of
default shall make all sums of principal and interest then remaining unpaid and
all other amounts payable immediately due and payable upon demand. As of
September 30, 2010, the unpaid convertible notes payable balance is $2,792,175;
unpaid accrued interest is $693,761; and unpaid accrued liquidated damages
penalty and default penalty are $2,296,003.





In an
effort to restructure the Notes and related accrued interest and liquidated
damages due, the Company circulated an Outline of Proposed Restructuring (the
“Term Sheet’) dated April 14, 2010 to the noteholders which was agreed to and
signed by 9 of 11 noteholders. The 9 noteholders who signed the Term Sheet
constituted $2,300,000 of the original $3,300,000 total principal balance of the
convertible Notes. Although the Term Sheet provided that the parties reserved
the right to approve all the terms of the definitive documents, definitive
documents have not yet been prepared. Accordingly, the Company has not as yet
recognized any reduction of the balance of the respective Notes and related
liabilities and consequent gain from this proposed restructuring. Also, the
Company has continued to accrue interest expense and liquidated damages
penalties in accordance with the terms of the original Notes.





Among
other things, the Term Sheet provides for the reduction of the balance of the
Notes ($2,792,175 at September 30, 2010) to $2,500,000 and the waiver of the
related accrued interest ($693,761 at September 30, 2010) and penalties
($2,296,003 at September 30, 2010). The restated Notes are to bear interest at
6%, payable monthly in cash or, at the option of the Company, in registered
common stock valued at a 20% discount to the market price. The principal of the
restated Notes are to be repaid in 21 monthly installments commencing 3 months
following the amendment, payable in cash or, at the option of the Company, in
registered common stock valued at a 20% discount to the market price. Also, the
Term Sheet provides for the reduction of the exercise price of the 13,200,000
class A Common Stock Purchase Warrants from $0.50 per share to $0.10 per share.
If effectuated, the gain from the restructuring will be reduced by any increase
in the fair value of the warrants.





The
Company did not make any scheduled interest payment and loan repayment per the
Term Sheet, nor has it had further discussion with the investors.





NOTE
21 – RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS





The
consolidated balance sheet at December 31, 2009 (which was previously included
in the Company’s Form 10-K filed with the SEC on April 15, 2010) and condensed
consolidated statements of losses and comprehensive losses and condensed
consolidated statements of cash flows for the three and nine months ended
September 30, 2009 (which were previously included in the Company’s Form 10-Q
filed with SEC on August 18, 2009) have been restated herein in order to correct
errors relating to the accrual of post-default interest on the convertible
Notes.


F-22




In the
Form 10-K filed April 15, 2010 and in earlier post-default SEC filings
commencing with the quarterly period ended September 30, 2008, the Company
accrued interest on the defaulted convertible Notes at a default rate of 25%
(rather than the specified default rate at 15%).





In the
Form 10-Q filed November 19, 2009, the condensed consolidated statements of
losses and comprehensive losses and condensed consolidated statements of cash
flows for the three and nine months ended September 30, 2009 included a default
loan penalty of $314,121, which was calculated at a default rate of 25% rather
than the specified default rate of 15%.





The
effect of the restatement adjustments on the consolidated balance sheet at
December 31, 2009 follows:





As Previously
                            Reported
                          
                          
                          Adjustments
                          
                          
                          As RestatedTotal
      Assets
                          
                          $
                          6,199,786
                          
                          
                          $
                          -
                          
                          
                          $
                          6,199,786Accounts
      payable and accrued expenses
                          
                          $
                          3,679,424
                          (1)
                          
                          
                          (418,828
                          )
                          
                          $
                          3,260,596Other
      current liabilities
                          
                          
                          5,565,410
                          
                          
                          
                          -
                          
                          
                          
                          5,565,410Total
      Current Liabilities and Total Liabilities
                          
                          
                          9,244,834
                          
                          
                          
                          (418,828
                          )
                          
                          
                          8,826,006Common
      stock
                          
                          
                          12,348
                          
                          
                          
                          -
                          
                          
                          
                          12,348Additional
      paid in capital
                          
                          
                          18,345,012
                          
                          
                          
                          -
                          
                          
                          
                          18,345,012Accumulated
      deficit
                          
                          
                          (21,715,270
                          )
      (1)
                          
                          
                          418,828
                          
                          
                          
                          (21,296,442
                          )Accumulated
      other comprehensive income
                          
                          
                          312,862
                          
                          
                          
                          -
                          
                          
                          
                          312,862Total
      stockholder's deficit
                          
                          
                          (3,045,048
                          )
                          
                          
                          418,828
                          
                          
                          
                          (2,626,220
                          )Total
      Liabilities and Stockholders' Deficit
                          
                          $
                          6,199,786
                          
                          
                          $
                          -
                          
                          
                          $
                          6,199,786





(1) to
adjust default interest payable at December 31, 2009 based on 15% rate (rather
than 25% rate).





