UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
Washington,
D.C. 20549
FORM 10-Q
x
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
|
|
For the quarterly period ended
December 31, 2010
|
|
|
|
OR
|
|
|
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT
OF 1934
|
|
|
|
For the transition period
from ________________ to
_________________
|
Commission File Number
333-120926
SOLAR ENERTECH CORP.
(Exact name of registrant as specified
in its charter)
Delaware
|
|
98-0434357
|
State or other jurisdiction
of
|
|
(I.R.S.
Employer
|
incorporation or
organization
|
|
Identification
No.)
|
655 West Evelyn Avenue, Suite
#2
Mountain View, CA
94041
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including
area code
(650)
688-5800
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes
x
No
o
Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit
and post such files).
Yes
o
No
o
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
|
Large accelerated
filer
|
o
|
|
Accelerated
Filer
o
|
|
|
Non-accelerated
filer
|
o
|
|
Smaller reporting
company
x
|
|
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).
Yes
o
No
x
Number of shares outstanding of
registrant’s class of common stock as of
February 7, 2011
:
171,473,177
SOLAR ENERTECH CORP
FORM 10-Q
INDEX
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PAGE
|
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Part I.
Financial Information
|
|
|
Item 1.
|
Financial
Statements
|
|
|
|
Consolidated Balance Sheets –
December 31, 2010 (Unaudited) and September 30,
2010 (Audited)
|
|
3
|
|
Unaudited Consolidated Statements
of Operations – Three Months Ended December 31, 2010 and
2009
|
|
4
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|
Unaudited Consolidated
Statements of Cash Flows – Three Months Ended December 31, 2010 and
2009
|
|
5
|
|
Notes to Unaudited Consolidated
Financial Statements
|
|
6
|
Item 2.
|
Management’s Discussion and
Analysis of Financial Condition and Results of
Operations
|
|
27
|
Item 3.
|
Quantitative and Qualitative
Disclosures about Market Risks
|
|
36
|
Item 4.
|
Controls and
Procedures
|
|
36
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Part II. Other
Information
|
|
|
Item 1.
|
Legal
Proceedings
|
|
37
|
Item 1A.
|
Risk
Factors
|
|
37
|
Item 2.
|
Unregistered Sale of Equity
Securities and Use of Proceeds
|
|
37
|
Item 3.
|
Defaults upon Senior
Securities
|
|
37
|
Item 4.
|
Removed and
Reserved
|
|
37
|
Item 5.
|
Other
Information
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|
37
|
Item 6.
|
Exhibits
|
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38
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Signatures
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|
39
|
PART I
ITEM 1. FINANCIAL
STATEMENTS
Solar EnerTech Corp.
Consolidated Balance
Sheets
|
|
December 31,
2010
|
|
|
September 30,
2010
|
|
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|
(Unaudited)
|
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|
Audited
|
|
ASSETS
|
|
|
|
|
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Current
assets:
|
|
|
|
|
|
|
Cash and cash
equivalents
|
|
$
|
1,699,000
|
|
|
$
|
6,578,000
|
|
Accounts receivable, net of
allowance for doubtful account of
|
|
|
|
|
|
|
|
|
$42,000 and $42,000 at December
31, 2010 and September 30, 2010, respectively
|
|
|
6,902,000
|
|
|
|
6,546,000
|
|
Advance payments and
other
|
|
|
941,000
|
|
|
|
1,274,000
|
|
Inventories,
net
|
|
|
5,392,000
|
|
|
|
4,083,000
|
|
VAT
receivable
|
|
|
1,978,000
|
|
|
|
870,000
|
|
Other
receivable
|
|
|
340,000
|
|
|
|
690,000
|
|
Total current
assets
|
|
|
17,252,000
|
|
|
|
20,041,000
|
|
Property and equipment,
net
|
|
|
8,375,000
|
|
|
|
8,874,000
|
|
Other
assets
|
|
|
740,000
|
|
|
|
735,000
|
|
Deposits
|
|
|
103,000
|
|
|
|
102,000
|
|
Total
assets
|
|
$
|
26,470,000
|
|
|
$
|
29,752,000
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS'
EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
6,089,000
|
|
|
$
|
7,895,000
|
|
Customer advance
payment
|
|
|
979,000
|
|
|
|
2,032,000
|
|
Accrued
expenses
|
|
|
2,631,000
|
|
|
|
2,596,000
|
|
Accounts payable and accrued
liabilities, related parties
|
|
|
-
|
|
|
|
5,817,000
|
|
Short-term
loans
|
|
|
1,464,000
|
|
|
|
1,312,000
|
|
Total current
liabilities
|
|
|
11,163,000
|
|
|
|
19,652,000
|
|
Convertible notes, net of
discount
|
|
|
1,473,000
|
|
|
|
1,531,000
|
|
Derivative
liabilities
|
|
|
207,000
|
|
|
|
422,000
|
|
Warrant
liabilities
|
|
|
436,000
|
|
|
|
902,000
|
|
Total
liabilities
|
|
|
13,279,000
|
|
|
|
22,507,000
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS'
EQUITY:
|
|
|
|
|
|
|
|
|
Common stock - 400,000,000 shares
authorized at $0.001 par value 171,177,443
|
|
|
|
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|
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and 170,338,954
shares issued and outstanding at December 31, 2010
and
|
|
|
|
|
|
|
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|
September 30,
2010, respectively
|
|
|
171,000
|
|
|
|
170,000
|
|
Additional paid in
capital
|
|
|
98,411,000
|
|
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|
97,656,000
|
|
Other comprehensive
income
|
|
|
2,958,000
|
|
|
|
2,755,000
|
|
Accumulated
deficit
|
|
|
(88,349,000
|
)
|
|
|
(93,336,000
|
)
|
Total stockholders'
equity
|
|
|
13,191,000
|
|
|
|
7,245,000
|
|
Total liabilities and
stockholders' equity
|
|
$
|
26,470,000
|
|
|
$
|
29,752,000
|
|
The accompanying notes are an integral
part of these consolidated financial statements.
Solar EnerTech Corp.
Consolidated Statements of
Operations
(Unaudited)
|
|
Quarter Ended December
31,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
15,507,000
|
|
|
$
|
17,693,000
|
|
Cost of
sales
|
|
|
(14,391,000
|
)
|
|
|
(15,762,000
|
)
|
Gross
profit
|
|
|
1,116,000
|
|
|
|
1,931,000
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
Selling, general and
administrative
|
|
|
2,351,000
|
|
|
|
2,218,000
|
|
Research and
development
|
|
|
69,000
|
|
|
|
108,000
|
|
Gain on debt
extinguishment
|
|
|
(32,000
|
)
|
|
|
-
|
|
Reversal of payroll related tax
accrual
|
|
|
(5,817,000
|
)
|
|
|
-
|
|
Total operating
(income) expenses
|
|
|
(3,429,000
|
)
|
|
|
2,326,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
(loss)
|
|
|
4,545,000
|
|
|
|
(395,000
|
)
|
|
|
|
|
|
|
|
|
|
Other income
(expense):
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
3,000
|
|
|
|
3,000
|
|
Interest
expense
|
|
|
(71,000
|
)
|
|
|
(4,425,000
|
)
|
Gain on change in fair market
value of compound embedded derivative
|
|
|
202,000
|
|
|
|
104,000
|
|
Gain on change in fair market
value of warrant liability
|
|
|
466,000
|
|
|
|
921,000
|
|
Impairment loss on
investment
|
|
|
-
|
|
|
|
-
|
|
Other
expense
|
|
|
(158,000
|
)
|
|
|
(132,000
|
)
|
Net income
(loss)
|
|
$
|
4,987,000
|
|
|
$
|
(3,924,000
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share -
basic
|
|
$
|
0.03
|
|
|
$
|
(0.04
|
)
|
Net income (loss) per share -
diluted
|
|
$
|
0.03
|
|
|
$
|
(0.04
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average shares
outstanding - basic
|
|
|
160,416,534
|
|
|
|
88,256,706
|
|
Weighted average shares
outstanding - diluted
|
|
|
171,351,607
|
|
|
|
88,256,706
|
|
The accompanying notes are an integral
part of these consolidated financial statements.
Solar EnerTech Corp.
Consolidated Statements of Cash
Flows
(Unaudited)
|
|
Quarter Ended December
31,
|
|
|
|
2010
|
|
|
2009
|
|
Cash flows from operating
activities:
|
|
|
|
|
|
|
Net income
(loss)
|
|
$
|
4,987,000
|
|
|
$
|
(3,924,000
|
)
|
Adjustments to reconcile net
income (loss) to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation of property and
equipment
|
|
|
642,000
|
|
|
|
605,000
|
|
Loss on disposal of property and
equipment
|
|
|
-
|
|
|
|
51,000
|
|
Stock-based
compensation
|
|
|
659,000
|
|
|
|
651,000
|
|
Accounts payable and accrued
liabilities, related parties
|
|
|
(5,817,000
|
)
|
|
|
43,000
|
|
Amortization of other
assets
|
|
|
5,000
|
|
|
|
-
|
|
Gain on debt
extinguishment
|
|
|
(32,000
|
)
|
|
|
-
|
|
Payment of interest by issuance of
shares
|
|
|
25,000
|
|
|
|
-
|
|
Amortization of note discount and
deferred financing cost
|
|
|
32,000
|
|
|
|
4,251,000
|
|
Gain on change in fair market
value of compound embedded derivative
|
|
|
(202,000
|
)
|
|
|
(104,000
|
)
|
Gain on change in fair market
value of warrant liability
|
|
|
(466,000
|
)
|
|
|
(921,000
|
)
|
Changes in operating assets and
liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable,
net
|
|
|
(277,000
|
)
|
|
|
(1,049,000
|
)
|
Advance payments and
other
|
|
|
473,000
|
|
|
|
170,000
|
|
Inventories,
net
|
|
|
(1,254,000
|
)
|
|
|
(1,802,000
|
)
|
VAT
receivable
|
|
|
(1,092,000
|
)
|
|
|
(544,000
|
)
|
Other
receivable
|
|
|
342,000
|
|
|
|
177,000
|
|
Accounts payable, accrued
liabilities and customer advance payment
|
|
|
(2,952,000
|
)
|
|
|
2,547,000
|
|
Deposits
|
|
|
-
|
|
|
|
(13,000
|
)
|
Net cash provided by (used in)
operating activities
|
|
|
(4,927,000
|
)
|
|
|
138,000
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing
activities:
|
|
|
|
|
|
|
|
|
Acquisition of property and
equipment
|
|
|
(169,000
|
)
|
|
|
(235,000
|
)
|
Proceeds from sales of property
and equipment
|
|
|
-
|
|
|
|
9,000
|
|
Net cash used in investing
activities
|
|
|
(169,000
|
)
|
|
|
(226,000
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing
activities:
|
|
|
|
|
|
|
|
|
Borrowing under short-term
loans
|
|
|
2,533,000
|
|
|
|
-
|
|
Short-term loans
repayment
|
|
|
(2,382,000
|
)
|
|
|
-
|
|
Net cash provided by financing
activities
|
|
|
151,000
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate on cash
and cash equivalents
|
|
|
66,000
|
|
|
|
2,000
|
|
Net decrease in cash and cash
equivalents
|
|
|
(4,879,000
|
)
|
|
|
(86,000
|
)
|
Cash and cash equivalents,
beginning of period
|
|
|
6,578,000
|
|
|
|
1,719,000
|
|
Cash and cash equivalents, end of
period
|
|
$
|
1,699,000
|
|
|
$
|
1,633,000
|
|
|
|
|
|
|
|
|
|
|
Cash paid:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
13,000
|
|
|
$
|
-
|
|
Supplemental disclosure of
non-cash activities:
|
|
|
|
|
|
|
|
|
Extinguishment of convertible
notes by issuance of common stock
|
|
$
|
(100,000
|
)
|
|
$
|
-
|
|
The accompanying notes are an integral
part of these consolidated financial statements
SOLAR ENERTECH CORP.
Notes to Consolidated Financial
Statements
December 31
, 2010 (Unaudited)
NOTE 1 — ORGANIZATION
AND NATURE OF OPERATIONS
Solar EnerTech Corp. was originally
incorporated under the laws of the State of Nevada on July 7, 2004 as Safer
Residence Corporation and was reincorporated to the State of Delaware on August
13, 2008 (“Solar EnerTech” or the “Company”). The Company engaged in
a variety of businesses until March 2006, when the Company began its current
operations as a photovoltaic (“PV”) solar energy cell (“PV Cell”) manufacturer.
The Company’s management decided that, to facilitate a change in business that
was focused on the PV Cell industry, it was appropriate to change the Company’s
name. A plan of merger between Safer Residence Corporation and Solar EnerTech
Corp., a wholly-owned inactive subsidiary of Safer Residence Corporation, was
approved on March 27, 2006, under which the Company was to be renamed “Solar
EnerTech Corp.” On April 7, 2006, the Company changed its name to Solar
EnerTech Corp. On August 13, 2008, the Company reincorporated to the
State of Delaware.
The Company conducts a substantial part
of its operations under a wholly-owned subsidiary in Shanghai, China named Solar
EnerTech (Shanghai) Co., Ltd.
On April 27, 2009, the Company entered
into a Joint Venture Agreement with Jiangsu Shunda Semiconductor Development
Co., Ltd. to form a joint venture in the United States by forming a new
company, to be known as Shunda-SolarE Technologies, Inc., in order to jointly
pursue opportunities in the United States solar market.
The
Agreement was valid for 18 months and expired on October 27, 2010.
After its formation, the joint venture
company’s name was later changed to SET-Solar Corp.
Since the agreement
was expired on October 27, 2010, SET-Solar Corp. became an independent company
and transactions with
SET-Solar
Corp
after that date would not be considered as related party
transactions.
On January 15, 2010, the Company
incorporated a wholly-owned subsidiary in Yizheng, Jiangsu Province of China to
supplement its existing production facilities to meet increased sales
demands.
On February 8, 2010, the Company
acquired land use rights of a 68,025 square meter parcel of land located in
Yizheng, Jiangsu Province of China, which will be used to house the Company’s
second manufacturing facility.
NOTE 2 — LIQUIDITY AND GOING
CONCERN
The
Company has incurred significant net losses during each period from inception
through December 31, 2010 and has an accumulated deficit of approximately $88.3
million at December 31, 2010. The conditions described raise substantial doubt
about the Company’s ability to continue as a going concern. The independent
auditor’s report on the Company’s most recent annual report on Form 10-K for the
year ended September 30, 2010 also contained an explanatory paragraph stating
that the Company’s recurring net losses and negative cash flows from operations
raises substantial doubt about the Company’s ability to continue as a going
concern. The Company’s consolidated financial statements have been prepared on
the assumption that it will continue as a going concern, which contemplates the
realization of assets and liquidation of liabilities in the normal course of
business. The consolidated financial statements do not include any adjustments
to reflect the possible future effects on the recoverability and classification
of assets or the amounts and classification of liabilities that may result from
the outcome of this uncertainty.
During
fiscal year 2010, significant steps were taken to reach positive gross margins
including securing sales contracts from recurring customers and establishing new
customer relationships, which has generated more operating cash inflows. In
addition, the Company engaged in various cost cutting programs and renegotiated
most of the contacts to reduce operating expenses. Due to the above efforts
taken, the Company has been generating positive gross margins throughout all
quarters in fiscal year 2010 and the first quarter of fiscal year 2011. However,
during the first quarter of fiscal year 2011, a shipment to a major customer in
Australia amounting to approximately $1 million was delayed until the following
quarter due to flooding in certain parts of Australia. Further, the Company’s
gross margin was 7.2% in the first quarter of 2011 compared to 10.9% for the
same quarter in the prior year.
The
decrease in gross profit was primarily due to the increase in raw material
prices, specifically silicon wafer prices, coupled with the slight decrease in
average selling prices of solar modules.
Operating cash outflows amounted
to $4.9 million in the first quarter of fiscal year 2011, mainly due to payments
to the Company’s vendors based on contractual terms. There have been no
significant changes in the payment terms of the Company’s major vendors
in
the
three
months ended December 31, 20
10
compared to the same period in the prior year.
As of
December 31, 2010, the Company had cash and cash equivalents balance of
approximately $1.7 million and short term loans outstanding of approximately
$1.5 million. Approximately $0.9 million of the bank loan balance was due on
January 27, 2011 and the remaining balance of $0.6 million is due on February
23, 2011. The Company’s line of credit which has funded these bank loans expires
on March 29, 2011. The Company is in the process of renewing the line of credit
prior to its expiration date. If the line of credit is not renewed in a timely
manner, the Company’s liquidity and results of operations may be materially and
adversely affected,
and may
not continue as a going concern.
In addition, in order to continue as a
going concern, the Company needs to continue to generate new sales while
controlling our costs. If the Company is unable to successfully
generate enough revenues to cover its costs, the Company will only have limited
cash resources to bear operating losses and may not continue as a going
concern.
NOTE 3 — SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and
Basis
of
Accounting
Prior to August 19, 2008, the Company
operated its business in the People’s Republic of China through Infotech Hong
Kong New Energy Technologies, Limited (“Infotech HK”) and Solar EnerTech
(Shanghai) Co., Ltd (“Infotech Shanghai” and together with Infotech HK,
“Infotech”). While the Company did not own Infotech, the Company’s financial
statements have included the results of the financials of each of Infotech HK
and Infotech Shanghai since these entities were wholly-controlled variable
interest entities of the Company through an Agency Agreement dated
April 10, 2006 by and between the Company and Infotech (the “Agency
Agreement”). Under the Agency Agreement the Company engaged Infotech to
undertake all activities necessary to build a solar technology business in
China, including the acquisition of manufacturing facilities and equipment,
employees and inventory. The Agency Agreement continued through April 10,
2008 and then on a month to month basis thereafter until terminated by either
party.
To permanently consolidate Infotech with
the Company through legal ownership, the Company acquired Infotech at a nominal
amount on August 19, 2008 through a series of agreements. In connection with
executing these agreements, the Company terminated the original agency
relationship with Infotech.
The Company had previously consolidated
the financial statements of Infotech with its financial statements pursuant to
FASB ASC 810-10 “Consolidations”, formerly referenced as FASB Interpretation No.
46(R), due to the agency relationship between the Company and
Infotech and, notwithstanding the termination of the Agency Agreement, the
Company continues to consolidate the financial statements of Infotech with its
financial statements since Infotech became a wholly-owned subsidiary of the
Company as a result of the acquisition.
The Company’s consolidated financial
statements include the accounts of Solar EnerTech Corp. and its subsidiaries.
All intercompany balances and transactions have been eliminated in
consolidation. These consolidated financial statements have been prepared in
U.S. dollars and in accordance with U.S. generally accepted accounting
principles (“U.S. GAAP”).
Use of Estimates
The preparation of consolidated
financial statements in conformity with U.S. GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of sales and
expenses during the reporting period. Actual results could differ from those
estimates.
Cash and Cash
Equivalents
Cash and cash equivalents are defined as
cash on hand, demand deposits and short-term, highly liquid investments that are
readily convertible to known amounts of cash within ninety days of
deposit.
Currency and Foreign
Exchange
The Company’s functional currency is the
Renminbi as substantially all of the Company’s operations are in China. The
Company’s reporting currency is the U.S. dollar.
Transactions and balances originally
denominated in U.S. dollars are presented at their original amounts.
Transactions and balances in other currencies are converted into U.S. dollars in
accordance with FASB ASC 830, “Foreign Currency Matters,” formerly referenced as
SFAS No. 52,
“
Foreign Currency
Translation”,
and
are included in
determining net income or loss.
For foreign operations with the local
currency as the functional currency, assets and liabilities are translated from
the local currencies into U.S. dollars at the exchange rate prevailing at the
balance sheet date. Revenues and expenses are translated at weighted average
exchange rates for the period to approximate translation at the exchange rates
prevailing at the dates those elements are recognized in the consolidated
financial statements. Translation adjustments resulting from the process of
translating the local currency consolidated financial statements into U.S.
dollars are included in determining comprehensive loss.
Property and
Equipment
The Company’s property and equipment are
stated at cost net of accumulated depreciation. Depreciation is provided using
the straight-line method over the related estimated useful lives, as
follows:
|
|
Useful Life (Years)
|
Office
equipment
|
|
3 to 5
|
Machinery
|
|
10
|
Production equipment
|
|
5
|
Automobiles
|
|
5
|
Furniture
|
|
5
|
Leasehold
improvement
|
|
the shorter of the lease term
or 5 years
|
Expenditures for maintenance and repairs
that do not improve or extend the lives of the related assets are expensed to
operations. Major repairs that improve or extend the lives of the related assets
are capitalized.
Inventories
Inventories are stated at the lower of
cost or market. Cost is determined by the weighted-average method. Market is
defined principally as net realizable value. Raw material cost is based on
purchase costs while work-in-progress and finished goods are comprised of direct
materials, direct labor and an allocation of manufacturing overhead costs.
Inventory in-transit is included in finished goods and consists of products
shipped but not recognized as revenue because it does not meet the revenue
recognition criteria. Provisions are made for excess, slow moving and obsolete
inventory as well as inventory whose carrying value is in excess of net
realizable value.
Warranty Cost
The Company provides product warranties
and accrues for estimated future warranty costs in the period in which revenue
is recognized. The Company’s standard solar modules are typically sold with a
two-year warranty for defects in materials and workmanship and a ten-year and
twenty five-year warranty against declines of more than 10.0% and 20.0%,
respectively, of the initial minimum power generation capacity at the time of
delivery. The Company therefore maintains warranty reserves to cover potential
liabilities that could arise from its warranty obligations and accrues the
estimated costs of warranties based primarily on management’s best estimate. In
estimating warranty costs, the Company applied Accounting Standards Codification
Topic 460 (“ASC 460”) – Guarantees, specifically paragraphs 460-10-25-5 to
460-10-25-7 of the FASB Accounting Standards Codification. This guidance
requires that the Company make a reasonable estimate of the amount of a warranty
obligation. It also provides that in the case of an entity that has no
experience of its own, reference to the experience of other entities in the same
business may be appropriate. Because the Company began to commercialize its
products in fiscal year 2007, there is insufficient experience and historical
data that can be used to reasonably estimate the expected failure rate of its
solar modules. Thus, the Company considers warranty cost provisions of other
China-based manufacturers that produce photovoltaic products that are comparable
in engineering design, raw material input and functionality to the Company’s
products, and sold to a similar target and class of customer with similar
warranty coverage. In determining whether such peer information can be used, the
Company also considers the years of experience that these manufacturers have in
the industry. Because the Company’s industry is relatively young as compared to
other traditional manufacturing industries, the selected peer companies that the
Company considers have less than ten years in manufacturing and selling history.
In addition, they have a manufacturing base in China, offer photovoltaic
products with comparable engineering design, raw material input, functionality
and similar warranty coverage, and sell in markets, including the geographic
areas and class of customer, where the Company competes. Based on the analysis
applied, the Company accrues warranty at 1% of sales. The Company has not
experienced any material warranty claims to date in connection with declines of
the power generation
capacity of its solar modules and will
prospectively revise its actual rate to the extent that actual warranty costs
differ from the estimates.
As of December 31, 2010 and September 30,
2010, the Company’s warranty liability was $1,247,000 and $1,125,000,
respectively.
The Company’s
warranty costs for the three months ended December 31, 2010 and 2009 were
$109,000 and $153,000, respectively.
The Company did not make any
warranty payments during the three months ended December 31, 2010 and
2009.
Other Assets
The Company acquired land use rights to
a parcel of land from the government in the People’s Republic of China (“PRC”).
All land in the PRC is owned by the PRC government and cannot be sold to any
individual or entity. The government in the PRC, according to relevant PRC law,
may sell the right to use the land for a specified period of time. Thus, the
Company’s land purchase in the PRC is considered to be leased land and recorded
as other assets at cost less accumulated amortization. Amortization is provided
over the term of the land use right agreements on a straight-line basis, which
is for 46.5 years from February 8, 2010 through August 31,
2056.
Impairment of
L
ong
L
ived
A
ssets
The Company reviews its long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying value of an asset may not be recoverable. When such factors and
circumstances exist, management compares the projected undiscounted future cash
flows associated with the future use and disposal of the related asset or group
of assets to their respective carrying values. Impairment, if any, is measured
as the excess of the carrying value over the fair value, based on market value
when available, or
discounted expected cash flows, of those assets and is recorded in the period in
which the determination is made. No loss on property and equipment impairment
was recorded during
the
three months
ended
December 31
, 2010
and 2009
.
Investments
Investments in an entity where the
Company owns less than twenty percent of the voting stock of the entity and does
not exercise significant influence over operating and financial policies of the
entity are accounted for using the cost method. Investments in the entity where
the Company owns twenty percent or more but not in excess of fifty percent of
the voting stock of the entity or less than twenty percent and exercises
significant influence over operating and financial policies of the entity are
accounted for using the equity method. The Company has a policy in place to
review its investments at least annually, to evaluate the carrying value of the
investments in these companies. The cost method investment is subject to
impairment assessment if there are identified events or changes in circumstance
that may have a significant adverse affect on the fair value of the investment.
If the Company believes that the carrying value of an investment is in excess of
estimated fair value, it is the Company’s policy to record an impairment charge
to adjust the carrying value to the estimated fair value, if the impairment is
considered other-than-temporary.
On August 21, 2008, the Company entered
into an equity purchase agreement in which it acquired two million shares of
common stock of 21-Century Silicon, Inc., a polysilicon manufacturer based in
Dallas, Texas (“21-Century Silicon”), for $1.0 million in cash. The two million
shares of common stock represented approximately 7.8% of 21-Century Silicon’s
outstanding equity. In connection with the equity purchase agreement, the
Company also signed a memorandum of understanding with 21-Century Silicon for a
four-year supply framework agreement for polysilicon shipments. The
first polysilicon shipment from 21-Century Silicon was initially expected in
March 2009, but was subsequently delayed to March 2010. On March 5, 2009, the
Emerging Technology Fund, created by the State of Texas, invested $3.5 million
in 21-Century Silicon to expedite production and commercialization of research.
The Company’s ownership of 21-Century Silicon became 5.5% as a result of the
dilution. This first polysilicon shipment that was to be delivered in March 2010
was further delayed without a specified date given by 21-Century Silicon. As a
result of the continued delays in shipment, in July 2010, members of the
Company’s executive team, including the CEO, visited 21-Century Silicon and
conducted reviews of the production facility and technical
development. The review indicated that 21-Century Silicon’s
production facility and technical development were significantly below expected
standards. Based on the findings from this visit, the timing of the first
polysilicon shipment is unknown and it is unknown whether it will even occur. In
addition, management of 21-Century Silicon expressed the need for more funding
to sustain operations. Moreover, 21-Century Silicon could not provide the
Company with updated financial information concerning 21-Century Silicon’s
working capital condition and future cash flows. The Company
considered the above findings were indicators that a significant adverse effect
on the fair value of the Company’s investment in 21-Century Silicon had
occurred. Accordingly, an impairment loss of $1.0 million was recorded in the
Consolidated Statements of Operations for the fiscal year ended September 30,
2010 to fully write-down the carrying amount of the investment. The Company
may also be obligated to acquire an additional two million shares of 21-Century
Silicon upon the first polysilicon shipment meeting the quality specifications
determined solely by the Company. As of December 31, 2010, the Company has not
yet acquired the additional two million shares as the product shipment has not
occurred.
On October
7, 2010, the X-Change Corporation announced that it has acquired 21-Century
Silicon, Inc. The terms of the acquisition are anticipated to involve a change
in control of the Company and the appointment of new directors. The X-Change
Corporation is anticipated to issue 20 million shares of its unregistered,
restricted common stock to the shareholders of the 21-Century Silicon in
exchange for 100% of the issued and outstanding stock of 21-Century Silicon. As
of the date of this report, the X-Change Corporation has not issued its shares
to the Company.
Income Taxes
The Company accounts for income taxes
under the liability method per the provisions of Accounting Standards
Codification Topic 740 (“ASC 740”), “Income Taxes”.
Under the provisions of ASC 740,
deferred tax assets and liabilities are determined based on the differences
between their financial statement carrying values and their respective tax bases
using enacted tax rates that will be in effect in the period in which the
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Valuation Allowance
Significant judgment is required in
determining any valuation allowance recorded against deferred tax assets. In
assessing the
need for a
valuation allowance, the Company
consider
s
all available evidence including past
operating results, estimates of future taxable income, and the feasibility of
tax planning
strategies. In the event that
the Company
chang
es
its
determination as to the amount of
deferred tax assets that can be realized,
the Company
will adjust its
valuation allowance with a corresponding
impact to the provision for income taxes in the period in which such
determination is made.
Unrecognized Tax
Benefits
Effective on October 1, 2007, the
Company adopted the provisions related to uncertain tax positions under ASC 740,
“Income Taxes”, formerly referenced as FIN 48, “Accounting for Uncertainty in
Income Taxes - An Interpretation of FASB Statement No. 109”. Under ASC
740, the impact of an uncertain income tax position on the income tax return
must be recognized at the largest amount that is more-likely-than-not to be
sustained upon audit by the relevant taxing authority based on the technical
merits of the associated tax position. An uncertain income tax position
will not be recognized if it has less than a 50% likelihood of being sustained.
The Company also elected
the accounting policy that requires interest and penalties to be recognized as
a
component of tax expense.
The Company classifies the unrecognized
tax benefits that are expected to be effectively settled within one year as
current liabilities, otherwise, the unrecognized tax benefits will be classified
as non-current liabilities.
Fair Value of
Warrants
The Company’s
management used the binomial valuation
model to value the warrants issued in conjunction with convertible notes entered
into in
March 2007. The model uses inputs such
as implied term, suboptimal exercise factor, volatility, dividend yield and risk
free interest rate. Selection of these
inputs involves management’s judgment
and may impact estimated value. Management selected the binomial model to value
these warrants as opposed to the
Black-Scholes-Merton model primarily
because management believes the binomial model produces a more reliable value
for these instruments because it
uses an additional valuation input
factor, the suboptimal exercise factor, which accounts for expected holder
exercise behavior which management believes is
a reasonable assumption with respect to
the holders of these warrants.
Stock-Based
Compensation
On January 1, 2006, Solar EnerTech
began recording compensation expense associated with stock options and other
forms of employee equity compensation in accordance with FASB ASC 718,
“Compensation – Stock Compensation”, formerly referenced as SFAS 123R,
“Share-Based Payment”.
The Company estimates the fair value of
stock options granted using the Black-Scholes-Merton option-pricing formula and
a single option approach. This fair value is then amortized on a straight-line
basis over the requisite service periods of the awards, which is generally the
vesting period. The following assumptions are used in the Black-Scholes-Merton
option pricing model:
Expected Term — The Company’s expected
term represents the period that the Company’s stock-based awards are expected to
be outstanding.
Expected Volatility — The Company’s
expected volatilities are based on historical volatility of the Company’s stock,
adjusted where determined by management for unusual and non-representative stock
price activity not expected to recur. Due to the limited trading history, the
Company also considered volatility data of guidance
companies.
Expected Dividend — The
Black-Scholes-Merton valuation model calls for a single expected dividend yield
as an input. The Company currently pays no dividends and does not expect to pay
dividends in the foreseeable future.
Risk-Free Interest Rate — The Company
bases the risk-free interest rate on the implied yield currently available on
U.S. Treasury zero-coupon issues with an equivalent remaining
term.
Estimated Forfeitures — When estimating
forfeitures, the Company takes into consideration the historical option
forfeitures over the expected term.
Revenue Recognition
The Company recognizes revenues from
product sales in accordance with guidance provided in FASB ASC 605, “Revenue
Recognition”,
which states
that revenue is
realized or realizable and earned when
all of the following criteria are met: persuasive evidence of an arrangement
exists; delivery has occurred or services
have been rendered; the price to the
buyer is fixed or determinable; and collectability is reasonably assured. Where
a revenue transaction does not meet any
of these criteria it is deferred and
recognized once all such criteria have been met. In instances where final
acceptance of the product, system, or solution is
specified by the customer, revenue is
deferred until all acceptance criteria have been met.
On a transaction by transaction basis,
the Company determines if the revenue should be recorded on a gross or net basis
based on criteria discussed in the Revenue Recognition topic of the FASB
Subtopic 605-405, “Reporting Revenue Gross as a Principal versus Net as an
Agent”. The Company considers the following factors to determine the gross
versus net presentation: if the Company (i) acts as principal in the
transaction; (ii) takes title to the products; (iii) has risks and rewards of
ownership, such as the risk of loss for collection, delivery or return; and (iv)
acts as an agent or broker (including performing services, in substance, as an
agent or broker) with compensation on a commission or fee
basis.
Accounts Receivable
and
Allowance for Doubtful
Accounts
Accounts receivable are carried at net
realizable value. The Company records
allowance for doubtful accounts based
upon its assessment of various
factors.
The Company
consider
s
historical experience, the age of the
accounts receivable balances, credit quality of
our
customers, current
economic conditions, and other factors
that may affect customers’ ability to pay.
Shipping and Handling
Costs
The Company incurred shipping and
handling
costs of
$
157
,000 and
$177,000 for
the
three months ended December 31, 2010 and
2009
, respectively, which
are included in
s
elling expenses. Shipping and handling
costs include costs incurred with third-party carriers to transport products to
customers.
Research and Development
Cost
Expenditures for research activities
relating to product development are charged to expense as incurred.
Research and development cost for the
three months ended December 31, 2010 and 2009
were $69,000 and
$108,000,
respectively.
Comprehensive
L
oss
C
omprehensive
loss
is defined as the change in equity of
the Company during a period from transactions and other events and circumstances
excluding transactions resulting from investments by owners and distributions to
owners.
C
omprehensive
loss
is reported in the consolidated
statements of shareholder’s equity.
O
ther comprehensive income of the Company
consists of cumulative foreign currency translation
adjustments.
Segment Information
The Company identifies its operating
segments based on its business activities. The Company operates within a single
operating segment - the manufacture of solar energy cells and modules in China.
The Company’s manufacturing operations and fixed assets are all based in China.
The solar energy cells and modules are distributed to customers, located in
Europe, Australia, North America and China.
During the three months ended December
31, 2010 and 2009, the
Company had one and
three customers,
respectively
that accounted
for more than 10% of net sales
.
Recent Accounting
Pronouncements
In January 2010, the FASB issued ASU
2010-06, which amended “Fair Value Measurements and Disclosures” (ASC Topic 820)
— “Improving Disclosures about Fair Value Measurements”. This guidance amends
existing authoritative guidance to require additional disclosures regarding fair
value measurements, including the amounts and reasons for significant transfers
between Level 1 and Level 2 of the fair value hierarchy, the reasons for any
transfers into or out of Level 3 of the fair value hierarchy, and presentation
on a gross basis of information regarding purchases, sales, issuances, and
settlements within the Level 3 rollforward. This guidance also clarifies
certain existing disclosure requirements. The guidance is effective for
interim and annual reporting periods beginning after December 15, 2009, except
for the disclosures about purchases, sales, issuances, and settlements within
the Level 3 rollforward, which are effective for interim and annual reporting
periods beginning after December 15, 2010. The Company adopted this
guidance on January 1, 2010. The adoption of this guidance did not have a
significant impact on the Company’s
consolidated
financial
statements.