The
effect of the restatement adjustments on the condensed consolidated statement of
losses for the three months ended September 30, 2009 follows:





As Previously
                          Reported
                        
                        
                        Adjustments
                        
                        
                        As RestatedIncome
      From Operations
                        
                        $
                        351,584
                        
                        
                        $
                        -
                        
                        
                        $
                        351,584Other
      Income (Expense):Interest
      income
                        
                        
                        324
                        
                        
                        
                        -
                        
                        
                        
                        324Interest
      expense
                        
                        
                        (521,263
                        )
      (1)
                        
                        
                        69,805
                        
                        
                        
                        (451,458
                        )Total
      Other (Expense)
                        
                        
                        (520,939
                        )
                        
                        
                        69,805
                        
                        
                        
                        (451,134
                        )Net
      Loss
                        
                        $
                        (169,355
                        )
                        
                        $
                        69,805
                        
                        
                        $
                        (99,550
                        )Net
      Loss Per Share - Basic and Diluted
                        
                        $
                        (0.00
                        )
                        
                        $
                        0.00
                        
                        
                        $
                        (0.00
                        )Comprehensive
      Loss:Net
      loss
                        
                        $
                        (169,355
                        )
                        
                        $
                        69,805
                        
                        
                        $
                        (99,550
                        )Foreign
      currency translation adjustment
                        
                        
                        2,062
                        
                        
                        
                        -
                        
                        
                        
                        2,062Comprehensive
      Loss
                        
                        $
                        (167,293
                        )
                        
                        $
                        69,805
                        
                        
                        $
                        (97,488
                        )




(1) to
adjust three months ended September 30, 2009 accrued default
interest  to proper rate of  15% (rather than
25%).


F-23





The
effect of the restatement adjustments on the condensed consolidated statement of
losses for the nine months ended September 30, 2009 follows:





As Previously
                          Reported
                        
                        
                        Adjustments
                        
                        
                        AsRestatedIncome
      From Operations
                        
                        $
                        282,325
                        
                        
                        $
                        -
                        
                        
                        $
                        282,325Other
      Income (Expense):Subsidy
      income
                        
                        
                        706,122
                        
                        
                        
                        -
                        
                        
                        
                        706,122Interest
      income
                        
                        
                        7,137
                        
                        
                        
                        -
                        
                        
                        
                        7,137Interest
      expense
                        
                        
                        (1,577,281
                        )
      (1)
                        
                        
                        209,414
                        
                        
                        
                        (1,367,867
                        )Total
      Other (Expense)
                        
                        
                        (864,022
                        )
                        
                        
                        209,414
                        
                        
                        
                        (654,608
                        )Net
      Loss
                        
                        $
                        (581,697
                        )
                        
                        $
                        209,414
                        
                        
                        $
                        (372,283
                        )Net
      Loss Per Share - Basic and Diluted
                        
                        $
                        (0.00
                        )
                        
                        $
                        0.00
                        
                        
                        $
                        (0.00
                        )Comprehensive
      Loss:Net
      loss
                        
                        $
                        (581,697
                        )
                        
                        $
                        209,414
                        
                        
                        $
                        (372,283
                        )Foreign
      currency translation adjustment
                        
                        
                        (912
                        )
                        
                        
                        -
                        
                        
                        
                        (912
                        )Comprehensive
      Loss:
                        
                        $
                        (582,609
                        )
                        
                        $
                        209,414
                        
                        
                        $
                        (373,195
                        )





1) to
adjust nine months ended September 30, 2009 accrued default interest to proper
rate of 15% (rather than 25%).





The
effect of the restatement adjustments on the condensed consolidated statement of
cash flows for the nine months ended September 30, 2009 follows:




As Previously
              Reported
            
            
            Adjustments
            
            
            As RestatedCash
      Flows from Operating Activities:Net
      Loss
            
            $
            (581,697
            )
      (1)
            
            $
            209,414
            
            
            $
            (372,283
            )Adjustments
      to Reconcile Net Loss to NetCash
      Provided by (Used in) Operating Activities:Depreciation
      expense
            
            
            68,390
            
            
            
            -
            
            
            
            68,390Provision
      for doubtful accounts
            
            
            18,537
            
            
            
            -
            
            
            
            18,537Accrued
      convertible notes interest and penalties
            
            
            -
            (1)
            
            
            (209,414
            )
            
            
            816,711(2)
            
            
            1,026,126(3)
            
            
            (1
            )Changes
      in operating assets and liabilities:(Increase)
      in accounts receivable
            
            
            1,753
            
            
            
            -
            
            
            
            1,753Decrease
      in inventories
            
            
            1,140,524
            
            
            
            -
            
            
            
            1,140,524Decrease
      in prepaid costs and expenses
            
            
            (633,439
            )
            
            
            -
            
            
            
            (633,439
            )Increase
      in accounts payable and accrued liabilities
            
            
            1,261,830
            (2)
            
            
            (1,026,126
            )
            
            
            235,704Increase
      in customer prepaid
            
            
            939,313
            
            
            
            -
            
            
            
            939,313Net
      Cash Provided by Operating Activities
            
            $
            2,215,211
            
            
            $
            (1
            )
            
            $
            2,215,210




(1) to
adjust nine months ended September 30, 2009 accrued default interest to proper
rate of 15% (rather than 25%).