In February 2010, the FASB issued
Accounting Standards Update (“ASU”) 2010-09, which amended “Subsequent Events”
(ASC Topic 855) — “Amendments to Certain Recognition and Disclosure
Requirements”. The amendments were made to address concerns about conflicts with
SEC guidance and other practice issues. Among the provisions of the amendment,
the FASB defined a new type of entity, termed an “SEC filer,” which is an entity
required to file or furnish its financial statements with the SEC. Entities
other than registrants whose financial statements are included in SEC filings
(e.g., businesses or real estate operations acquired or to be acquired, equity
method investees, and entities whose securities collateralize registered
securities) are not SEC filers. While an SEC filer is still required by U.S.
GAAP to evaluate subsequent events through the date its financial statements are
issued, it is no longer required to disclose in the financial statements that it
has done so or the date through which subsequent events have been evaluated. The
Company adopted this guidance on February 24, 2010. The adoption of this
guidance did not have a significant impact on the Company’s
consolidated
financial
statements.
In July 2010, the FASB issued a final
Accounting Standards Update (“ASU”) 2010-20, which requires entities to provide
extensive new disclosures in the financial statements about the financing
receivables, including credit risk exposures and the allowance for credit
losses. A financing receivable is an arrangement that represents a
contractual right to receive money on demand or on fixed or determinable dates
and that is recognized as an asset in the entity’s statement of financial
position. Entities with financing receivables will be required to disclose,
among other things (a) a roll-forward of the allowance for credit losses;
(b)
credit quality information such as
credit risk scores or external credit agency ratings; (c) impaired loan
information; (d) modification information; and (e)
non-accrual and past due information.
The Company will adopt this guidance in second quarter of fiscal year 2011. The
adoption of this guidance will not have a significant impact on the Company’s
consolidated financial statements.
NOTE 4 — FINANCIAL
INSTRUMENTS
The
Company’s assets that are potentially subject to significant concentration of
credit risk are primarily cash and cash equivalents, advance payments to
suppliers and accounts receivable.
The Company maintains cash deposits with
financial institutions, which from time to time may exceed federally insured
limits. The Company has not experienced any losses in connection with these
deposits
and believes it is
not exposed to any significant credit risk from cash. At December 31, 2010 and
September 30, 2010, the Company had approximately $82,000
and
$
82
,000, respectively in excess of insured
limits.
Advance
payments to suppliers are typically unsecured and arise from deposits paid in
advance for future purchases of raw materials. The Company does not require
collateral or other security against the prepayments to suppliers for raw
materials. In the event of a failure by the Company’s suppliers to
fulfill their contractual obligations and to the extent that the Company is not
able to recover its prepayments, the Company would suffer losses. The Company’s
prepayments to suppliers have been steadily decreasing
due
to the change in the industry practice
from requiring full cash advance to secure key raw material (
silicon
wafer
s
) as a result of the financial crisis in
2008 to requiring
less or
no cash advance during fiscal year 2
009 as the economy is recovering from
the crisis.
The economic crisis may affect the Company’s customers’
ability to pay the Company for its products that the Company has
delivered. If the customers fail to pay the Company for its products
and services, the Company’s financial condition, results of operations and
liquidity may be adversely affected.
Other financial instruments that
potentially subject the Company to concentration of credit risk consist
principally of accounts receivables. Concentrations of credit risk
with respect to accounts receivables are limited because a number of
geographically diverse customers make up the Company’s customer base, thus
spreading the trade credit risk. The Company controls credit risk
through credit approvals, credit limits and monitoring
procedures. The Company performs credit evaluations for all new
customers but generally does not require collateral to support customer
receivables. All of the Company’s customers have gone through a very strict
credit approval process. The Company diligently monitors the
customers’ financial position. Payment terms for our solar module sales
generally range from 0 to 60 days. In some cases, these terms are extended up to
200 days for certain qualifying customers of whom the Company applied rigorous
credit requirements. The Company has also purchased insurance from the
China Export & Credit Insurance Company to insure the collectability of the
outstanding accounts receivable balances of two key customers. During the three
months ended December 31, 2010 and
2009, the Company had one
and three
customers,
respectively that accounted for more
than 10% of net sales.
Foreign
exchange risk and translation
The Company may be subject to
significant currency risk due to the fluctuations of exchange rates between the
Chinese Renminbi
, Euro
and the United States
dollar.
The local currency is the functional
currency for the China subsidiary. Assets and liabilities are
translated at end of period exchange rates while revenues and expenses are
translated at the average exchange rates in effect during the
period. Equity is translated at historical rates and the resulting
cumulative translation adjustments, to the extent not included in net income,
are included as a component
of other comprehensive income (loss)
until the translation adjustments are realized. Included in other comprehensive
income were foreign currency translation adjustment gains of $203,000
and $6,000 for the
three months
ended December 31, 2010 and 2009,
respectively
. Foreign currency
transaction gains and losses are included in earnings. For the three months
ended December 31, 2010 and 2009, the Company recorded foreign exchange losses
of $0.2
million and $0.1 million,
respectively.
NOTE 5
— ADVANCE PAYMENTS AND
OTHER
At December 31, 2010 and September 30,
2010, advance payments and other consist of:
|
|
December 31,
2010
|
|
|
September 30,
2010
|
|
Prepayment for raw
materials
|
|
$
|
220,000
|
|
|
$
|
673,000
|
|
Prepayment for
equipments
|
|
|
527,000
|
|
|
|
402,000
|
|
Others
|
|
|
194,000
|
|
|
|
199,000
|
|
Total advance payments and
other
|
|
$
|
941,000
|
|
|
$
|
1,274,000
|
|
NOTE 6
— INVENTORIES
At
December 31, 2010 and September 30,
2010
, inventories consist
of:
|
|
December 31,
2010
|
|
|
September 30,
2010
|
|
Raw
materials
|
|
$
|
2,870,000
|
|
|
$
|
2,639,000
|
|
Finished
goods
|
|
|
2,522,000
|
|
|
|
1,444,000
|
|
Total
inventories
|
|
$
|
5,392,000
|
|
|
$
|
4,083,000
|
|
NOTE 7
— PROPERTY AND
EQUIPMENT
The Company
depreciates
its assets
over their estimated useful lives. A
summary of property and equipment at December 31, 2010 and September 30, 2010 is
as follows:
|
|
December 31,
2010
|
|
|
September 30,
2010
|
|
Production
equipment
|
|
$
|
8,227,000
|
|
|
$
|
8,130,000
|
|
Leasehold
improvements
|
|
|
3,752,000
|
|
|
|
3,709,000
|
|
Automobiles
|
|
|
371,000
|
|
|
|
366,000
|
|
Office
equipment
|
|
|
353,000
|
|
|
|
348,000
|
|
Machinery
|
|
|
2,991,000
|
|
|
|
2,916,000
|
|
Furniture
|
|
|
40,000
|
|
|
|
40,000
|
|
Total property and
equipment
|
|
|
15,734,000
|
|
|
|
15,509,000
|
|
Less: accumulated
depreciation
|
|
|
(7,359,000
|
)
|
|
|
(6,635,000
|
)
|
Total property and equipment,
net
|
|
$
|
8,375,000
|
|
|
$
|
8,874,000
|
|
NOTE 8
—
OTHER ASSETS
Other
assets at December 31, 2010 and September 30, 2010 mainly consist of the
following:
|
|
December 31,
2010
|
|
|
September 30,
2010
|
|
|
|
|
|
|
|
|
Land use
rights
|
|
|
|
|
|
|
Cost
|
|
$
|
755,000
|
|
|
$
|
746,000
|
|
Less: Accumulated
amortization
|
|
|
(15,000
|
)
|
|
|
(11,000
|
)
|
Total other
assets
|
|
$
|
740,000
|
|
|
$
|
735,000
|
|
On
February 8, 2010, the Company acquired land use rights of a 68,025 square meter
parcel of land located in Yizheng, Jiangsu Province of China, which will be used
to house the Company’s second manufacturing facility. For each of the next five
years, annual amortization expense of the land use rights will be approximately
$16,000 with an estimated useful life of 46.5 years
.
NOTE 9
—
SHORT TERM LOANS
At
December 31, 2010 and September 30,
20
10, Short term loans
consist of:
|
|
December 31,
2010
|
|
|
September 30,
2010
|
|
|
|
|
|
|
|
|
Short-term
loans
|
|
$
|
1,464,000
|
|
|
$
|
1,312,000
|
|
On March
25, 2010, the Company entered into a one year contract with China Export &
Credit Insurance Corporation (“CECIC”) to insure the collectability of
outstanding accounts receivable for two of the Company’s key customers. The
Company pays a fee based on a fixed percentage of the accounts
receivable outstanding and expenses this fee when it is incurred. The cost
of the insurance on accounts receivable is recorded as selling, general and
administrative costs in the Statement of Operation of the Company. In addition,
on March 30, 2010, the Company entered into a one year revolving credit
facility arrangement with IBC that is secured by the accounts receivable
balances of the two key customers insured by CECIC above.
The credit facility will
expire on March 29, 2011.
The interest rate of this credit facility is
variable and ranges from 3.13% to 4.48% during the period from March 30, 2010 to
December 31, 2010.
The
Company can draw up to the lower of $2,000,000 or the cumulative amount of
accounts receivable outstanding from the respective two key customers. If
any of the insured customers fail to repay the amounts outstanding due to the
Company, the insurance proceeds will be remitted directly to IBC instead of
the Company. Amounts drawn down as of December 31, 2010, amounted to
$1,464,000, of which $851,000 and $613,000 are due on January 27, 2011 and
February 23, 2011, respectively. As of December 31, 2010, the amount available
to be drawn was $536,000. There have been no insurance claims submitted to
CECIC. There is no commitment fees associated with the unused portion of the
credit facility. The weighted average interest rate on this credit facility in
the three months ended December 31, 2010 was 3.47% per annum.
The
credit facility contains certain non-financial ratios related covenants,
including maintaining creditworthiness, complying with all contractual
obligations, providing true and accurate records as requested by IBC,
fulfillment of other indebtedness (if any), maintaining its business license and
continuing operations, ensuring its financial condition does not deteriorate,
remaining solvent, and other conditions, as defined in the credit facility
agreement. The Company complied with these covenants as of December 31,
2010.
NOTE 10
— INCOME TAX
The Company has no taxable income and no
provision for federal and state income taxes is required for the
three months ended December
31
, 2010 and 2009,
respectively, except certain
state minimum tax
.
The Company conducts its business in the
United States and in various foreign locations and generally is subject to the
respective local countries’ statutory tax rates.
Utilization of the U.S. federal and
state net operating loss carry forwards may be subject to substantial annual
limitation due to certain limitations resulting from ownership changes provided
by U.S. federal and state tax laws. The annual limitation may result in the
expiration of net operating losses carryforwards and credits before utilization.
The Company has net operating losses in its foreign jurisdictions and those
losses can be carried forward 5 years from the year the loss was incurred. As of
December 31
, 2010 and 2009, the Company’s deferred
tax assets were subject to a full valuation allowance.
Under
the New Income Tax Law
in PRC
, dividends paid by PRC
enterprises out of profits earned post-2007 to non-PRC tax resident investors
are subject to PRC withholding tax of 10%. A lower withholding tax rate may be
applied based on applicable tax treaties with certain countries.
The New
Income Tax Law also provides that enterprises established under the laws of
foreign countries or regions and whose “place of effective management” is
located within the PRC are considered PRC tax resident enterprises and subject
to PRC income tax at the rate of 25% on worldwide income. The definition of
“place of effective management" refers to an establishment that exercises, in
substance, overall management and control over the production and business,
personnel, accounting, properties, etc. of an enterprise. If the Company or any
of its non-PRC subsidiaries is treated as a “resident enterprise” for PRC tax
purposes, the Company or such subsidiary will be subject to PRC income tax. The
Company will continue to monitor its tax status with regard to the PRC tax
resident enterprise regulation but do not anticipate material adverse impact to
financial statement as a whole.
There are no ongoing examinations by
taxing authorities at this time. The Company’s tax
years starting
from 2006 to 2010
remain open in various tax
jurisdictions
. The Company
has not recorded any unrecognized tax benefits; and does not anticipate any
significant changes within the next 12 months.
NOTE 11 — CONVERTIBLE
NOTES
On March 7, 2007, Solar EnerTech
entered into a securities purchase agreement to issue $17.3 million of secured
convertible notes (the “Notes”) and detachable stock purchase warrants the
“Series A and Series B Warrants”). Accordingly, during the quarter ended
March 31, 2007, Solar EnerTech sold units consisting
of:
|
•
|
|
$5.0 million in principal amount
of Series A Convertible Notes and warrants to purchase 7,246,377
shares (exercise price of $1.21 per share) of its common
stock;
|
|
|
|
•
|
|
$3.3 million in principal amount
of Series B Convertible Notes and warrants to purchase 5,789,474
shares (exercise price of $0.90 per share) of its common stock ;
and
|
|
|
|
•
|
|
$9.0 million in principal amount
of Series B Convertible Notes and warrants to purchase 15,789,474
shares (exercise price of $0.90 per share) of its common
stock.
|
These Notes bear interest at 6% per
annum and are due in 2010. Under their original terms, the principal amount of
the Series A Convertible Notes may be converted at the initial rate of
$0.69 per share for a total of 7,246,377 shares of common stock (which amount
does not include shares of common stock that may be issued for the payment of
interest). Under their original terms, the principal amount of the Series B
Convertible Notes may be converted at the initial rate of $0.57 per share for a
total of 21,578,948 shares of common stock (which amount does not include shares
of common stock that may be issued for the payment of
interest).
The Company evaluated the Notes for
derivative accounting considerations under FASB ASC 815 and determined that the
notes contained two embedded derivative features, the conversion option and a
redemption privilege accruing to the holder if certain conditions exist (the
“compound embedded derivative” or “CED”). The compound embedded derivative is
measured at fair value both initially and in subsequent periods. Changes in fair
value of the compound embedded derivative are recorded in the account “gain
(loss) on fair market value of compound embedded derivative” in the accompanying
consolidated statements of operations.
In connection with the issuance of the
Notes and Series A and Series B Warrants, the Company engaged an exclusive
advisor and placement agent (the “Advisor”) and issued warrants to the Advisor
to purchase an aggregate of 1,510,528 shares at an exercise price of $0.57 per
share and 507,247 shares at an exercise price of $0.69 per share, of the
Company’s common stock (the “Advisor Warrants”). In addition to the issuance of
the warrants, the Company paid $1,038,000 in commissions, an advisory fee of
$173,000, and other fees and expenses of $84,025.
The Series A and Series B Warrants
(including the Advisor Warrants) were classified as a liability, as required by
FASB ASC 480, “Distinguishing Liabilities from Equity”, formerly referenced as
SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics
of Both Liabilities and Equity”, due to the terms of the warrant agreement which
contains a cash redemption provision in the event of a fundamental transaction.
The warrants are measured at fair value both initially and in subsequent
periods. Changes in fair value of the warrants are recorded in the account “gain
(loss) on fair market value of warrant liability” in the accompanying
consolidated statements of operations.
In conjunction with the March 2007
financing, the Company recorded a total deferred financing cost of $2.5 million,
of which $1.3 million represented cash payment and $1.2 million represented the
fair market value of the Advisor Warrants. The deferred financing cost is
amortized over the three year life of the notes using a method that approximates
the effective interest rate method. The Advisor Warrants were recorded as a
liability and adjusted to fair value in each subsequent
period.
On January 7, 2010 (the “Conversion
Date”), the Company entered into a Series A and Series B Notes Conversion
Agreement (the “Conversion Agreement”) with the holders of Notes representing at
least seventy-five percent of the aggregate principal amounts outstanding under
the Notes to restructure the terms of the Notes. As of the Conversion Date,
approximately $9.8 million of the Series A and B Convertible Notes were
effectively converted into 64,959,227 shares of the Company’s common stock along
with 1,035,791 shares of the Company’s common stock as settlement of the accrued
interest on the Series A and B Convertible Notes, and the remaining $1.8 million
of the Series B Notes were exchanged into another convertible note as further
discussed below. In connection with the Conversion Agreement, on January 7,
2010, the Company entered into an Amendment (the “Warrant Amendment”) to the
Series A, Series B and Series C Warrants with the holders of at least a majority
of the common stock underlying each of its outstanding Series A Warrants, Series
B Warrants and Series C Warrants (collectively the “PIPE Warrants”). The Warrant
Amendment reduced the exercise price for all of the PIPE Warrants from $1.21,
$0.90 and $1.00, respectively, to $0.15, removed certain maximum ownership
provisions and removed anti-dilution provisions for lower-priced security
issuances.
The Conversion Agreement resulted in
modifications or exchanges of the Notes and PIPE Warrants, which should be
accounted for pursuant to FASB ASC 405-20, “Liabilities” and FASB ASC 470-50,
"Debt/Modifications and Extinguishment" formerly referenced as EITF Consensus
for Issue No. 96-19, "Debtor's Accounting for a Modification (or Exchange) of
Convertible Debt Instruments". The combination of the adjustment to conversion
price and the automatic conversion of the Notes effectively resulted in the
settlement of the Notes through the issuance of shares of the Company’s common
stock and amendment of the PIPE Warrants’ terms. Since the Company is relieved
of its obligation for the Notes, the transaction is accounted for as an
extinguishment of the Notes upon issuance of ordinary shares and modification of
the PIPE Warrants’ terms. The loss on extinguishment associated with the
Conversion Agreement amounted to approximately $17.2
million.
On January 19, 2010, a holder of
approximately $1.8 million of the Company’s formerly outstanding Series B Notes
and Series B Warrants (hereinafter referred to as the “Holder”) of the Company’s
common stock disputed the effectiveness of the Conversion Agreement and the
Warrant Amendment. Accordingly, the Holder did not tender its Series
B Notes for conversion. After negotiations with the Holder, on March 19, 2010,
the Company entered into an Exchange Agreement with the Holder (the “Exchange
Agreement”), whereby the Company issued the Series B-1 Note with a principal
amount of $1.8 million (the “Series B-1 Note”) to the Holder along with 283,498
shares of the Company’s common stock as settlement of the accrued interest on
the Holder’s Series B Notes and 666,666 shares of the Company’s common stock as
settlement of the outstanding dispute regarding the effectiveness of the
Company’s Conversion Agreement and the Warrant Amendment. The Company
did not capitalize any financing costs associated with the issuance of the
Series B-1 Note.