(2) to
reclassify accrued convertible notes interest and penalties.


(3)
rounding adjustment.


F-24




NOTE
22 – SUBSEQUENT EVENT


The
Company received $1,292,916 (8,650,000 RMB) between November 12 and November 16,
2010 from individuals and entities other than Guojing on behalf of Guojing
towards the amount due the Company of $1,322,472 at September 30, 2010 described
in Note 6.
 
 Base on
the funds made available described in the preceding paragraph, on November 15,
2010, the Company repaid the bank acceptance payable to related party of
$1,494,700 (RMB 10,000,000) and the restricted cash of $748,329 held by the bank
to secure the acceptance financing was released to the Company. See Note
7.
 
 On
November 17, 2010, the Company advanced $1,497,700 (RMB 10,000,000) to Guojing
under a new 60 day acceptance obligation established with the bank. The
acceptance obligation to the bank is $1,497,700 (RMB 10,000,000) for a term of
60 days, with a 50% restricted cash account established of $747,350 (RMB
5,000,000) with the bank, pursuant to the Loan agreement in Note
10.


F-25


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 and the Form 10-K
filed on April 15, 2010. 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 were 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), of which 6,800,000 RMB ($996,200) was paid through December 31,
2009. In February 2009, the due date of the remaining 3,574,800 RMB ($523,708)
due was extended to September 2009.  In May 2010, the Fulin Municipal
Government revoked the Company’s right to operate the Zhengzhong assets. The
loan of RMB 6,750,000 ($995,625), which the Company received from Chongqing
Fulin State-Owned-Assets Management Co. (“Fulin Asset Management”) during the
first quarter 2010, was offset against deposits receivable from Zhengzhong in
the same aggregate amount based on Fulin Asset Management’s authorization to do
so.





The
Company is currently in negotiation with the Fulin Government for the return of
the rights related to the Zhengzhong cocoon station operations. However, there
can be no assurance that the Company will be able to re-obtain the
right.




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 intended 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 had 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.





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.


3




Results
of Operations


Three
Months Ended September 30, 2010 as compared to Three Months Ended September30,
2009


Comparison of Sales for the
Three Months Ended September30, 2010 and 2009





Three Months Ended September
      30,Sales
      in US dollars
                      
                      2010
                      
                      
                      2009Silk
                      
                      $
                      168,230
                      
                      
                      $
                      1,235,169Cocoons
                      
                      
                      31,694
                      
                      
                      
                      593,338By
      products and others
                      
                      
                      137,253
                      
                      
                      
                      411,942Total
      sales
                      
                      $
                      337,177
                      
                      
                      $
                      2,240,449




Net
Sales


Our net
sales decreased $1,903,272, or 85% to $337,177 in the three months ended
September 30, 2010 from $2,240,449 in the comparable period of
2009.  The Company sold 4.7 tons silk during the three months ended
September 30, 2010, a decrease of 46.5 tons, or 91%, compared to 51.2 tons
during the same period of 2009. The revenue from sale of silk was $168,230 in
the three months ended September 30, 2010, a decrease of $1,066,939, or 86%
compared to $1,235,169 for the three months ended September 30,
2009.





The
decrease in sales was mainly attributable to the lack of quality raw materials.
Cocoon is the raw material for production of silk. The Company had difficulties
in purchasing good quality cocoons from third parties due to the fact that the
Fulin Municipal Government revoked the Company’s right to operate the
“Zhengzhong” cocoon station (see Plan of Operation) during the second quarter of
2010.





Gross
Profit





Comparison of Gross Profit
for the Three Months Ended September 30, 2010 and 2009





Three Months Ended September
      30,2010
                  
                  
                  2009Net
      sales
                  
                  $
                  337,177
                  
                  
                  $
                  2,240,449Cost
      of sales
                  
                  
                  (357,124
                  )
                  
                  
                  (1,647,072
                  )Gross
      profit
                  
                  $
                  (19,947
                  )
                  
                  $
                  593,377Gross
      profit margin rate
                  
                  
                  -5.92
                  %
                  
                  
                  26.48
                  %




The
Company had a negative gross profit for the three months ended September 30,
2010. It resulted from the revoking of the Company’s right to operate the
“Zhengzhong” cocoon station (see Plan of Operation) by the Fuling Municipal
Government during the second quarter of 2010. Consequently, the Company
purchased cocoon from third parties at a higher price. The average cocoon
purchase price increased over 30%.




4




(Loss)
from Operations





Comparison of (Loss) from
Operations for the Three Months Ended September 30, 2010 and
2009





Three Months Ended September
      30,2010
                    
                    
                    2009Gross
      (loss) profit
                    
                    $
                    (19,947
                    )
                    
                    $
                    593,377Professional
      fees
                    
                    
                    9,718
                    
                    
                    
                    14,018Depreciation
      and amortization
                    
                    
                    9,028
                    
                    
                    
                    8,725Selling,
      general and administrative expenses
                    
                    
                    59,374
                    
                    
                    
                    219,050Total
      operating expenses
                    
                    
                    78,120
                    
                    
                    
                    241,793(Loss)
      income from operations
                    
                    $
                    (98,067
                    )
                    
                    $
                    351,584





Loss from
operations for the three months ended September 30, 2010 was $98,067, compared
to income from operations of $351,584 for the comparable period of
2009.




Other
Expense, Net





Comparison of Other Expense,
net for the Three Months Ended September 30, 2010 and 2009





Three Months Ended September30,2010
                    
                    
                    2009Subsidy
      income (expense)
                    
                    $
                    (2,955
                    )
                    
                    $
                    -Interest
      income
                    
                    
                    908
                    
                    
                    
                    324Interest
      expense
                    
                    
                    (272,888
                    )
                    
                    
                    (451,458
                    )Other
      Expense, net
                    
                    $
                    (274,935
                    )
                    
                    $
                    (451,134
                    )




Total
other expense, net was $274,935 for the three months ended September 30, 2010, a
decrease of $176,199 compared to $451,134 for the three months ended September
30, 2009. The Company had $121,163 government subsidy income in the three months
ended September 30, 2010, and costs to apply for current and future government
subsidy were $124,118. The net expense was $2,955. The government subsidies were
in connection with the purchase of cocoons and as an incentive for technology
innovation. Parts of these subsidies were passed through to the farmers who
produced the cocoons when we purchased the cocoons from farmers.





Interest
expense included interest paid for short term loans and accrued loan interest
expense and default penalties in connection with the defaulted convertible
notes. Interest expense totaled $272,888 in the three months ended September 30,
2010, decreased in $178,570, or 40% compared to $451458 in the comparable period
of 2009. The decrease in interest expense was a result from the reduced short
term loan principal in current period.


5




Nine
Months Ended September 30, 2010 as compared to Nine Months Ended September 30,
2009





Comparison of Sales for the
Nine Months Ended September 30, 2010 and 2009





Nine Months Ended September
    30,Sales
      in US dollars
                  
                  2010
                  
                  
                  2009Silk
                  
                  $
                  1,821,838
                  
                  
                  $
                  3,004,533Cocoons
                  
                  
                  31,694
                  
                  
                  
                  1,350,830By
      products and others
                  
                  
                  306,741
                  
                  
                  
                  768,984Total
      sales
                  
                  $
                  2,160,273
                  
                  
                  $
                  5,124,347





Net
Sales





Our net
sales decreased $2,964,074, or 58% to $2,160,271 in the nine months ended
September 30, 2010 from $5,124,347 in the comparable period of
2009.  The Company sold 57.2 tons of silk during the nine months ended
September 30, 2010, a decreased of 79.3 tons, or 58%, compared to 136.5 tons
during the same period of 2009. The revenue from sale of silk was $1,821,838 in
the nine months ended September 30, 2010, a decreased of $1,182,695 or 39%
compared to $3,004,533 for the nine months ended September 30,
2009.





The
decrease in sales was mainly attributable to the lack of quality raw materials.
Cocoon is the raw material for production of silk. The Company had difficulties
in purchasing good quality cocoons from third parties due to the fact that the
Fulin Municipal Government revoked the Company’s right to operate the
“Zhengzhong” cocoon station (see Plan of Operation) during the second quarter of
2010.





Gross
Profit





Comparison of Gross Profit
for the Nine Months Ended September 30, 2010 and 2009





Nine Months Ended September
    30,2010
                  
                  
                  2009Net
      sales
                  
                  $
                  2,160,273
                  
                  
                  $
                  5,124,347Cost
      of sales
                  
                  
                  (2,160,584
                  )
                  
                  
                  (4,298,110
                  )Gross
      profit
                  
                  $
                  (311
                  )
                  
                  $
                  826,237Gross
      profit margin rate
                  
                  
                  -0.01
                  %
                  
                  
                  16.12
                  %




The
Company had a gross loss of $311 in the nine months ended September 30, 2010,
compared to a gross profit of $826,237 in the nine months ended September 30,
2009. The decrease in gross profit resulted from the revoking of the Company’s
right to operate the “Zhengzhong” cocoon station (see Plan of Operation) by the
Fuling Municipal Government during the second quarter of 2010. Consequently, the
Company purchased cocoon from third parties instead of through the Zhengzhong
cocoon station at a higher price. The average cocoon purchase price increased
more than 30%.




6




(Loss)
from Operations





Comparison of (Loss) from
Operations for the Nine Months Ended September 30, 2010 and
2009





Nine Months Ended September
    30,2010
                  
                  
                  2009Gross
      (loss) profit
                  
                  $
                  (311
                  )
                  
                  $
                  826,237Professional
      fees
                  
                  
                  40,173
                  
                  
                  
                  48,012Depreciation
      and amortization
                  
                  
                  29,223
                  
                  
                  
                  28,438Selling,
      general and administrative expenses
                  
                  
                  310,914
                  
                  
                  
                  467,462Total
      operating expenses
                  
                  
                  380,310
                  
                  
                  
                  543,912(Loss)
      income from operations
                  
                  $
                  (380,621
                  )
                  
                  $
                  282,325




Loss from
operations for the nine months ended September 30, 2010 was $380,621, compared
to income of $282,325 in the comparable period of 2009. The loss was mainly
attributable to the reduced gross profit that resulted from higher cocoon
costs.