As
of
December 31
, 2010, the Company has an outstanding
convertible note with a principal balance of $1.
6
million consisting of the Series B-1
Note, which was recorded at a carrying amount of $1.5 million. The Series B-1
Note bears interest at 6% per annum and is due on
March 19,
2012. During the
three months ended December
31
, 2010, the Company
issued 243,696 shares
of
its common
stock
to settle the accrued interest
on the Series B-1 Note.
The Exchange Agreement resulted in
modifications or exchanges of the Holder’s rights under its former Series B
Note, which should be accounted for pursuant to FASB ASC 470-50,
"Debt/Modifications and Extinguishment" formerly referenced as EITF Consensus
for Issue No. 96-19, "Debtor's Accounting for a Modification (or Exchange) of
Convertible Debt Instruments", and FASB ASC 470-50, "Debt/Modifications and
Extinguishment" formerly referenced as EITF Consensus for Issue No.06-06,
"Debtor's Accounting for a Modification (or Exchange) of Convertible Debt
Instruments". The loss on debt extinguishment associated with the Exchange
Agreement amounted to approximately $1.3 million.
The costs associated with the Conversion
Agreement were directly derived from the execution of the Company’s plan in
improving its liquidity and business sustainability. The related loss on debt
extinguishment was a cost that was integral to the continuing operations of the
business which is different in nature to the continuing interest payments and
change in fair value of the compound embedded derivative and warrant liability.
Accordingly, the loss on debt extinguishment is included in operating expenses
in the accompanying consolidated statements of operations.
The Company evaluated the Series B-1
Note for derivative accounting considerations under FASB ASC 815 and determined
that the Series B-1 Note contained two embedded derivative features, the
conversion option and a redemption privilege accruing to the holder if certain
conditions exist (the “compound embedded derivative”). The compound embedded
derivative is measured at fair value both initially and in subsequent periods.
Changes in fair value of the compound embedded derivative are recorded in the
account “gain (loss) on fair market value of compound embedded derivative” in
the accompanying consolidated statements of operations.
The
gain
on debt extinguishment is computed as
follows:
|
|
Quarter Ended December
31,
|
|
|
|
2010
|
|
|
2009
|
|
Fair value of the common
shares
|
|
$
|
70,000
|
|
|
$
|
-
|
|
Fair value of the CED liability
associated with the converted notes
|
|
|
(13,000
|
)
|
|
|
-
|
|
Accreted amount of the notes
discount
|
|
|
(89,000
|
)
|
|
|
-
|
|
Gain on debt
extinguishment
|
|
$
|
(32,000
|
)
|
|
$
|
-
|
|
During the quarter ended December 31,
2010, $100,000 of the Series B-1 Note was converted into 666,667 shares of the
Company’s common stock.
As
a result, t
he Company
recorded a cumulative gain on debt extinguishment of approximately $32,000
during the quarter ended December 31, 2010.
For the quarter ended December 31, 2009,
none of Series A and B Convertible Notes were converted into the Company’s
common shares. As a result, no loss on debt extinguishment
was recorded during the quarter ended
December 31, 2009.
The following table summarizes the
valuation of the Notes and the related Compound Embedded Derivative, the Series
A and Series B Warrants (including the Advisor Warrants), and the Series B-1
Note and the related Compound Embedded Derivative:
Carrying amount of Series B-1 Note
at March 19, 2010
|
|
$
|
1,815,000
|
|
Fair value of compound embedded
derivative liabilities
|
|
|
(1,573,000
|
)
|
Loss on debt
extinguishment
|
|
|
1,293,000
|
|
Amortization of note discount and
conversion effect
|
|
|
(4,000
|
)
|
Carrying amount of Series B-1 Note
at September 30, 2010
|
|
$
|
1,531,000
|
|
Amortization of note discount and
conversion effect
|
|
|
(58,000
|
)
|
Carrying amount of Series B-1 Note
at December 31, 2010
|
|
$
|
1,473,000
|
|
|
|
|
|
|
Fair value of the Series B-1
compound embedded derivative liabilities at March 19,
2010
|
|
$
|
1,573,000
|
|
Gain on fair market value of
embedded derivative liability
|
|
|
(1,131,000
|
)
|
Effect on debt
conversion
|
|
|
(20,000
|
)
|
Fair value of the Series
B-1compound embedded derivative liabilities at September 30,
2010
|
|
$
|
422,000
|
|
Gain on fair market value of
embedded derivative liability
|
|
|
(202,000
|
)
|
Effect on debt
conversion
|
|
|
(13,000
|
)
|
Fair value of the Series
B-1compound embedded derivative liabilities at December 31,
2010
|
|
$
|
207,000
|
|
|
|
|
|
|
Fair value of warrant liability at
September 30, 2009
|
|
$
|
2,068,000
|
|
Loss on PIPE warrant
extinguishment
|
|
|
3,502,000
|
|
Cashless exercise of
warrants
|
|
|
(157,000
|
)
|
Gain on fair market value of
warrant liability
|
|
|
(4,511,000
|
)
|
Fair value of warrant liability at
September 30, 2010
|
|
$
|
902,000
|
|
Gain on fair market value of
warrant liability
|
|
|
(466,000
|
)
|
Fair value of warrant liability at
December 31, 2010
|
|
$
|
436,000
|
|
Series B-1 Note
The material terms of the Series B-1
Note are as follows:
Interest Payments
The Series B-1 Note bears interest at 6%
per annum and the principal of $1.5 million is due on March 19, 2012. Accrued
interest is payable quarterly in arrears on each of January 1,
April 1, July 1 and October 1
,
beginning on the first such
date after issuance, in cash or registered shares of common stock at the option
of the Company. If the Company elects to pay any interest due in registered
shares of the Company’s common stock: (i) the issuance price will be 90% of
the 5-day weighted average price of the common stock ending on the day prior to
the interest payment due date, and (ii) a trigger event shall not have
occurred.
Voting Rights
The holder of the Series B-1 Note does
not have voting rights under these agreements.
Dividends
Until all amounts owed under the Series
B-1 Note have been converted, redeemed or otherwise satisfied in accordance with
their terms, the Company shall not, directly or indirectly, redeem, repurchase
or declare or pay any cash dividend or distribution on its capital stock without
the prior express written consent of the required holders.
Conversion Right
At any time or times on or after the
issuance date of the Series B-1 Note, the holder is entitled to convert, at the
holder’s sole discretion, any portion of the outstanding and unpaid conversion
amount (principal, accrued and unpaid interest and accrued and unpaid late
charges) may be converted into fully paid and non-assessable shares of common
stock, at the conversion rate discussed next.
Conversion Rate
The number of shares of common stock
issuable upon conversion of the Series B-1 Note is determined by dividing
(x) the conversion amount (principal, interest and late charges accrued and
unpaid), by (y) the then applicable conversion price (initially $0.15 for
Series B-1 Note, subject to adjustment as provided in the agreement). No
adjustment in the conversion price of the Series B-1 Note will be made in
respect of the issuance of additional shares of common stock unless the
consideration per share of an additional share of common stock issued or deemed
to be issued by the Company is less than the conversion price of the Series B-1
Note in effect on the date of, and immediately prior to, such issuance. Should
the outstanding shares of common stock increase (by stock split, stock dividend,
or otherwise) or decrease (by reclassification or otherwise), the conversion
price of the Series B-1 Note in effect immediately prior to the change shall be
proportionately adjusted.
Redemptions
The Series B-1 Note permits the holder
the right of redemption in the event of certain specified triggering events such
as:
1)
|
The suspension from trading or
failure of the common stock to be listed on the principal market or an
eligible market for a period of five (5) consecutive trading days or
for more than an aggregate of ten (10) trading days in any 365-day
period;
|
|
|
2)
|
The Company’s (A) failure to
cure a conversion failure by delivery of the required number of shares of
common stock within ten (10) trading days after the applicable
conversion date or (B) notice, written or oral, to any holder of the
Series B-1 Note, including by way of public announcement or through any of
its agents, at any time, of its intention not to comply with a request for
conversion of any Series B-1 Note into shares of common stock that is
tendered in accordance with the provisions of the Series B-1
Note;
|
|
|
3)
|
The Company's failure to pay to
the Holder any amount of principal (including, without limitation, any
redemption payments), interest, late charges or other amounts when and as
due under this Series B-1 Note except, in the case of a failure to pay any
interest and late charges when and as due, in which case only if such
failure continues for a period of at least five (5) business days;
|
|
|
4)
|
(A) The occurrence of any
payment default or other default under any indebtedness of the Company or
any of its subsidiaries that results in a redemption of or acceleration
prior to maturity of $100,000 or more of such indebtedness in the
aggregate, or (B) the occurrence of any material default under any
indebtedness of the Company or any of its subsidiaries having an aggregate
outstanding balance in excess of $100,000 and such default continues
uncured for more than ten (10) business days, other than, in each case
(A) or (B) above, or a default with respect to any other Series
B-1 Note;
|
|
|
5)
|
The Company or any of its
subsidiaries, pursuant to or within the meaning of Title 11, U.S. Code, or
any similar Federal, foreign or state law for the relief of debtors
(A) commences a voluntary case, (B) consents to the entry of an
order for relief against it in an involuntary case, (C) consents to
the appointment of a receiver, trustee, assignee, liquidator or similar
official
,
(D) makes a
general assignment for the benefit of its creditors or (E) admits in
writing that it is generally unable to pay its debts as they become
due;
|
|
|
6)
|
A court of competent jurisdiction
enters an order or decree under any bankruptcy law that (A) is for
relief against the Company or any of its subsidiaries in an involuntary
case, (B) appoints a custodian of the Company or any of its
subsidiaries or (C) orders the liquidation of the Company or any of
its subsidiaries;
|
7)
|
A final judgment or judgments for
the payment of money aggregating in excess of $250,000 are rendered
against the Company or any of its subsidiaries and which judgments are
not, within sixty (60) days after the entry thereof, bonded,
discharged or stayed pending appeal, or are not discharged within sixty
(60) days after the expiration of such stay; provided, however, that
any judgment which is covered by insurance or an indemnity from a credit
worthy party shall not be included in calculating the $250,000 amount set
forth above so long as the Company provides the holder with a written
statement from such insurer or indemnity provider (which written statement
shall be reasonably satisfactory to the holder) to the effect that such
judgment is covered by insurance or an indemnity and the Company will
receive the proceeds of such insurance or indemnity within thirty (30)
days of the issuance of such judgment; and
|
|
|
8)
|
The Company breaches any
representation, warranty, covenant or other term or condition of any
transaction document, except, in the case of a breach of a covenant which
is curable, only if such breach continues for a period of at least ten
(10) consecutive business days.
|
At any time after becoming aware of a
trigger event, the holder may require the Company to redeem all or any portion
of the Series B-1 Note at an amount equal to any accrued and unpaid liquidated
damages, plus the greater of (A) the conversion amount to be redeemed
multiplied by the redemption premium (125% for trigger events described above in
subparagraphs 1 to 5 and 8 above or 100% for other events), or (B) the
conversion amount to be redeemed multiplied by the quotient of (i) the
closing sale price at the time of the trigger event (or at the time of payment
of the redemption price, if greater) divided by (ii) the conversion
price
,
provided,
however, (B) shall be applicable only in the event that a trigger event of
the type specified above in subparagraphs 1, 2 or 3 has occurred and remains
uncured or the conversion shares otherwise could not be received or sold by the
holder without any resale restrictions.
Rights upon Fundamental Transaction,
Change of Control and Qualified Financing
The Series B-1 Note also contains
certain provisions relating to the occurrences of a fundamental transaction
limiting the type of entity that can be a successor entity and requiring the
successor entity to assume the obligations of the Series B-1 Note. In
addition, the Series B-1 Note contains certain provisions relating to a change
of control or qualified financing which permit the holder the right of
redemption for all or a portion of the Series B-1 Note.
1)
|
Assumption.
The Company may not enter into or
be party to a fundamental transaction, as such terms is defined in the
Series B-1 Note, unless:
|
|
•
|
The successor entity assumes in
writing all of the obligations of the Company under the Series B-1 Note
and related documents; and
|
|
|
|
|
•
|
The successor entity (including
its parent entity) is a publicly traded corporation whose common stock is
quoted on or listed for trading on an eligible
market.
|
2)
|
Redemption
Right on Change of Control.
At any time during the period
beginning on the date of the holder’s receipt of a change of control
notice and ending twenty (20) trading days after the consummation of
such change of control, the holder may require the Company to redeem all
or any portion of the Series B-1 Note in cash for an amount equal to any
accrued and unpaid liquidated damages, plus the greater of (i) the
product of (x) the conversion amount being redeemed and (y) the
quotient determined by dividing (A) the greater of the closing sale
price of the common stock immediately prior to the consummation of the
change of control, the closing sale price immediately following the public
announcement of such proposed change of control and the closing sale price
of the common stock immediately prior to the public announcement of such
proposed change of control by (B) the conversion price and
(ii) 125% of the conversion amount being redeemed
.
|
3)
|
Redemption
Right on Subsequent Financing.
In the event that the Company or
any of its subsidiaries shall issue any of its or its subsidiaries' equity
or equity equivalent securities, or commit to issue or sell in one or more
series of related transactions or financings, including without limitation
any debt, preferred stock or other instrument or security that is, at any
time during its life and under any circumstances, convertible into or
exchangeable or exercisable for shares of common stock, options or
convertible securities (any such offer, sale, grant, disposition or
announcement of such current or future committed financing is referred to
as a "Subsequent Financing"), the Company is obligated to provide the
Holder written notice of the Subsequent Financing and the Holder, at its
option, may require the Company to redeem the Series B-1 Note up to the
Redemption Amount.
|
|
|
|
(A) In the event that the Gross
Proceeds of the Subsequent Financing equals or exceeds $15,000,000 (a
“Qualified Financing”), the “Redemption Amount” shall equal 100% of the
Principal Amount then outstanding. For purposes hereof, “Gross
Proceeds” shall mean the aggregate proceeds received or receivable by the
Company in respect of one or more series of related future transactions or
financings for which the Company is committed in connection with such
Qualified Financing.
(B) In the event that the Gross
Proceeds of the Subsequent Financing is less than $15,000,000, the
Redemption Amount shall equal a pro-rated portion of the Principal Amount
equaling a ratio, the numerator of which is the amount of proceeds raised
by the Company in the Subsequent Financing and the denominator which is
$15,000,000.
|
NOTE 12
—
STOCKHOLDERS’ EQUITY
Warrants
During March 2007, in conjunction
with the issuance of $17,300,000 in convertible debt, the board of directors
approved the issuance of Warrants to purchase shares of the Company’s common
stock. Under their original terms, the 7,246,377 Series A warrants and the
21,578,948 Series B warrants are exercisable at $1.21 and $0.90, respectively
and expire in March 2012. In addition, in March 2007, as additional
compensation for services as placement agent for the convertible debt offering,
the Company issued the Advisor Warrants, which entitle the placement agent to
purchase 507,247 and 1,510,528 shares of the Company’s common stock at exercise
prices of $0.69 and $0.57 per share, respectively. The Advisor Warrants expire
in March 2012.
The Series A and Series B Warrants
(including the Advisor Warrants) are classified as a liability in accordance
with FASB ASC 480, “Distinguishing Liabilities from Equity”, due to the terms of
the warrant agreements which contain cash redemption provisions in the event of
a fundamental transaction, which provide that the Company would repurchase any
unexercised portion of the warrants at the date of the occurrence of the
fundamental transaction for the value as determined by the Black-Scholes Merton
valuation model. As a result, the warrants are measured at fair value both
initially and in subsequent periods. Changes in fair value of the warrants are
recorded in the account “gain (loss) on fair market value of warrant liability”
in the accompanying Consolidated Statements of Operations.
Additionally, in connection with the
offering, all of the Company’s Series A and Series B warrant holders
waived their full ratchet anti-dilution and price protection rights previously
granted to them in connection with the Company’s March 2007 convertible
note and warrant financing.
On January 12, 2008, the Company sold
24,318,181 shares of its common stock and 24,318,181 Series C warrants (the
“Series C Warrants”) to purchase shares of common stock for an aggregate
purchase price of $21.4 million in a private placement offering to accredited
investors. Under its original terms, the exercise price of the Series C Warrants
is $1.00 per share. The warrants are exercisable for a period of 5 years from
the date of issuance of the Series C Warrants.
For the services in connection with this
closing, the placement agent and the selected dealer, Knight Capital Markets,
LLC and Ardour Capital Investments, received an aggregate of a 6.0% cash
commission, a 1.0% advisory fee and warrants to purchase 1,215,909 shares of
common stock at $0.88 per share, exercisable for a period of 5 years from the
date of issuance of the warrants. The net proceeds from issuing common stock and
Series C warrants in January 2008 after all the financing costs were $19.9
million and were recorded in additional paid in capital and common stock.
Neither the shares of common stock nor the shares of common stock underlying the
warrants sold in this offering were granted registration
rights.
In connection with the Conversion
Agreement, on January 7, 2010, the Company entered into an Amendment (the
“Warrant Amendment”) to the Series A, Series B and Series C Warrants with the
holders of at least a majority of the common stock underlying each of its
outstanding Series A Warrants, Series B Warrants and Series C Warrants
(collectively the “PIPE Warrants”). The Warrant Amendment reduced the exercise
price for all of the PIPE Warrants from $1.21, $0.90 and $1.00, respectively, to
$0.15, removed certain maximum ownership provisions and removed anti-dilution
provisions for lower-priced security issuances. Given the above, the liability
associated with the PIPE Warrants at the pre Conversion Agreement exercise price
was considered extinguished and was replaced with the liability associated with
the PIPE Warrants at the post Conversion Agreement exercise price, which were
recorded at fair value.