Other
Expenss, Net





Comparison of Other Expense,
net for the Nine Months Ended September 30, 2010 and 2009





Nine Months Ended September
    30,2010
                  
                  
                  2009Subsidy
      income
                  
                  $
                  170,656
                  
                  
                  $
                  706,122Interest
      income
                  
                  
                  3,129
                  
                  
                  
                  7,137Interest
      expense
                  
                  
                  (1,005,538
                  )
                  
                  
                  (1,367,867
                  )Other
      Expense, net
                  
                  $
                  (831,753
                  )
                  
                  $
                  (654,608
                  )




Total
other expense, net was $831,753 for the nine months ended September 30, 2010, a
decrease of $177,145, or 26%, compared to $654,608 for the nine months ended
September 30, 2009. The Company had $170,656 net government subsidy income in
the nine months ended September 30, 2010, which decreased by $535,466, compared
to $706,122 subsidy income in the comparable period of 2009. The government
subsidies were in connection with the purchase of cocoons and as an incentive
for technology innovation. Parts of these subsidies were passed through to the
farmers who produced the cocoons when we purchased the cocoons from
farmers.





Interest
expense included interest paid for short term loans and accrued loan interest
expense and default penalties in connection with the defaulted convertible
notes. Interest expense totaled $1,005,538 in the nine months ended September
30, 2010, decreased by $362,329, or 26% compared to $1,367,867 in the comparable
period of 2009. The decrease in interest expense resulted from the reduced short
term loan principal in the current period. Interest expense paid for short term
loan was $186,874 in the nine months ended September 30, 2010, a decrease
of $362,328, compared to $549,202 in the comparable period of 2009.





Liquidity
and Capital Resources





As of
September 30, 2010 and December 31, 2009, we had $11,837 and $2,788,581 in cash,
respectively. The cash balance at December 31, 2009 was prepared for repayment
of the Shangxia Bank loan which was due by January 19, 2010. 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.


7




The major
sources of the Company’s liquidity for its operations were cash generated from
operations and short term loans from banks and other entities.





Net cash
used in operating activities was $1,033,125 for the nine months ended September
30, 2010, compared to net cash provided by operating activities of $2,215,210
during the nine months ended September 30, 2009. This was mainly due to the
Company’s $840,091 increase in net loss and the $643,521 reduction of accounts
payable and accrued liabilities in 2010.





Net cash
used in investing activities was $586,137 and $4,817,023 during the nine months
ended September 30, 2010 and 2009, respectively. The Company received $19,704
from the return of property during the nine months ended September 30, 2010. The
Company advanced $575,122 to a related party and $30,719 to other entities in
2010. As comparison, during the nine months ended September 30, 2009, the
Company spent $5,275 on equipment, paid $512,750 in connection with the purchase
of Zhengzhong assets and advanced$4,298,998 to various entities and
individuals.





The loan
of RMB 6,750,000 ($995,625), with the Company received from Chongqing Fulin
State-Owned-Assets Management Co. (“Fulin Asset Management”) during the nine
months ended September 30, 2010, was offset against deposits receivable from
Zhengzhong in the same aggregate amount based on Fulin Asset Management’s
authorization to do so. The Company received $747,350 advances from related
parties and deposited $747,350 into a bank as restricted cash to secure the bank
acceptance payable during the nine months ended September 30, 2010. The Company
repaid $2,197,500 of short term loans in the nine months ended September 30,
2010.




Short Term Loans
Payable





September
      30,
                                  
                                  
                                  December
      31,Loans
      payable consist of:
                                  
                                  2010
                                  
                                  
                                  2009(Unaudited)Qiluo
      loans payable to Chongqing Shan Xia Bank30,000,000
      RMB, interest at 10% per annum, due January 19, 2010
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  4,395,000Less:
      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
                                  )25,000,000
      RMB, interest at 7.965% per annum, due January 29, 2011
                                  
                                  
                                  3,687,500
                                  
                                  
                                  
                                  -5,000,000
      RMB, interest at 7.965% per annum, due February 9, 2011
                                  
                                  
                                  737,500
                                  
                                  
                                  
                                  -Less:
      used by Mr. Chen, Wensheng, 3,000,000 RMB
                                  
                                  
                                  (442,500
                                  )
                                  
                                  
                                  -Less:
      used by Mr. Zhong, Songbai, 2,000,000 RMB
                                  
                                  
                                  (295,000
                                  )
                                  
                                  
                                  -Less:
      used by Guojing Silk, 20,000,000 RMB
                                  
                                  
                                  (2,950,000
                                  )
                                  
                                  
                                  -Less:
      used by Mr. Jingshi Kuang, 5,000,000 RMB
                                  
                                  
                                  (737,500
                                  )
                                  
                                  
                                  -Qiluo
      loans payable to Chongqing Shan Xia Bank, net
                                  
                                  
                                  -
                                  
                                  
                                  
                                  2,197,500Franklin
      loans payable to two individualsinterest
      at 8% per annum, due April 24, 2008 (past due)
                                  
                                  
                                  20,000
                                  
                                  
                                  
                                  20,000Total
                                  
                                  $
                                  20,000
                                  
                                  
                                  $
                                  2,217,500


8


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
December 31, 2009 exchange rate) from Chongqing Shan Xia Bank. The loan was
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.