During the quarter ended March 31, 2010,
a warrants holder exchanged 1,147,394 warrants for 450,878 shares of the
Company’s common stock after a cashless exercise. There was no
warrants exercise during the three months ended December 31,
2010.
A summary of outstanding warrants as of
December 31, 2010 is as follows:
|
|
Number of
Shares
|
|
|
Exercise Price
($)
|
|
Recognized
as
|
Granted in connection with
convertible notes — Series A
|
|
|
7,246,377
|
|
|
|
1.21
|
|
Discount to notes
payable
|
Granted in connection with
convertible notes — Series B
|
|
|
21,578,948
|
|
|
|
0.90
|
|
Discount to notes
payable
|
Granted in connection with common
stock purchase — Series C
|
|
|
24,318,181
|
|
|
|
1.00
|
|
Additional paid in
capital
|
Granted in connection with
placement service
|
|
|
507,247
|
|
|
|
0.69
|
|
Deferred financing
cost
|
Granted in connection with
placement service
|
|
|
1,510,528
|
|
|
|
0.57
|
|
Deferred financing
cost
|
Granted in connection with
placement service
|
|
|
1,215,909
|
|
|
|
0.88
|
|
Additional paid in
capital
|
Extinguishment in accordance with
the Conversion Agreement
|
|
|
(53,143,506
|
)
|
|
|
N/A
|
|
Loss on debt
extinguishment
|
Issuance in accordance with the
Conversion Agreement
|
|
|
53,143,506
|
|
|
|
0.15
|
|
Warrant
liabilities
|
Cashless exercise of
warrants
|
|
|
(1,147,394
|
)
|
|
|
0.15
|
|
Additional paid in
capital
|
Outstanding at December 31,
2010
|
|
|
55,229,796
|
|
|
|
|
|
|
At December 31, 2010, the range of
warrant prices for shares under warrants and the weighted-average remaining
contractual life is as follows:
Warrants Outstanding and
Exercisable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Weighted-
|
|
|
Average
|
|
Range of
|
|
|
|
|
Average
|
|
|
Remaining
|
|
Warrant
|
|
Number of
|
|
|
Exercise
|
|
|
Contractual
|
|
Exercise
Price
|
|
Warrants
|
|
|
Price
|
|
|
Life
|
|
$0.15
|
|
|
51,996,112
|
|
|
|
$0.15
|
|
|
|
1.59
|
|
$0.57-$0.88
|
|
|
3,233,684
|
|
|
|
$0.71
|
|
|
|
1.52
|
|
Restricted Stock
On August 19, 2008, Mr. Leo Young, the
Company’s Chief Executive Officer, entered into a Stock Option Cancellation and
Share Contribution Agreement with Jean Blanchard, a former officer, to provide
for (i) the cancellation of a stock option agreement by and between Mr. Young
and Ms. Blanchard dated on or about March 1, 2006 and (ii) the contribution to
the Company by Ms. Blanchard of the remaining 25,250,000 shares of common stock
underlying the cancelled option agreement.
On the same day, an Independent
Committee of the Company’s Board adopted the 2008 Restricted Stock Plan (the
“2008 Plan”) providing for the issuance of 25,250,000 shares of restricted
common stock to be granted to the Company’s employees pursuant to forms of
restricted stock agreements.
The 2008 Plan provides for the issuance
of a maximum of 25,250,000 shares of restricted stock in connection with awards
under the 2008 Plan. The 2008 Plan is administered by the Company’s Compensation
Committee, a subcommittee of the Company’s Board of Directors, and has a term of
10 years. Restricted stock vest over a three year period and unvested
restricted stock are forfeited and cancelled as of the date that employment
terminates. Participation is limited to employees, directors and consultants of
the Company and its subsidiaries and other affiliates. During any period in
which shares acquired pursuant to the 2008 Plan remain subject to vesting
conditions, the participant shall have all of the rights of a stockholder of the
Company holding shares of stock, including the right to vote such shares and to
receive all dividends and other distributions paid with respect to such
shares. If a participant terminates his or her service for any reason
(other than death or disability), or the participant’s service is terminated by
the Company for cause, then the participant shall forfeit to the Company any
shares acquired by the participant which remain subject to vesting Conditions as
of the date of the participant’s termination of service. If a participant’s
service is terminated by the Company without cause, or due to the death or
disability of the participant, then the vesting of any restricted stock award
shall be accelerated in full as of the effective date of the participant’s
termination of service.
Issuance of fully vested restricted
stock to the Company’s former Board of Directors
On January 12, 2010, the Company issued
400,000 shares of fully vested restricted stock to the Company’s former board of
directors on their resignation date. As the former directors no longer provide
services to the Company, these awards were properly accounted for as awards to
non-employees in accordance with FASB ASC 718.
The following table summarizes the
activity of the Company’s unvested restricted stock units as of December 31,
2010 and September 30, 2010
is
presented below:
|
|
Restricted
Stock
|
|
|
|
Number of
|
|
|
Weighted-
|
|
|
|
shares
|
|
|
average grant-
|
|
|
|
|
|
|
date
fair value
|
|
Unvested as of September 30,
2009
|
|
|
23,150,000
|
|
|
$
|
0.62
|
|
Restricted stock
canceled
|
|
|
(10,000,000
|
)
|
|
$
|
0.62
|
|
Restricted stock
granted
|
|
|
400,000
|
|
|
$
|
0.31
|
|
Restricted stock
vested
|
|
|
(400,000
|
)
|
|
$
|
0.31
|
|
Unvested as of September 30,
2010
|
|
|
13,150,000
|
|
|
$
|
0.62
|
|
Restricted stock
canceled
|
|
|
(80,000
|
)
|
|
$
|
0.62
|
|
Restricted stock
vested
|
|
|
(2,630,000
|
)
|
|
$
|
0.62
|
|
Unvested as of December 31,
2010
|
|
|
10,440,000
|
|
|
$
|
0.76
|
|
The total unvested restricted stock as
of December 31, 2010 and September 30, 2010
were
10,440
,000 and
13,150,000
shares,
respectively.
Stock-based compensation expense for
restricted stock for the three months ended December 31, 2010 and
2009 were 0.6 million and $0.6 million,
respectively. As of December 31, 2010, the total unrecognized compensation
expense net of forfeitures relate
d
to unvested awards was $1.7 million and
is expected to be amortized over a weighted average period of 0.63
years.
Issuance of common shares to
non-employees
On February 1, 2010, the Company issued
400,000 shares of common stock to the Company’s third party financial advisors.
These awards were properly accounted for as awards to non-employees in
accordance with FASB ASC 718.
Options
Amended and Restated 2007 Equity
Incentive Plan
In September 2007, the Company
adopted the 2007 Equity Incentive Plan (the “2007 Plan”) that allows the Company
to grant non-statutory stock options to employees, consultants and directors. A
total of 10 million shares of the Company’s common stock are authorized for
issuance under the 2007 Plan. The maximum number of shares that may be issued
under the 2007 Plan will be increased for any options granted that expire, are
terminated or repurchased by the Company for an amount not greater than the
holder’s purchase price and may also be adjusted subject to action by the
stockholders for changes in capital structure. Stock options may have exercise
prices of not less than 100% of the fair value of a share of stock at the
effective date of the grant of the option.
On February 5, 2008, the Board of
Directors of the Company adopted the Amended and Restated 2007 Equity Incentive
Plan (the “Amended 2007 Plan”), which increases the number of shares authorized
for issuance from 10 million to 15 million shares of common stock and was to be
effective upon approval of the Company’s stockholders and upon the Company’s
reincorporation into the State of Delaware.
On May 5, 2008, at the Company’s Annual
Meeting of Stockholders, the Company’s stockholders approved the Amended 2007
Plan. On August 13, 2008, the Company reincorporated into the State
of Delaware. As of December 31, 2010 and September 30, 2010, 12,860,000 and
12,860,000 shares of common stock, respectively remain available for future
grants under the Amended 2007 Plan.
These options vest over various periods
up to four years and expire no more than ten years from the date of grant. A
summary of activity under the Amended 2007 Plan is as
follows:
|
|
Option Available For
Grant
|
|
|
Number of Option
Outstanding
|
|
|
Weighted Average Fair Value Per
Share
|
|
|
Weighted Average Exercise Price
Per Share
|
|
Balance at September 30,
2009
|
|
|
12,060,000
|
|
|
|
2,940,000
|
|
|
$
|
0.39
|
|
|
$
|
0.62
|
|
Options
granted
|
|
|
(250,000
|
)
|
|
|
250,000
|
|
|
$
|
0.13
|
|
|
$
|
0.20
|
|
Options
cancelled
|
|
|
1,050,000
|
|
|
|
(1,050,000
|
)
|
|
$
|
0.39
|
|
|
$
|
0.62
|
|
Balance at September 30,
2010
|
|
|
12,860,000
|
|
|
|
2,140,000
|
|
|
$
|
0.32
|
|
|
$
|
0.55
|
|
Options
granted
|
|
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Balance at December 31,
2010
|
|
|
12,860,000
|
|
|
|
2,140,000
|
|
|
$
|
0.27
|
|
|
$
|
0.49
|
|
The total fair value of shares vested
during the three months ended December 31, 2010 and
2009 were approximately $6,000
and
$13,000,
respectively.
At December 31, 2010 and September 30,
2010
,
2,140,000 and
2,140,000
options were outstanding, respectively
and had a weighted-average remaining contractual life
of 7.41 years
and
7.66
years, respectively. Of these
options,
1,577,917
and
1,542,917
shares were vested and e
xercisable on December 31, 2010 and
September 30, 2010
,
respectively. The weighted-average exercise price and weighted-average
remaining contractual term of options currently
exercisable were $0.57 and 6.96 years,
respectively.
There were no employee stock options
granted during the three months ended December 31, 2010
and 2009.
In accordance with the provisions of
FASB ASC 718, the Company has recorded stock-based
compensation expense of $0.7 million and
$0.7 million for the three months ended December 31, 2010 and 2009,
respectively, which include the compensation effect for the options and
restricted stock. The stock-based compensation expense is based on the fair
value of the options at the grant
date. The Company recognized
compensation expense for share-based awards based upon their value on the date
of grant amortized over the applicable service period, less an allowance
estimated future forfeited awards.
NOTE 13
— FAIR VALUE OF FINANCIAL
INSTRUMENTS
In September 2006, the FASB issued SFAS
157, “Fair Value Measurements”, codified in FASB ASC 820, “Fair Value
Measurements and Disclosures”, which defines fair value to measure assets and
liabilities, establishes a framework for measuring fair value, and requires
additional disclosures about the use of fair value. FASB ASC 820 is applicable
whenever another accounting pronouncement requires or permits assets and
liabilities to be measured at fair value. FASB ASC 820 does not expand or
require any new fair value measures. FASB ASC 820 is effective for fiscal years
beginning after November 15, 2007. In December 2007, the FASB agreed to a one
year deferral of FASB ASC 820’s fair value measurement requirements for
nonfinancial assets and liabilities that are not required or permitted to be
measured at fair value on a recurring basis. The Company adopted FASB ASC 820 on
October 1, 2008, which had no effect on the Company’s financial position,
operating results or cash flows.
FASB ASC 820 defines fair value and
establishes a hierarchal framework which prioritizes and ranks the market price
observability used in fair value measurements. Market price observability is
affected by a number of factors, including the type of asset or liability and
the characteristics specific to the asset or liability being measured. Assets
and liabilities with readily available, active, quoted market prices or for
which fair value can be measured from actively quoted prices generally are
deemed to have a higher degree of market price observability and a lesser degree
of judgment used in measuring fair value. Under FASB ASC 820, the inputs used to
measure fair value must be classified into one of three levels as
follows:
Level 1 -
|
Quoted prices in an active market
for identical assets or liabilities;
|
Level 2 -
|
Observable inputs other than Level
1, quoted prices for similar assets or liabilities in active markets,
quoted prices for identical or similar assets and liabilities in markets
that are not active, and model-derived prices whose inputs are observable
or whose significant value drivers are observable;
and
|
|
|
Level 3 -
|
Assets and liabilities whose
significant value drivers are
unobservable.
|
Observable inputs are based on market
data obtained from independent sources, while unobservable inputs are based on
the Company’s market assumptions. Unobservable inputs require significant
management judgment or estimation. In some cases, the inputs used to measure an
asset or liability may fall into different levels of the fair value hierarchy.
In those instances, the fair value measurement is required to be classified
using the lowest level of input that is significant to the fair value
measurement. Such determination requires significant management
judgment.
The Company’s liabilities measured at
fair value on a recurring basis consisted of the following types of instruments
as of December 31, 2010:
|
|
Fair Value at December 31,
2010
|
|
Quoted prices in active markets
for identical assets
|
|
Significant other observable
inputs
|
|
Significant unobservable
inputs
|
|
|
|
|
|
(Level 1)
|
|
(Level 2)
|
|
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
liabilites
|
|
$
|
207,000
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
207,000
|
|
Warrant
liabilities
|
|
|
436,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
436,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
$
|
643,000
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
643,000
|
|
The method used to estimate the value of
the Series B-1 Note compound embedded derivatives (“CED”) was a binomial model
with the following assumptions:
|
|
December 31,
2010
|
|
|
September 30,
2010
|
|
Implied term
(years)
|
|
|
1.22
|
|
|
|
1.46
|
|
Suboptimal exercise
factor
|
|
|
2.50
|
|
|
|
2.50
|
|
Volatility
|
|
|
62.00
|
%
|
|
|
66.30
|
%
|
Dividend
yield
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
Risk-free interest
rate
|
|
|
0.36
|
%
|
|
|
0.34
|
%
|
The fair value of the Series A and
Series B Warrants (including the Advisor Warrants) were estimated using a
binomial valuation model with the following assumptions:
|
|
December 31,
2010
|
|
|
September 30,
2010
|
|
Implied term
(years)
|
|
|
1.18
|
|
|
|
1.43
|
|
Suboptimal exercise
factor
|
|
|
2.5
|
|
|
|
2.5
|
|
Volatility
|
|
|
70
|
%
|
|
|
78
|
%
|
Dividend
yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Risk free interest
rate
|
|
|
0.35
|
%
|
|
|
0.33
|
%
|
The carrying values of cash and cash
equivalents, accounts receivable, accrued expenses, accounts payable, accrued
liabilities and amounts due to related party approximate fair value because of
the short-term maturity of these instruments. The Company does not invest its
cash in auction rate securities.
At December 31, 2010, the principal
outstanding and the carrying value of the Company’s Series B-1 Note were
$1.
6
million and $1.5 million, respectively.
The Series B-1 Note contains two embedded derivative features, the conversion
option and a redemption privilege accruing to the holder if certain conditions
exist (the “compound embedded derivative”), which are measured at fair value
both initially and in subsequent periods
. The fair value of the convertible
notes can be determined based on the fair value of the entire financial
instrument.
NOTE 14
— COMPREHENSIVE
INCOME (
LOSS
)
The components of comprehensive
income (
loss
)
were as
follows:
|
|
Quarter Ended December
31,
|
|
|
|
2010
|
|
|
2009
|
|
Net income
(loss)
|
|
$
|
4,987,000
|
|
|
$
|
(3,924,000
|
)
|
Other comprehensive
income:
|
|
|
|
|
|
|
|
|
Change in foreign currency
translation
|
|
|
203,000
|
|
|
|
6,000
|
|
Comprehensive income
(loss)
|
|
$
|
5,190,000
|
|
|
$
|
(3,918,000
|
)
|
The accumulated other comprehensive
income at
December 31, 2010
and September 30, 2010
comprised of accumulated translation adjustments
of $3.0 million and
$2.
8
million,
respectively.
NOTE 15 — NET INCOME (LOSS) PER
SHARE
The following table presents the
computation of basic and diluted net income (loss) per share applicable to
common stockholders:
|
|
Quarter Ended December
31,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
|
Calculation of net income (loss)
per share - basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
(loss)
|
|
$
|
4,987,000
|
|
|
$
|
(3,924,000
|
)
|
Weighted-average number of common
shares outstanding
|
|
|
160,416,534
|
|
|
|
88,256,706
|
|
Net income (loss) per share -
basic
|
|
$
|
0.03
|
|
|
$
|
(0.04
|
)
|
|
|
|
|
|
|
|
|
|
Calculation of net income (loss)
per share - diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
(loss)
|
|
$
|
4,987,000
|
|
|
$
|
(3,924,000
|
)
|
Less: Gain on change in
fair market value of compound embedded derivative
|
|
|
(202,000
|
)
|
|
|
-
|
|
Interest
expense on convertible notes
|
|
|
57,000
|
|
|
|
-
|
|
Net income (loss) assuming
dilution
|
|
$
|
4,842,000
|
|
|
$
|
(3,924,000
|
)
|
|
|
|
|
|
|
|
|
|
Weighted-average number of common
shares outstanding
|
|
|
160,416,534
|
|
|
|
88,256,706
|
|
Effect of potentially dilutive
securities:
|
|
|
|
|
|
|
|
|
Convertible
notes
|
|
|
10,935,073
|
|
|
|
-
|
|
Weighted-average number of common
shares outstanding assuming dillution
|
|
|
171,351,607
|
|
|
|
88,256,706
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share -
diluted
|
|
$
|
0.03
|
|
|
$
|
(0.04
|
)
|
During the quarter ended December 31,
2010, 2,140,000 stock
options,
55,229,796
warrants and 10,440,000 restricted stocks were excluded from the calculation of
earnings per share because their effect would be
anti-dilutive.