On
January 22, 2010, the Company jointly with Chongqing Guojing Silk Company, Ltd.,
Mr. Wensheng Chen and Mr. Songbai Zhong, returned RMB 30,000,000 ($4,395,000) to
Shanxia Bank.





Pursuant
to a Loan Agreement that provides for a 40,000,000 RMB ($5,900,000) Line of
Credit that expires November 26, 2011 (30,000,000 RMB - $4,425,000 for working
capital; and 10,000,000 RMB - $1,475,000 acceptance financing/requiring 50%
collateral security) on January 29, 2010, the Company jointly with Chongqing
Guojing Silk Company, Ltd., Mr. Wensheng Chen, Mr. Songbai Zhong and Mr. Jingshi
Kuang, obtained a short term secured loan of RMB 25,000,000 ($3,662,500) from
Shanxia Bank. The loan bears interest at 7.965% per annum payable monthly. The
loan provides for a 50% penalty increase in the interest rate on a daily basis
while the Company is in default on payment of principal. It also provides for a
100% penalty increase in interest rate if the loan proceeds are not used for the
purpose stated in the loan. The maturity date of this loan is January 29, 2011,
and it is secured by the assets of Guojing Silk and real estate of Mr. Wenshen
Chen, Mr. Songbai Song and Mr. Jingshi Kuang.





On
February 9, 2010, the Company jointly with Chongqing Guojing Silk Company, Ltd.,
Mr. Wensheng Chen Mr. Songbai Zhong and Mr. Jingshi Kuang, obtained a short term
loan of RMB 5,000,000 ($732,500) for working capital. The loan bears interest at
7.965% per annum payable monthly. The loan provides for a 50% penalty increase
in the interest rate on a daily basis while the Company is in default on payment
of principal. It also provides for a 100% penalty increase in interest rate if
the loan proceeds are not used for the purpose stated in the loan. The maturity
date of this loan is February 9, 2011, and it is secured by the assets of
Guojing Silk and real estate of Mr. Wenshen Chen, Mr. Songbai Song and Mr.
Jingshi Kuang.





During
the second quarter 2010, the Company reached agreement with Guojing Silk, in
principle, to transfer $1,475,000 (10,000,000 RMB), its remaining allocated
portion of the line of credit, effective July 1, 2010 to Guojing. The purpose of
making the transfer was due to significant reductions in the Company’s business
caused by a recession in the Silk industry. According to the terms of the Loan
Agreement, the Company remains primarily responsible to the lender for the loans
taken under the Line of Credit, which aggregated 40,000,000 RMB ($5,989,600) at
September 30, 2010, no matter how the proceeds of the loans have been allocated
among the Company and the other parties/guarantors of the loan.





During
the first quarter 2010, the Company received a RMB 6,750,000 ($988,875) loan
from Chongqing Fulin State-Owned-Assets Management Co. The loan was interest
free and due by December 31, 2010. In May 2010, the Fulin Municipal Government
revoked the Company’s right to operate the Zhengzhong assets. The loan of RMB
6,750,000 ($995,625) was offset against deposits receivable from Zhengzhong in
the same aggregate amount based on Fulin Asset Management’s authorization to do
so in the second quarter of 2010.





As of
September 30, 2010 and December 31, 2009, the accrued interest payable for short
term loans totaled $7,220 and $22,634, respectively, which was included in
accounts payable and accrued expenses.


9




Loans Payable to Related
Parties





September
      30,
                          
                          
                          December
      31,Loans
      payable – related parties consist of:
                          
                          2010
                          
                          
                          2009(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
                          
                          
                          
                          7,158Due
      to Xin Shengxiang, non-interest bearing, due on demand
                          
                          
                          1,891
                          
                          
                          
                          -Total
                          
                          $
                          21,282
                          
                          
                          $
                          19,391




The
accrued interest payable to related party was $4,008 and $3,272 as of September
30, 2010 and December 31, 2009, respectively.




Convertible Notes
Payable




September
      30,
                                
                                
                                December 31,Convertible
      notes payable, net consist of:
                                
                                2010
                                
                                
                                2009(Unaudited)Convertible
      notes - initial face amount
                                
                                $
                                3,300,000
                                
                                
                                $
                                3,300,000Less
      unamortized debt discounts:Discount
      on relative fair value of warrants
                                
                                
                                (2,903,247
                                )
                                
                                
                                (2,903,247
                                )Discount
      on beneficial conversion feature
                                
                                
                                (396,753
                                )
                                
                                
                                (396,753
                                )Less
      accumulated amortization
                                
                                
                                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 commenced on March 12, 2008 and all accrued but
unpaid interest and any other amounts due thereon were 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
contained default events which, if triggered and not timely cured (if curable),
would result in a default interest rate of 15% per annum. The Notes also contain
full ratchet anti-dilution provisions with respect to certain securities
issuances, including the issuances of stock for less than $0.25 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.