NOTE 16
— COMMITMENTS AND
CONTINGENCIES
Research and development
commitment
Pursuant to a joint research and
development laboratory agreement with Shanghai University, dated
December 15, 2006 and expiring on December 15, 2016, Solar EnerTech is
committed to fund the establishment of laboratories and completion of research
and development activities.
On November 12, 2010, the Company
amended the agreement with Shanghai University and extended the funding
commitment from five years to eight years, and consequently the agreement will
end on December 15, 2014.
Based on the amendment, the Company has
committed to fund no
less than RMB
30 mil
lion ($4.5 million) cumulatively across
the
eight
years.
The
funding requirements are based on
specific milestones agreed upon by the Company and Shanghai University.
As of December 31,
20
10, there are approximately
$3.2
million
remaining to be funded in full by
December 15, 2014.
The Company will continue to invest in
research and development as it grows its business. The payment to
Shanghai University will be used to fund program expenses and equipment
purchase. Shanghai University needs to obtain the pre-approval from the Company
before incurring expenditures on the program. If the Company fails to
make
pre-approved funding payments, when
requested, it is deemed to be a breach of the agreement. If the Company is
unable to correct the breach within the requested time frame,
Shanghai University could seek compensation up to an additional 15% of the
total committed amount for approximately $0.7 million. As of December 31 2010,
the Company is not in breach as it has not received any additional compensation
requests for pre-approved funding payment from
Shanghai University.
The agreement is for shared investment
in research and development on fundamental and applied technology in the fields
of semi-conductive photovoltaic theory, materials, cells and modules. The
agreement calls for Shanghai University to provide equipment, personnel and
facilities for joint laboratories. The Company will provide funding, personnel
and facilities for conducting research and testing. Research and development
achievements from this joint research and development agreement will be
available to both parties. The Company is entitled to intellectual property
rights including copyrights and patents obtained as a result of this
research.
Other than capital expenditure related
to purchase of fixed assets, expenditures under this agreement will be accounted
for as research and development expenditures under FASB ASC 730, "Research and
Development” and expensed as incurred.
Capital commitments
On August 21, 2008, the Company acquired
two million shares of common stock of 21-Century Silicon for $1.0 million in
cash as previously discussed in “Note 3 — Summary of Significant Accounting
Policies – Investments” above. In July 2010, members of
the Company’s executive team, including the CEO, visited 21-Century Silicon and
conducted reviews of the production facility and technical development. The
review indicated that 21-Century Silicon’s production facility and technical
development were significantly below expected standards. In addition, management
of 21-Century Silicon expressed the need for more funding to sustain operations.
Moreover, 21-Century Silicon could not provide the Company with updated
financial information concerning 21-Century Silicon’s working capital condition
and future cash flows. The timing of the first polysilicon shipment is unknown
and it is unknown whether it will even occur. The Company considered the factors
above as indicators that a significant adverse effect on the fair value of the
Company’s investment in 21-Century Silicon had occurred. Accordingly,
an impairment loss of $1.0 million was recorded in the Consolidated Statements
of Operations for the fiscal year ended September 30, 2010 to fully write-down
the carrying amount of the investment. The Company may also be obligated to
acquire an additional two million shares of 21-Century Silicon upon the first
polysilicon shipment meeting the quality specifications determined solely by the
Company. As of December 31, 2010, the Company has not yet acquired the
additional two million shares as the product shipment has not
occurred.
On October 7, 2010, the X-Change
Corporation announced that it has acquired 21-Century Silicon, Inc. The terms of
the acquisition is anticipated to involve a change in control of the Company and
the appointment of new directors. The X-Change Corporation is anticipated to
issue 20 million shares of its unregistered, restricted common stock to the
shareholders of the 21-Century Silicon in exchange for 100% of the issued and
outstanding stock of 21-Century Silicon. As of the date of this report, the
X-Change Corporation has not issued its shares to the
Company.
On September 22, 2008, the registered
capital of Solar EnerTech (Shanghai) Co., Ltd was increased from $25 million to
$47.5 million, which was approved by the Board of Directors of the Company and
authorized by Shanghai Municipal Government (the “Shanghai
Government
”). The paid-in
capital as of December 31, 2010 was $32 million, with an outstanding remaining
balance of $15.5 million to be originally funded by September 21, 2010. In
August 2010, the Company received the approval of the Shanghai Government to
extend the funding requirement
date by nine months to June 2011. In
order to fund the registered capital requirement, the Company will have to raise
fund or otherwise file an application with the Shanghai Government to reduce the
capital requirement, which is legally permissible under PRC
law.
On January 15, 2010, the Company
incorporated a wholly-owned subsidiary in Yizheng, Jiangsu Province of China to
supplement its existing production facilities to meet increased sales
demands. The subsidiary was formed with a registered capital
requirement of $33 million, of which $23.4 million is to be funded by October
16, 2011. In order to fund the registered capital requirement, the
Company will have to raise funds or otherwise obtain the approval of local
authorities to extend the payment of registered capital for the subsidiary. The
registered capital requirement outstanding as of December 31,
2010 is $23.4
million.
On February 8, 2010, the Company
acquired land use rights of a parcel of land at the price of approximately $0.7
million. This piece of land is 68,025 square meters and is located in Yizheng,
Jiangsu Province of China, which will be used to house the Company’s second
manufacturing facility. As part of the acquisition of the land use right, the
Company is required to complete construction of the facility by February 8,
2012.
NOTE 17
— RELATED PARTY
TRANSACTIONS
At December 31, 2010 and September 30,
2010, the accounts payable and accrued liabilities, related party balance was $0
million and $5.8 million, respectively. The $5.8 million accrued
liability
at
fiscal year ended September 30, 2010
represents $4.8 million of compensation expense related to the Company’s
obligation to withhold tax upon
exercise of stock options by Mr. Young
in the fiscal year 2006 and the related interest and penalties, and $1.0 million
of indemnification provided by the Company to Mr. Young for any
liabilities he may incur as a result of previous stock options granted to him by
Ms. Blanchard, a former officer, in conjunction with the purchase of Infotech on
August 19, 2008.
Both the Company’s obligation to
withhold tax upon the exercise of stock options by Mr. Young and the
indemnification have a three year statute of limitation.
T
he statute of limitation
expired as of December 31, 2010. As a
result,
the Company
released the $5.8 million
on
December 31,
2010
.
NOTE 18 — FOREIGN
OPERATIONS
The Company identifies its operating
segments based on its business activities. The Company operates within a single
operating segment, the manufacture of solar energy cells and modules in
China.
The Company
’s manufacturing operations and fixed
assets are all based in
China. The Company’s sales occurred in
Europe, Australia, North America and China.
ITEM 2. MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
All references to “Solar EnerTech”, the
“Company,” “we,” “our,” and “us” refer to Solar EnerTech Corp. and its
subsidiaries.
The following discussion contains
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 that relate to our current expectations and views
of future events. In some cases, readers can identify forward-looking statements
by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,”
“anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue.”
These statements relate to events that involve known and unknown risks,
uncertainties and other factors, including those listed under the
heading
s
“Risks Related to Our
Business
and Our
Industry
,” “Risks Related
to
Doing Business in China”
and
“Risks Related To an
Investment in Our Securities” in
our Form 10-K filed with the Securities
and Exchange Commission on December 17, 2010
as well as other relevant risks
detailed in our filings with the SEC which may cause our actual results,
performance or achievements to be materially different from any future results,
performance or achievements expressed or implied by the forward-looking
statements. The information set forth in this report on Form 10-Q should be read
in light of such risks and in conjunction with the consolidated financial
statements and the notes thereto included elsewhere in this Form
10-Q.
Overview
Solar EnerTech Corp. is a solar product
manufacturer
with its
headquarters
based in
Mountain View, California,
and
with low-cost operations located in
Shanghai, China. Our principal products are monocrystalline silicon
and polycrystalline silicon solar cells and solar modules. Solar cells convert
sunlight to electricity through the photovoltaic effect, with multiple solar
cells electrically interconnected and packaged into solar modules to form the
building blocks for solar power generating systems. We primarily sell solar
modules to solar panel installers who incorporate our modules into their power
generating systems that are sold to end-customers located in Europe, Australia,
North America and China.
We have established our manufacturing
base in Shanghai, China to capitalize on the cost advantages offered in
manufacturing of solar power products. In our 67,107-square-foot
manufacturing facility we operate two 25MW solar cell production lines and a
50MW solar module production facility. We believe that the choice of
Shanghai, China for our manufacturing base provides us with convenient and
timely access to key resources and conditions to support our growth and low-cost
manufacturing operations.
Our solar cells and modules are sold
under the brand name “SolarE”. Our total sales for the
three months ended December
31
, 2010 was $
15.5
million and our end users are mainly in
Europe and Australia. In anticipation of entering the US market, we
have established a
headquarter office which also serves as
marketing, purchasing and
distribution office in Mountain View, California. Our goal is to become a
worldwide supplier of PV cells and modules.
We purchase our key raw materials,
silicon wafer, from the spot market. We do not have a long term
contract with any silicon supplier.
We have been able to increase sales
since our inception in 2006. Although our efforts to reach profitability have
been adversely affected by the global
recession, the credit market
contraction and a volatile polysilicon market, during fiscal year 2010 and the
first quarter of fiscal year 2011 we had significantly improved our gross margin
as a result of
declines in raw materials costs and the efficiencies
gained from greater capacity utilization at our facilities.
In December 2006, we entered into a
joint venture with Shanghai University to operate a research facility to
study various aspects of advanced PV technology. Our joint venture with
Shanghai University is for shared investment in research and development on
fundamental and applied technologies in the fields of semi-conductive
photovoltaic theory, materials, cells and modules. The agreement calls for
Shanghai University to provide equipment, personnel and facilities for
joint laboratories. It is our responsibility to provide funding, personnel and
facilities for conducting research and testing. Research and development
achievements from this joint research and development agreement will be
available for use by both parties. We are entitled to the intellectual property
rights, including copyrights and patents, obtained as a result of this research.
The research and development we will undertake pursuant to this agreement
includes the following:
|
•
|
we plan to research and test
theories of PV, thermo-physics, physics of materials and
chemistry;
|
|
•
|
we plan to develop efficient and
ultra-efficient PV cells with light/electricity conversion rates ranging
from 20% to 35%;
|
|
•
|
we plan to develop environmentally
friendly high conversion rate manufacturing technology of chemical
compound film PV cell
materials;
|
|
•
|
we plan to develop highly
reliable, low-cost manufacturing technology and equipment for thin film PV
cells;
|
|
•
|
we plan to research and develop
key material for low-cost flexible film PV cells and non-vacuum
technology; and
|
|
•
|
we plan to research and develop
key technology and fundamental theory for third-generation PV
cells.
|
On January 7, 2010 (the “Conversion
Date”), we entered into a Series A and Series B Notes Conversion Agreement (the
“Conversion Agreement”) with the holders of Notes representing at least
seventy-five percent of the aggregate principal amounts outstanding under the
Notes to restructure the terms of the Notes. On January 7, 2010, as part of the
Conversion Agreement, approximately $9.8 million of convertible notes
outstanding were successfully converted into shares of our common stock. On
January 19, 2010, a holder of approximately $1.8 million of our formerly
outstanding Series B Notes and Series B Warrants disputed the effectiveness of
the Conversion Agreement and the Warrant Amendment. Accordingly, such
holder did not tender its Series B Notes for conversion. After negotiations with
such holder, on March 19, 2010, the Company entered into an Exchange Agreement
with the holder (“Exchange Agreement”), whereby the Company issued the Series
B-1 Note with a principal amount of $1.8 million (the “Series B-1 Note”) due on
March 19, 2012, which extended the original maturity date by 24 months, in
exchange for the Series B Notes.
On March 30, 2010, we secured a one year
revolving credit facility arrangement with Industrial Bank Co., Ltd. (“IBC”)
that is secured by the accounts receivable balances of two key customers. We can
draw up to the lower of $2.0 million or the cumulative amount of accounts
receivable outstanding from the respective two key
customers.
As
of December 31, 2010, we had
cash and cash equivalents
balance of approximately $1.7 million and $1.5 million outstanding on the line
of credit. Approximately $0.9 million of the line of credit facility was due on
January 27, 2011 and the remaining balance of $0.6 million is due on February
23, 2011. Our line of credit expires on March 29, 2011. We
are in the process of
renewing
the line of credit
prior to its expiration date. If the line of credit is not renewed in a timely
manner, our liquidity and results of operations may be materially and adversely
affected.
Our future operations are dependent upon
the achievement of profitable operations. Other than as discussed in this
report, we know of no trends, events or uncertainties that are reasonably likely
to impact our future liquidity.
Environmental, Health and Safety
Regulations
We will use, generate and discharge
toxic, volatile or otherwise hazardous chemicals and wastes in our manufacturing
activities. We are subject to a variety of federal, state and local governmental
laws and regulations related to the purchase, storage, use and disposal of
hazardous materials. We are also subject to occupational health and safety
regulations designed to protect worker health and safety from injuries and
adverse health effects from exposure to hazardous chemicals and working
conditions. If we fail to comply with present or future environmental laws and
regulations, we could be subject to fines, suspension of production or a
cessation of operations. In addition, under some federal, state and local
statutes and regulations, a governmental agency may seek recovery and response
costs from operators of property where releases of hazardous substances have
occurred or are ongoing, even if the operator was not responsible for the
release or otherwise was not at fault.
Any failure by us to control the use of,
or to restrict adequately the discharge of, hazardous substances could subject
us to substantial financial liabilities, operational interruptions and adverse
publicity, any of which could materially and adversely affect our business,
results of operations and financial condition.
Solar Energy
Industry
We believe that economic and national
security issues, technological advances, environmental regulations seeking to
limit emissions by fossil fuel, air pollution regulations restricting the
release of greenhouse gasses, aging electricity transmission infrastructure and
depletion and limited supply of fossil fuels, has made reliance on traditional
sources of fuel for generating electricity less attractive. Government policies,
in the form of both regulation and incentives, have accelerated the adoption of
solar technologies by businesses and consumers. For example, in the U.S., the
Energy Policy Act (EPACT) enacted a 30% investment tax credit for solar, and in
January 2006, California approved the largest solar program in the country's
history that provides for long term subsidies in the form of rebates to
encourage use of solar energy where possible.
Government Subsidies and
Incentives
Various subsidies and tax incentive
programs exist at the federal and state level to encourage the adoption of solar
power including capital cost rebates, performance-based incentives, feed-in
tariffs, tax credits and net metering. Capital cost rebates provide funds to
customers based on the cost or size of a customer's solar power system.
Performance-based incentives provide funding to a customer based on the energy
produced by their solar system. Under a feed-in tariff subsidy, the government
sets prices that regulated utilities are required to pay for renewable
electricity generated by end-users. The prices are set above market rates and
may be differentiated based on system size or application. Feed-in tariffs pay
customers for solar power system generation based on kilowatt-hours produced, at
a rate generally guaranteed for a period of time. Tax credits reduce a
customer's taxes at the time the taxes are due. Under net metering programs, a
customer can generate more energy than used, during which periods the
electricity meter will spin backwards. During these periods, the customer
"lends" electricity to the grid, retrieving an equal amount of power at a later
Net time metering programs enable end-users to sell excess solar electricity to
their local utility in exchange for a credit against their utility bills. Net
metering programs are usually combined with rebates, and do not provide cash
payments if delivered solar electricity exceeds their utility bills. In
addition, several states have adopted renewable portfolio standards, which
mandate that a certain portion of electricity delivered to customers come from a
set of eligible renewable energy resources. Under a renewable portfolio
standard, the government requires regulated utilities to supply a portion of
their total electricity in the form of renewable electricity. Some programs
further specify that a portion of the renewable energy quota must be from solar
electricity.
Despite the benefits of solar power,
there are also certain risks and challenges faced by solar power. Solar power is
heavily dependent on government subsidies to promote acceptance by mass markets.
We believe that the near-term growth in the solar energy industry depends
significantly on the availability and size of these government subsidies and on
the ability of the industry to reduce the cost of generating solar electricity.
The market for solar energy products is, and will continue to be, heavily
dependent on public policies that support growth of solar energy. There can be
no assurances that such policies will continue. Decrease in the level of
rebates, incentives or other governmental support for solar energy would have an
adverse affect on our ability to sell our products.
Critical Accounting
Policies
We consider our accounting policies
related to principles of consolidation, revenue recognition, inventory reserve,
and stock based compensation, fair value of equity instruments and derivative
financial instruments to be critical accounting policies. A number of
significant estimates, assumptions, and judgments are inherent in determining
our consolidation policy, when to recognize revenue, how to evaluate our equity
instruments and derivative financial instruments, and the calculation of our
inventory reserve and stock-based compensation expense. We base our estimates
and judgments on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances. Actual results could differ
materially from these estimates. Management believes that
there have been no significant
ch
anges during the three
months ended
December 31
, 2010 to the items that we disclosed as
our critical accounting policies and estimates in Management’s Discussion and
Analysis or Plan of Operations in our Annual Report on Form 10-K filed for
t
he year ended September
30, 2010
with the
Securities and Exchange Commission (the “SEC”). For a description of those
critical accounting policies, please ref
er to our 2010
Annual Report on Form
10-K.
Inventories
Inventories are stated at the lower of
cost or market. Cost is determined by the weighted-average method. Market is
defined principally as net realizable
value. Raw material cost is based on
purchase costs while work-in-progress and finished goods are comprised of direct
materials, direct labor and an
allocation of manufacturing overhead
costs. Inventory in-transit is included in finished goods and consists of
products shipped but not recognized as revenue
because it does not meet the revenue
recognition criteria. Provisions are made for excess, slow moving and obsolete
inventory as well as inventory whose
carrying value is in excess of net
realizable value.