10




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 was triggered after March 12, 2008
as well as “full ratchet” anti-dilution 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 was
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 Company withdrew the
registration statement on Form S-1 on August 27, 2010.





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
were 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 six months ended June 30, 2008,
which represented accrued interest of $174,912 and repayment of principal of
$493,950. The Company did not make any repayments during the six months ended
December 31, 2008 due to its financing difficulties. The Company has been in
default to all eleven investors (see Note 19) since then. 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 during the year ended December 31, 2008.





In an
effort to restructure the Notes and related accrued interest and liquidated
damages due, the Company circulated an Outline of Proposed Restructuring (the
“Term Sheet’) dated April 14, 2010 to the note holders which was agreed to and
signed by 9 of 11 note holders. The 9 note holders who signed the Term Sheet
constituted $2,300,000 of the original $3,300,000 total principal balance of the
convertible Notes. Although the Term Sheet provided that the parties reserved
the right to approve all the terms of the definitive documents, definitive
documents have not yet been prepared. Accordingly, the Company has not as yet
recognized any reduction of the balance of the respective Notes and related
liabilities and consequent gain from this proposed restructuring. Also, the
Company has continued to accrue interest expense and liquidated damages
penalties in accordance with the terms of the original Notes.


11





Among
other things, the Term Sheet provides for the reduction of the balance of the
Notes ($2,792,175 at September 30, 2010) to $2,500,000 and the waiver of the
related accrued interest ($693,761 at September 30, 2010) and penalties
($2,296,003 at September 30, 2010). The restated Notes are to bear interest at
6%, payable monthly in cash or, at the option of the Company, in registered
common stock valued at a 20% discount to the market price. The principal of the
restated Notes are to be repaid in 21 monthly installments commencing 3 months
following the amendment, payable in cash or, at the option of the Company, in
registered common stock valued at a 20% discount to the market price. Also, the
Term Sheet provides for the reduction of the exercise price of the 13,200,000
class A Common Stock Purchase Warrants from $0.50 per share to $0.10 per share.
If effectuated, the gain from the restructuring will be reduced by any increase
in the fair value of the warrants. The Company did not make any scheduled
repayment per the Term Sheet, nor has it had further discussion with the
investors.




Going
Concern Consideration





The
Company started its test production at the end of June 2007 and commenced its
manufacturing operations during the third quarter of 2007. The Company has
incurred a net loss of $1,212,374 and $372,283 for the nine months ended
September 30, 2010 and 2009, respectively.  The Company has an
accumulated deficit of $22,508,816 at September 30, 2010.  Substantial
portions of the losses are attributable to common stock issued for consulting
services, 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 $4,508,787 and $4,418,564 as of September 30, 2010 and December 31, 2009,
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, 2010, the unpaid convertible notes payable balance is
$2,792,175; unpaid accrued interest is $693,761; and unpaid accrued liquidated
damages penalty and default penalty are $2,296,003.





In an
effort to restructure the Notes and related accrued interest and liquidated
damages due, the Company circulated an Outline of Proposed Restructuring (the
“Term Sheet’) dated April 14, 2010 to the note holders which was agreed to and
signed by 9 of 11 note holders (see Note 12). The 9 note holders who signed the
Term Sheet constituted $2,300,000 of the original $3,300,000 total principal
balance of the convertible Notes. Although the Term Sheet provided that the
parties reserved the right to approve all the terms of the definitive documents,
definitive documents have not yet been prepared. Accordingly, the Company has
not as yet recognized any reduction of the balance of the respective Notes and
related liabilities and consequent gain from this proposed restructuring. Also,
the Company has continued to accrue interest expense and liquidated damages
penalties in accordance with the terms of the original Notes. The Company did
not make any scheduled interest payment and loan repayment per the Term Sheet,
nor has it had further discussion with the 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
2008, the Company received proceeds from a significant shareholder in the amount
of $1,722,656 as a repayment of nonreciprocal funds transferred to this
shareholder during 2007. The Company also received proceeds of short term loans
totaling $351,206 and $955,209 during 2009 and 2008, respectively.





In May
2010, the Fulin Municipal Government revoked the Company’s right to operate the
Zhengzhong assets. The loan of RMB 6,750,000 ($995,625), which the Company
received from Chongqing Fulin State-Owned-Assets Management Co. (“Fulin Asset
Management”) during the first quarter 2010, was offset against deposits
receivable from Zhengzhong in the same aggregate amount based on Fulin Asset
Management’s authorization to do so.


12




The
Company has undertaken further steps as part of a plan to improve operations.
The Company planned to reduce its cost of goods sold by purchasing more of its
main raw material – cocoon 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 9), thereby helping the Company to reduce its raw material - cocoon
cost. However, the Fulin Municipal Government revoked the Company’s right to
operate the “Zhengzhong” assets in May 2010. The Company has to purchase cocoon
from third parties with increased price. This will have a material impact on the
profitability of the Company. There can be no assurance that the Company will be
able to re-obtain the rights.