Impairment of Long Lived
Assets
We review our long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable. When such factors and
circumstances exist, management compares the projected undiscounted future cash
flows associated with the future use and disposal of the related asset or group
of assets to their respective carrying values. Impairment, if any, is measured
as the excess of the carrying value over the fair value, based on market value
when available, or
discounted expected cash flows, of those assets and is recorded in the period in
which the determination is made. No loss on property and equipment impairment
was recorded during
the
three months
ended
December 31
, 2010
and 2009.
Investment
Investment in an entity where we own
less than twenty percent of the voting stock of the entity and do not exercise
significant influence over operating and financial policies of the entity are
accounted for using the cost method. Investment in the entity where we own
twenty percent or more, but not in excess of fifty percent of the voting stock
of the entity or less than twenty percent and exercises significant influence
over operating and financial policies of the entity are accounted for using the
equity method. We have a policy in place to review our investments at least
annually and to evaluate the carrying value of the investments in these
companies. The cost method investment is subject to impairment assessment if
there are identified events or changes in circumstance that may have a
significant adverse affect on the fair value of the investment. If we believe
that the carrying value of an investment is in excess of estimated fair value,
it is our policy to record an impairment charge to adjust the carrying value to
the estimated fair value, if the impairment is considered
other-than-temporary.
On August 21, 2008, we entered into an
equity purchase agreement in which we acquired two million shares of common
stock of 21-Century Silicon for $1.0 million in cash.
See “Note 3
–
Summary of Significant
Accounting Policies
–
Investments
” in the Notes to Consolidated Financial Statements of this
Form 10-Q.
Warranty
C
ost
We provide product warranties and accrue
for estimated future warranty costs in the period in which revenue is
recognized. Our standard solar modules are typically sold with a two-year
warranty for defects in materials and workmanship and a ten-year and twenty
five-year warranty against declines of more than 10.0% and 20.0%, respectively,
of the initial minimum power generation capacity at the time of delivery. We
therefore maintain warranty reserves to cover potential liabilities that could
arise from our warranty obligations and accrue the estimated costs of warranties
based primarily on management’s best estimate. In estimating warranty costs, we
applied FASB ASC 460 – Guarantees, specifically paragraphs 460-10-25-5 to
460-10-25-7 of the FASB Accounting Standards Codification. This guidance
requires that we make a reasonable estimate of the amount of a warranty
obligation. It also provides that in the case of an entity that has no
experience of its own, reference to the experience of other entities in the same
business may be appropriate. Because we began to commercialize our products in
fiscal year 2007, there is insufficient experience and historical data that can
be used to reasonably estimate the expected failure rate of our solar modules.
Thus, we consider warranty cost provisions of other China-based manufacturers
that produce photovoltaic products that are comparable in engineering design,
raw material input and functionality to our products, and sold to a similar
target and class of customer with similar warranty coverage. In determining
whether such peer information can be used, we also consider the years of
experience that these manufacturers have in the industry. Because our industry
is relatively young as compared to other traditional manufacturing industries,
the selected peer companies that we consider have less than ten years in
manufacturing and selling history. In addition, they have a manufacturing base
in China, offer photovoltaic products with comparable engineering design, raw
material input, functionality and similar warranty coverage, and sell in
markets, including the geographic areas and class of customer, where we
compete. Based on the analysis applied, we accrue warranty at 1% of
sales. We have not experienced any material warranty claims to date in
connection with declines of the power generation capacity of its solar modules
and will prospectively revise its actual rate to the extent that actual warranty
costs differ from the estimates.
Income Taxes
We
account for income taxes under
the
liability method per
the
provisions of FASB ASC
740,
“Income Taxes”, formerly referenced as
SFAS No. 109, “Accounting for Income Taxes”.
Under the provisions of FASB ASC 740,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between
their financial statement carrying
values and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates expected to
apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and
liabilities of a change in tax rates is
recognized in income in the period that includes the enactment
date.
Valuation Allowance
Significant judgment is required in
determining any valuation allowance recorded against deferred tax assets. In
assessing the need for a valuation allowance,
we
consider all available evidence
including past operating results, estimates of future taxable income, and the
feasibility of tax planning
strategies. In the event that
we
change
our
determination as to the amount of
deferred tax assets that can be realized,
we will adjust our
valuation allowance with a corresponding
impact to the provision for income taxes in the period in which such
determination is made.
Unrecognized Tax
Benefits
Effective on October 1, 2007,
we
adopted the provisions related to
uncertain tax positions under FASB ASC 740, “Income Taxes”, formerly
referenced as FIN 48, “Accounting for
Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109”.
Under FASB ASC 740, the impact of
an uncertain income tax position on the
income tax return must be recognized at the largest amount that is
more-likely-than-not to be sustained upon audit by
the relevant taxing authority based
solely on the technical merits of the associated tax position. An uncertain
income tax position will not be recognized if it
has less than a 50% likelihood of being
sustained.
We
also elected the accounting policy that
requires interest and penalties to be recognized as a
component of tax expense.
We
classif
y
the unrecognized tax benefits that are
expected to result in payment or receipt of cash within one year as
current liabilities, otherwise, the
unrecognized tax benefits will be classified as non-current liabili
ties.
Fair Value of
Derivative Financial Instruments and
Warrants
Our
management used the binomial valuation
model to value the
derivative financial instruments and
warrants. The model uses
inputs such as implied term, suboptimal exercise factor, volatility, dividend
yield and risk free interest rate. Selection of these
inputs involves management’s judgment
and may impact estimated value. Management selected the binomial model to value
these
derivative financial
instruments and
warrants as
opposed to the
Black-Scholes-Merton model primarily
because management believes the binomial model produces a more reliable value
for these instruments because it
uses an additional valuation input
factor, the suboptimal exercise factor, which accounts for expected holder
exercise behavior which management believes is
a reasonable assumption with respect to
the holders of these warrants.
Stock-Based
Compensation
On January 1, 2006, Solar EnerTech began
recording compensation expense associated with stock options and other forms of
employee equity compensation
in accordance with FASB ASC 718,
“Compensation – Stock Compensation”.
We
estimate the fair value of stock
options granted using the Black-Scholes-Merton option-pricing formula and a
single option approach. This
fair value is then amortized on a
straight-line basis over the requisite service periods of the awards, which is
generally the vesting period. The following
assumptions are used in the
Black-Scholes-Merton option pricing model:
Expected Term —
Our
expected term represents the period
that
our
stock-based awards are expected to be
outstanding.
Expected Volatility
—
We
expected volatilities are based on
historical volatility of
our
stock, adjusted where determined
by
management for unusual and
non-representative stock price activity not expected to recur. Due to the
limited trading history, we also considered volatility
data of guidance
companies.
Expected Dividend —The
Black-Scholes-Merton valuation model calls for a single expected dividend yield
as an input.
We
currently pay no
dividends and do not expect to pay
dividends in the foreseeable future.
Risk-Free Interest Rate—
We
base the risk-free interest rate on the
implied yield currently available on U.S. Treasury zero-coupon issues with
an
equivalent remaining
term.
Estimated Forfeitures— When estimating
forfeitures,
We
take into consideration the historical
option forfeitures over the expected term.
Revenue Recognition
We
recognize revenues from product sales in
accordance with guidance in FASB ASC 605, “Revenue Recognition”, which states
that revenue is
realized or realizable and earned when
all of the following criteria are met: persuasive evidence of an arrangement
exists; delivery has occurred or services
have been rendered; the price to the
buyer is fixed or determinable; and collectability is reasonably assured. Where
a revenue transaction does not meet any
of these criteria it is deferred and
recognized once all such criteria have been met. In instances where final
acceptance of the product, system, or solution is
specified by the customer, revenue is
deferred until all acceptance criteria have been met.
On a transaction by transaction basis,
the Company determines if the revenue should be recorded on a gross or net basis
based on criteria discussed in the
Revenue Recognition topic of the FASB
Subtopic 605-405, “Reporting Revenue Gross as a Principal versus Net as an
Agent”. The Company considers the
following factors to determine the gross
versus net presentation: if the Company (i) acts as principal in the
transaction; (ii) takes title to the products; (iii) has
risks and rewards of ownership, such as
the risk of loss for collection, delivery or return; and (iv) acts as an agent
or broker (including performing services, in
substance, as an agent or broker) with
compensation on a commission or fee basis.
Accounts Receivable and Allowance for
Doubtful Accounts
Accounts receivable are carried at net
realizable value.
We
record
our
allowance for
doubtful accounts based upon
our
assessment of
various
factors.
We
consider historical experience, the age
of the accounts receivable balances, credit quality of
our
customers, current
economic conditions, and other factors
that may affect customers’ ability to pay.
Recent Accounting
Pronouncements
For recent accounting pronouncements,
including the expected dates of adoption and estimated effects, if any, on our
consolidated condensed financial statements, see “Note 3 — Summary of
Significant Accounting Policies” in the Notes to Consolidated Financial
Statements of this Form 10-Q.
Results of Op
erations for the three
months ended
December 31
, 2010 and 2009
The following discussion of the
financial condition, results of operations, cash flows and changes in financial
position of our Company should be read in conjunction with our audited
consolidated financial statements and notes filed with the SEC on Form 10-K and
its subsequent amendments.
Sales, Cost of Sales and Gross Profit
(Loss)
|
|
Quarter Ended December 31,
2010
|
|
|
Quarter Ended December 31,
2009
|
|
|
Year-Over-Year
Change
|
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of change
|
|
Sales
|
|
$
|
15,507,000
|
|
|
|
100.0
|
%
|
|
$
|
17,693,000
|
|
|
|
100.0
|
%
|
|
$
|
(2,186,000
|
)
|
|
|
(12.4
|
%)
|
Cost of
sales
|
|
|
(14,391,000
|
)
|
|
|
(92.8
|
%)
|
|
|
(15,762,000
|
)
|
|
|
(89.1
|
%)
|
|
|
1,371,000
|
|
|
|
(8.7
|
%)
|
Gross
profit
|
|
$
|
1,116,000
|
|
|
|
7.2
|
%
|
|
$
|
1,931,000
|
|
|
|
10.9
|
%
|
|
$
|
(815,000
|
)
|
|
|
(42.2
|
%)
|
For the three months ended December 31,
2010, we reported total sales of $15.5 million, representing a decrease of $2.2
million, or 12.4%, compared to $17.7 million of sales in the same period of the
prior year. For the three months ended December 31, 2010,
our
$15.5 million in sales comprised
of $15.3 million in solar module sales and $0.2 million in
solar
cell sales
. In comparison, our
$17.7 million in sales in the same
period of the prior year
comprised of $15.3 million in solar
module sales, $
1.2
million in
solar
cell sales and $
1.2
million in resale of raw
materials.
The
decrease in solar
cell and
raw materials sales is primarily because our focus is now on solar module sales.
Further, in the prior year, we resold our raw materials due to our overstock of
materials relative to our then limited production capacity. The decline in sales
was also attributed by the decrease in average selling prices for solar modules
from $1.93 per watt in the three months ended December 31, 2009 to $1.91 per
watt in the three months ended December 31, 2010. The decrease was partially
offset by increase in
solar
module shipments from
7
.9 MW in the three months ended December
31, 2009 to 8.0 MW in the three months ended December 31, 2010
.
For the three months ended December 31,
2010, we incurred a gross profit of $1.1 million, representing a decrease of
$0.8 million, or 42.2%, compared to
a
gross profit of $1.9 million in the same
period of the prior year.
The decrease in gross profit was
primarily due to the increase in raw material prices, specifically silicon wafer
prices
, coupled with the
above-mentioned decrease in average selling price for solar modules.
Silicon wafer prices
increased approximately 24.4% from RMB 16
.0
/piece during the three months ended
December 31, 2009 to RMB 19.9/piece during the three months ended December 31,
2010.
Selling, general
and
administrative
|
|
Quarter Ended December 31,
2010
|
|
|
Quarter Ended December 31,
2009
|
|
|
Year-Over-Year
Change
|
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of change
|
|
Selling, general and
administrative
|
|
$
|
2,351,000
|
|
|
|
15.2
|
%
|
|
$
|
2,218,000
|
|
|
|
12.5
|
%
|
|
$
|
133,000
|
|
|
|
6.0
|
%
|
For the three months ended
December 31
, 2010
, our selling, general and
administrative expenses were $2.4 million, representing an increase of $0.1
million, or 6.0%, from $2.2 million in the three months ended December 31, 2009.
Selling, general and administrative expenses as a percentage of sales for the
three months ended December 31, 2010 increased to 15.2% from 12.5% for the three
months ended December 31, 2009. The increase in the selling, general and
administrative expenses was primarily due to
an increase of $0.1 million in sales and
marketing activities.
Research
and
development
|
|
Quarter Ended December 31,
2010
|
|
|
Quarter Ended December 31,
2009
|
|
|
Year-Over-Year
Change
|
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of change
|
|
Research and
development
|
|
$
|
69,000
|
|
|
|
0.4
|
%
|
|
$
|
108,000
|
|
|
|
0.6
|
%
|
|
$
|
(39,000
|
)
|
|
|
(36.1
|
%)
|
Research and development expenses in the
three months ended
December
31
, 2010
and
2009 were similar at $0.1 million.
Research and development expenses as a percentage of sales for the three months
ended December 31, 2010 decreased to 0.4% from 0.6% for the three months ended
December 31, 2009.
In accordance with our joint research
and development laboratory agreement with Shanghai University, dated
December 15, 2006
(amended
on November 12, 2010) expiring on
December 15, 201
6
,
we committed to fund the establishment
of
laboratories and
completion of research and development activities at no less than RMB 30 million
($4.5 million) cumulatively within eight years (extended from five years).
The
funding requirements are based on
specific milestones agreed upon by Shanghai University and us.
Shanghai University needs to obtain the
pre-approval from the Company before incurring expenditures on the
program
. There was $13,000
funding to Shanghai University during the three months ended
December 31, 2010.
As of December 31, 20
10, there are approximately
$3.2
million
remaining to be funded in full by
December 15, 2014.
Gain
on debt
extinguishment
|
|
Quarter Ended December 31,
2010
|
|
|
Quarter Ended December 31,
2009
|
|
|
Year-Over-Year
Change
|
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of change
|
|
Gain on debt
extinguishment
|
|
$
|
(32,000
|
)
|
|
|
(0.2
|
%)
|
|
$
|
-
|
|
|
|
0.0
|
%
|
|
$
|
(32,000
|
)
|
|
|
0.
|
%
|
During the
three months
ended December 31, 2010, $100,000 of the
Series B-1 Note was converted into 666,667 shares of
our
common stock.
As a result, we
recorded a cumulative gain on debt
extinguishment of approximately $32,000 as a result of the Conversion Agreement
and the Exchange Agreement during the quarter ended December 31,
2010.
For the
three months
ended December 31, 2009, none of Series
A and B Convertible Notes were converted into
our
common shares. As a result, no loss on
debt extinguishment
was
recorded during the quarter ended December 31, 2009.
Reversal of
payroll
related tax accrual
|
|
Quarter Ended December 31,
2010
|
|
|
Quarter Ended December 31,
2009
|
|
|
Year-Over-Year
Change
|
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of change
|
|
Reversal of payroll related tax
accrual
|
|
$
|
(5,817,000
|
)
|
|
|
(37.5
|
%)
|
|
$
|
-
|
|
|
|
0.0
|
%
|
|
$
|
(5,817,000
|
)
|
|
|
0.0
|
%
|
The
reversal of payroll related tax accrual
of
$5.8 million during the
three months ended December 31, 2010 represented $4.8 million of compensation
expense related to
our
obligation to withhold tax upon
exercise of stock options by Mr. Young in the fiscal year 2006 and the related
interest and penalties, and $1.0 million of indemnification provided by
us
to Mr. Young for any
liabilities he may incur as a result of previous stock options granted to him by
Ms. Blanchard, a former officer, in conjunction with the purchase of Infotech on
August 19, 2008.
Both
our
obligation to withhold tax upon the
exercise of stock options by Mr. Young and the indemnification have a three year
statute of limitation.
The
statute of limitation expired as of December 31, 2010. As a result,
we
released the $5.8 million
on
December 31, 2010.
Other
income (expense)
|
|
Quarter Ended December 31,
2010
|
|
|
Quarter Ended December 31,
2009
|
|
|
Year-Over-Year
Change
|
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of net
sales
|
|
|
Amount
|
|
|
% of change
|
|
Interest
income
|
|
$
|
3,000
|
|
|
|
0.0
|
%
|
|
$
|
3,000
|
|
|
|
0.0
|
%
|
|
$
|
-
|
|
|
|
0.0
|
%
|
Interest
expense
|
|
|
(71,000
|
)
|
|
|
(0.5
|
%)
|
|
|
(4,425,000
|
)
|
|
|
(25.0
|
%)
|
|
|
4,354,000
|
|
|
|
(98.4
|
%)
|
Gain on change in fair market
value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of compound
embedded derivative
|
|
|
202,000
|
|
|
|
1.3
|
%
|
|
|
104,000
|
|
|
|
0.6
|
%
|
|
|
98,000
|
|
|
|
94.2
|
%
|
Gain on change in fair market
value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of warrant
liability
|
|
|
466,000
|
|
|
|
3.0
|
%
|
|
|
921,000
|
|
|
|
5.2
|
%
|
|
|
(455,000
|
)
|
|
|
(49.4
|
%)
|
Other
expense
|
|
|
(158,000
|
)
|
|
|
(1.0
|
%)
|
|
|
(132,000
|
)
|
|
|
(0.7
|
%)
|
|
|
(26,000
|
)
|
|
|
19.7
|
%
|
Total other income
(expense)
|
|
$
|
442,000
|
|
|
|
2.9
|
%
|
|
$
|
(3,529,000
|
)
|
|
|
(19.9
|
%)
|
|
$
|
3,971,000
|
|
|
|
(112.5
|
%)
|
For the three months ended
December 31
, 2010,
total other income was $0.4
million,
representing an increase of $4.0
million, or 112
.5%,
compare
d to total other
expense of $3.5
million for
the same period of the prior year. Other income as a percentage of sales for the
three months ended
December
31
,
2010 was 2.9
% compared t
o a negative 19.9
% for the same period in the prior year.
We i
ncurred interest
expenses of $71
,000 in the
three months ended
December
31
, 2010 primarily related
to 6% interest charges on the Series B-1 Note. In the three months ended
December 31
, 2009, we i
ncurred interest expense of
$4.4
million primarily
related to the amortization of the discount on the convertible notes and
deferred financing cost, and 6% interest charges on Series A and B Convertible
Notes.
In the three months ended
December 31
, 2010, we recorded a gain on change in
fair market val
ue of
warranty liability of $0.5
million and a gain on change in fair market value of comp
ound embedded derivative of $0.2 million
compared to a gain
on
change in fair market value of
warrant liability of $0.9 million and a
gain
on change in fair
market value of comp
ound
embedded derivative of $0.1
million during the three months ended
December 31
, 2009.
Other expenses of $0.2
million and $0.1
million for the three months ended
December 31
, 2010 and 2009, respectively, were
primarily re
lated to
foreign exchange losses
.
Liquidity and Capital
Resources
|
|
December 31,
2010
|
|
|
September 30,
2010
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents
|
|
$
|
1,699,000
|
|
|
$
|
6,578,000
|
|
|
$
|
(4,879,000
|
)
|
As of
December 31
, 2010, we had
cash and
cash equivalents of $1.7 million as compared to $6.6 million at September 30,
2010
. We
will require a significant amount of cash to fund our operations. Changes in our
operating plans, an increase in our inventory, increased expenses, or other
events, may cause us to seek additional equity or debt financing in the future.
In order to continue as a going concern, we will need to continue to generate
new sales while controlling our costs. If we are unable to
successfully generate enough sales to cover our costs, we only have limited cash
resources to bear operating losses. To the extent our operations are
not profitable, we may not continue as a going concern.
Our liquidity is impacted to a large
extent based on both the nature of the products we sell and also the
geographical location of our customers, as our payment terms on sale vary
greatly depending on both factors. With respect to the products we sell, while
in the past we have engaged in transactions where we have resold our raw
materials due to our overstock of materials relative to our then limited
production capacity, as our production capacity has increased over the years,
our sales now consist primarily of solar modules to solar panel installers in
Europe and Australia who incorporate our modules into their power generating
systems that are sold to end-customers. Payment terms for the sale of our
modules are generally longer than payment terms where we resell our raw
materials in China and as a result, our payment terms have lengthened relative
to prior years. In addition, with respect to the geographic location of our
customers, the payment terms for the sale of our solar modules are generally
longer for our customers in the United States than for our customers in Europe
and Australia. While our current sales to customers in the United States are
limited, if we are able to increase our sales in the U.S. market or in other
markets that may have longer payment terms, our payment terms may lengthen.
Payment terms for our solar module sales generally range from 0 to 60 days.
In some cases, these terms
are extended up to 200 days for certain qualifying customers
of whom the Company applied rigorous
credit requirements. If we have more sales of products or in geographies with
longer payment terms, the longer payment terms will impact the timing of our
cash flows.
|
|
Quarter Ended December
31,
|
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used
in):
|
|
|
|
|
|
|
|
|
|
Operating
activities
|
|
$
|
(4,927,000
|
)
|
|
$
|
138,000
|
|
|
$
|
(5,065,000
|
)
|
Investing
activities
|
|
|
(169,000
|
)
|
|
|
(226,000
|
)
|
|
|
57,000
|
|
Financing
activities
|
|
|
151,000
|
|
|
|
-
|
|
|
|
151,000
|
|
Effect of exchange rate changes on
cash and cash equivalents
|
|
|
66,000
|
|
|
|
2,000
|
|
|
|
64,000
|
|
Net decrease in cash and cash
equivalents
|
|
$
|
(4,879,000
|
)
|
|
$
|
(86,000
|
)
|
|
$
|
(4,793,000
|
)
|
Net cash used in operating activities
w
as
$
4.
9
million for the three months ended
December 31, 2010,
representing an increase of
$
5
.
1
million, compared to net cash provided
by operating activities of $0.1 million for the three months ended December 31,
2009. Cash flow from operating activities reflected a net income of $5.0 million
adjusted for non-cash items, including amortization of note discount and
deferred financing cost, depreciation of property and equipment, stock-based
compensation,
reversal of
payroll related tax accruals,
the change in the fair market value of
the compound derivative liabilities and warrants liabilities, payment of
interest by issuance of shares, and gain on debt extinguishment. The increase of
$
5
.
1
million in net cash used in operating
activities from the three months ended December 31, 2009 to the three months
ended December 31, 2010 was mainly attributable to
more cash out flow for purchase of raw
materials in the three months ended December 31, 20
10 compared to the same period in
2009
. The payment terms
granted by the major vendors of the Company were from 0 to 60 days
. There was no material changes in the
payment terms granted by the major vendors of the Company in the three months
ended December 31, 2010 compared to the same period in the prior
year.
The net gain excluding
non-cash expenses for the three months ended December 31, 2010 decreased $0.4
million compared to the same period in 2009, coupled with lower balances in
accounts payable, accrued liabilities and customer advance payment as of
December 31, 2010 compared to December 31, 2009.
Net cash used in investing activities
remains the same at
$0.
2
million
and $0.2 million in the three months
ended December 31, 2010 and 2009, respectively.
Net cash provided by financing
activities was $0.1 million in the three months ended December 31, 2010
primarily
because
of
we
dr
e
w
funds
from a credit facility with Industrial
Bank Co., Ltd (“IBC”). There was no cash provided by financing activities for
the three months ended December 31, 2009.
Our consolidated balance sheet,
statements of operations and cash flows have been prepared on the assumption
that the Company will continue as a going concern, which contemplates the
realization of assets and liquidation of liabilities in the normal course of
business.
After consummating the transactions
contemplated under the Conversion Agreement and Exchange Agreement, our only
outstanding convertible note is the Series B-1 Note. As of December 31, 2010,
the principal outstanding and the carrying value of the Series B-1 Note were
$1.
6
million and $1.5 million, respectively.
The Series B-1 Note bears interest at 6% per annum and the principal of $1.5
million is due on March 19, 2012. The holders of the Series B-1 Note can demand
repayment from us upon the occurrence of any of the triggering events detailed
in the Series B-1 Note. In addition, we have certain commitments as disclosed in
the “Off-Balance Sheet Arrangements” section below.
On March 25, 2010, we entered into a one
year contract with China Export & Credit Insurance Corporation (“CECIC”) to
insure the collectability of outstanding accounts receivable for two of the
our key customers. We pay a fee based on a fixed percentage of the accounts
receivable outstanding and expense this fee when it is incurred. In
addition, on March 30, 2010, we entered into a one year
revolving credit
facility arrangement with IBC that is secured by the accounts receivable
balances of the our two key customers insured by CECIC above.
The credit facility will
expire on March 29, 2011.
We can draw up to the lower of
$2,000,000 or the cumulative amount of accounts receivable outstanding from the
respective two key customers. If any of the insured customers fail to repay
the amounts outstanding due to us, the insurance proceeds will be remitted
directly to IBC instead of us. The interest rate of the credit
facility is variable and ranged from 3.3% to 4.5% during the three months ended
December 31, 2010. As of December 31, 2010, we drew on this credit
facility with IBC in the amount of $1,464,000 and there have been no insurance
claims submitted to CECIC. The credit facility contains certain
non-financial ratios related covenants, including maintaining creditworthiness,
complying with all contractual obligations, providing true and accurate records
as requested by IBC, fulfillment of other indebtedness (if any), maintaining its
business license and continuing operations, ensuring its financial condition
does not deteriorate, remaining solvent, and other conditions, as defined in the
credit facility agreement. We complied with these covenants as of December 31,
2010.
As of December 31, 2010, we had cash and
cash equivalents balance of approximately $1.7 million and $1.5 million
outstanding on the line of credit. Approximately $0.9 million of the line of
credit facility was due on January 27, 2011 and the remaining balance of $0.6
million is due on February 23, 2011. Our line of credit expires on March 29,
2011. We are in the process of renewing the line of credit prior to its
expiration date. If the line of credit is not renewed in a timely
manner, our liquidity and results of operations may be materially and adversely
affected.
If we experience a
material shortfall versus our operating
plans, we have a range of actions we can take
to remediate the cash shortage,
including but not limited
to raising additional funds through debt financing, securing a credit facility,
entering into secured or unsecured bank loans, or undertaking equity offerings
such
as
a rights offering to existing
shareholders. However, due to the tight capital and credit markets, we
cannot be sure that external financing will be available when needed or that, if
available, financing will be obtained on terms favorable to us or our
stockholders.
Off-Balance Sheet
Arrangements
Pursuant to a joint research and
development laboratory agreement with Shanghai University, dated
December 15, 2006 and expiring on December 15, 2016, we are committed
to funding the establishment of laboratories and completion of research and
development activities.
On
November 12, 2010, w
e
amended the agreement with
Shanghai University and extended the commitment from five years to eight years,
and consequently the agreement will end on December 15, 2014. Based on the
amendment, we
committed to
fund no
less than
RMB
30 mil
lion ($4.5 million) cumulatively across
the
eight
years.
The
funding requirements are based on
specific milestones agreed upon by Shanghai University and us.
As of
December 31, 2010, there are
approximately $3.2
million
remaining to be funded in full by December 15, 2014.
We intend to increase research and
development spending as we grow our business. The payment to
Shanghai University will be used to fund program expenses and equipment
purchase.
Shanghai
University needs to obtain the pre-approval from the Company before incurring
expenditures on the program.
If we fail to make
pre-approved funding
payments, when requested, we will be
deemed to be in breach of the agreement. If we are unable to correct the breach
within the requested time frame, Shanghai University could seek
compensation up to an additional 15% of the total committed amount for
approximately $0.7 million. As of
December 31
, 2010, we are not in breach as we have
not received any additional compensation requests
for pre-approved funding payment
from
Shanghai University.
On August 21, 2008, we entered into an
equity purchase agreement in which we acquired two million shares of common
stock of 21-Century Silicon for $1.0 million in cash. However, 21-Century
Silicon’s production facilities and technical development were significantly
below expected standards and was in a working capital deficit. Therefore, we
considered the above findings as indicators that a significant adverse effect on
the fair value of our investment in 21-Century Silicon had occurred.
Accordingly, an impairment loss of $1.0 million was recorded to fully write-down
the carrying amount of the investment as of June 30, 2010.
See “Note 3 — Summary of Significant
Accounting Policies – Investments” in the Notes to Consolidated Financial
Statements of this Form 10-Q.
On September 22, 2008, the registered
capital of Solar EnerTech (Shanghai) Co., Ltd was increased from $25 million to
$47.5 million, which was approved by our Board of Directors and authorized by
Shanghai Municipal Government (the “Shanghai Government”). The paid-in capital
as of December 31, 2010 was $32 million, with an outstanding remaining balance
of $15.5 million, originally to be funded by September 21, 2010. In August 2010,
we received the approval of the Shanghai Government to extend the funding
requirement date by nine months to June 2011.
In order to fund the registered capital
requirement
, we
will
have to raise fund or
otherwise
file an
application with the Shanghai Government to reduce the capital requirement,
which is legally permissible under PRC law.
On January 15, 2010, we incorporated a
wholly-owned subsidiary in Yizheng, Jiangsu Province of China to supplement our
existing production facilities to meet increased sales demands. The
subsidiary was formed with a registered capital requirement of $33 million, of
which $23.4 million is to be funded by October 16, 2011. In order to
fund the registered capital requirement, we will have to raise funds or
otherwise obtain the approval of local authorities to
extend the payment
of registered capital for the
subsidiary. The registered capital requirement outstanding as of
December 31
, 2010
, is $23.4 million.
On February 8, 2010, we acquired land
use rights of a parcel of land at the price of approximately $0.7 million. This
piece of land is 68,025 square meters and is located in Yizheng, Jiangsu
Province of China, which will be used to house our second manufacturing
facility. As part of the acquisition of the land use right, we are required to
complete construction of the facility by February 8, 2012.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
As a Smaller Reporting Company as
defined by Rule 12b-2 of the Exchange Act and in item 10(f)(1) of Regulation
S-K, we are electing scaled disclosure reporting obligations and therefore are
not required to provide the information requested by this Item 3.
ITEM
4. CONTROLS AND PROCEDURES
Disclosure
Controls and Procedures
As
required by Rule 13a-15 of the Securities Exchange Act of 1934, our Chief
Executive Officer and Chief Financial Officer evaluated our company's disclosure
controls and procedures (as defined in Rules 13a-15(e) of the Securities
Exchange Act of 1934) as of the end of the period covered by this report. Based
on this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that as of the end of the period covered by this report, these
disclosure controls and procedures were not effective to ensure that the
information required to be disclosed by our company in reports we file or submit
under the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported, within the time periods specified in the rules and
forms of the Securities Exchange Commission, and to ensure that such information
required to be disclosed by our company in the reports that we file or submit
under the Securities Exchange Act of 1934, as amended, is accumulated and
communicated to our company's management, including our Chief Executive Officer
and Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure. The conclusion that our disclosure controls and procedures
were not effective was due to the lack of finance and accounting personnel with
an appropriate level of knowledge, experience and training in the application of
U.S. GAAP
. Our fiscal 2010
financial reporting close process was ineffective in recording certain
transactions according to the applicable accounting pronouncement and preparing
certain critical financial statement disclosures. Our plan to remediate the
material weaknesses primarily consisted of hiring finance and accounting
personnel with an appropriate level of knowledge, experience and training in the
application of U.S. GAAP and training, educating and equipping our existing
personnel on U.S. GAAP accounting matters and enhance our accounting and finance
policy.
We are in the process of implementing
the following measures to remediate these material weaknesses: (a) hire
additional financial reporting and accounting personnel with relevant account
experience, skills, and knowledge in the preparation of financial statements
under the requirements of U.S. GAAP; (b) continue to work with internal and
external consultants to improve the process for collecting and reviewing
information required for the preparation of financial statements; and (c)
e
nhance our accounting and
finance policy and procedure manuals to provide guidance to our finance and
accounting staff and develop tools or checklists to improve the completeness and
accuracies of financial disclosures.
Changes
in Internal Control over Financial Reporting
Our management, with the participation
of our Chief Executive Officer and our Chief Financial Officer, has concluded
there were no changes in our internal controls over financial reporting that
occurred during the quarter ended December 31, 2010 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting
.
PART II - OTHER
INFORMATION
ITEM 1. LEGAL
PROCEEDINGS
ITEM 1A. RISK
FACTORS
Except as set forth below, the Company’s
risk factors are included in the Company’s Annual Report on Form 10-K for the
fiscal year ended September 30, 2010 and remain the same.
We have
a limited amount of cash to fund our operations. If we cannot obtain
additional sources of cash, our growth prospects and future profitability
may be materially adversely affected and we may not be able to continue as a
going concern.
As
of December 31, 2010, we had cash and cash equivalents of $1.7 million. We
will require a significant amount of cash to fund our operations. We have
short term loans outstanding under a line of credit of approximately $1.5
million, which will expire on March 29, 2011, and while we are in the
process of renewing our line of credit, if the line of credit is not
renewed in a timely manner, our liquidity and results of operations may be
materially and adversely affected. In addition, in order to continue as a
going concern, we will need to continue to generate new sales while controlling
our costs. If we are unable to successfully generate enough revenues
to cover our costs, we only have limited cash resources to bear operating
losses. To the extent our operations are not profitable, we may not
continue as a going concern.
ITEM 2. UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS
On
October
1, 2010, we issued
247,821
shares of our common stock as accrued
interest to the holder of our Series B-1 convertible note. These shares were
exempt from any registration requirement under the Securities Act pursuant to
Section 3(a)(9) of the Securities Act and Rule 144 promulgated under the
Securities Act.
On
October
21
, 2010, we issued
334,430
shares of our common stock to the
holder of our Series B-1 convertible note
in connection with a conversion of a
portion of the principal and interest on the note
. These shares were exempt from any
registration requirement under the Securities Act pursuant to Section 3(a)(9) of
the Securities Act and Rule 144 promulgated under the Securities
Act.
On
November 23
,
2010
we issued
336,238
shares of our common stock to the
holder of our Series B-1 convertible note
in connection with a conversion of a
portion of the principal and interest on the note
. These shares were exempt from any
registration requirement under the Securities Act pursuant to Section 3(a)(9) of
the Securities Act and Rule 144 promulgated under the Securities
Act.
On
January
1, 201
1
, we issued
295,734
shares of our common stock as accrued
interest to the holder of our Series B-1 convertible note. These shares were
exempt from any registration requirement under the Securities Act pursuant to
Section 3(a)(9)
of the Securities Act and Rule 144
promulgated under the Securities Act.
ITEM 3. DEFAULTS UPON SENIOR
SECURITIES
None
ITEM 4. REMOVED AND
RESERVED
ITEM 5. OTHER
INFORMATION
None
ITEM 6. EXHIBITS
(a) Pursuant to Rule 601 of Regulation
S-K, the following exhibits are included herein or incorporated by
reference.
31.1
|
Section 302 Certification - Chief
Executive Officer
|
|
|
31.2
|
Section 302 Certification - Chief
Financial Officer
|
|
|
32.1
|
Certification Pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 - Chief Executive
Officer.
|
|
|
32.2
|
Certification Pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 - Chief Financial
Officer.
|
|
|
SIGNATURES
Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly
authorized.
SOLAR ENERTECH CORP.
Date: February 11,
2011
|
By:
|
/s/ Steve
Ye
|
|
|
|
|
|
Steve Ye
|
|
|
Chief Financial
Officer
|
Solar Enertech (CE) (USOTC:SOEN)
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