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.




Critical
Accounting Policies and Estimates





General





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





Basis of
Presentation





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





Foreign Currency
Translation





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





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





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


13





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.





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 Adopted Accounting
Standards




In
February 2010, the Company adopted an amendment to previously adopted accounting
guidance on subsequent event disclosure, which established standards of
accounting for and disclosure of events or transactions that occur after the
balance sheet date but before financial statements are issued or available to be
issued. Under the amended guidance, the Company is no longer required to
disclose the date through which subsequent events have been evaluated. The
adoption of this requirement did not have a material impact on the Company’s
financial condition or results of operations.


14





We
adopted the accounting principles established by ASU 2009-17, Consolidations: Improvements to
Financial Reporting by Enterprises Involved with Variable Interest
Entities, effective January 1, 2010. This ASU requires an ongoing
reassessment and replaces the quantitative-based risks and rewards calculation
for determining which reporting entity, if any, has a controlling financial
interest in a variable interest entity (“VIE”) with a primarily qualitative
analysis. The qualitative analysis is based on identifying the party that has
the power to direct the activities that most significantly impact the VIE’s
economic performance (the “power criterion”) and the obligation to absorb losses
from or the right to receive benefits of the VIE that could potentially be
significant to the VIE (the “losses/benefit criterion”). The party that meets
both these criteria is deemed to have a controlling financial interest. The
party with the controlling financial interest is considered to be the primary
beneficiary and as a result is required to consolidate the VIE.  The
adoption of this new guidance did not have a material effect on our financial
statements.





Recently Issued Accounting
Standards





In
January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance
which expands the required disclosures about fair value measurements. This
guidance requires disclosures about transfers of investments between levels in
the fair value hierarchy and disclosures relating to the reconciliation of fair
value measurements using significant unobservable inputs (level 3 investments).
This guidance is effective for the Company as of January 1, 2011. The
adoption of this guidance will not have a material impact on its financial
condition or results of operations.





In April
2010, the FASB issued ASU 2010-13, “Compensation-Stock Compensation (Topic 718)
- Effect of Denominating the Exercise Price of a Share-Based Payment Award in
the Currency of the Market in Which the Underlying Equity Security Trades - a
consensus of the FASB Emerging Issues Task Force,” or ASU 2010-13. ASU 2010-13
provides amendments to Topic 718 to clarify that an employee share-based payment
award with an exercise price denominated in the currency of a market in which a
substantial portion of the entity’s equity securities trades should not be
considered a condition that is not a market, performance, or service condition.
Therefore, an entity would not classify such an award as a liability if it
otherwise qualifies as equity. The amendments in this update do not expand the
recurring disclosures required by Topic 718. Disclosures currently required
under Topic 718 are applicable to a share-based payment award, including the
nature and the term of share-based payment arrangements. The amendments in this
update are effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2010. The Company is currently
evaluating the impact of the adoption of ASU 2010-13 on its financial
statements.





Certain
other accounting pronouncements were 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.





Item
3. Quantitative and Qualitative Disclosures About Market Risk.





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





Item
4.  Controls and Procedures.





Evaluation
of Disclosure Controls and Procedures





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.




15





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.





There are
no pending legal proceedings to which the Company is a party or in which any
director, officer or affiliate of the Company, any owner of record or
beneficially of more than 5% of any class of voting securities of the Company,
or security holder is a party adverse to the Company or has a material interest
adverse to the Company, and the Company's property is not the subject of any
pending legal proceedings, except as follows:





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.





As of
June 12, 2008, the Company was in default to six (6) Purchasers on convertible
notes payments due June 12, 2008 and earlier. As of July 12, 2008, the Company
was in default to all eleven (11) Purchasers on convertible notes payments due
July 12, 2008. The Notes provide that, at the option of the holder, an event of
default shall make all sums of principal and interest then remaining unpaid and
all other amounts payable immediately due and payable upon demand. As of March
31, 2010, the unpaid convertible notes payable balance is $2,792,175; unpaid
accrued interest is $554,153; and unpaid accrued liquidated damages penalty and
default penalty are $2,379,770. The Company is currently continuing to negotiate
with investors and is seeking ways to resolve the default issue with all
investors.





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





Unregistered Sales of Equity
Securities





None




Purchases of equity
securities by the issuer and affiliated purchasers





None.




Use of
Proceeds





None




16





Item
3.  Defaults Upon Senior Securities.





See Part
II – Item 1. above.




Item
4.  Removed and Reserved.





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 (file
  herewith)32.1
                
                Section
      1350 Certifications of Dingliang Kuang, the President, Chief Executive
      Officer, Treasurer and Director (file
herewith)




17


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, 2010
                By:
                /s/  Dingliang
    KuangName:
                Dingliang
      KuangTitle:
                President,
      Chief Executive Officer, Treasurer and Director(Principal
      Executive, Financial and Accounting Officer)




18