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EX-32.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 906 - PERFECTENERGY INTERNATIONAL LTDv225667_ex32-2.htm
EX-32.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 906 - PERFECTENERGY INTERNATIONAL LTDv225667_ex32-1.htm
EX-10.5 - DIRECTOR AGREEMENT WITH ADAM ROSEMAN, DATED FEBRUARY 11, 2011 - PERFECTENERGY INTERNATIONAL LTDv225667_ex10-5.htm
EX-31.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 302 - PERFECTENERGY INTERNATIONAL LTDv225667_ex31-2.htm
EX-31.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 302 - PERFECTENERGY INTERNATIONAL LTDv225667_ex31-1.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
x
Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For the quarterly period ended: April 30, 2011

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: 000-51704

PERFECTENERGY INTERNATIONAL LIMITED
(Exact name of registrant as specified in its charter)
 
Nevada
 
98-0548438
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation of origination)
 
Identification Number)
     
No. 479 You Dong Road,
   
Xinzhuang Town, Shanghai 201100
   
People’s Republic of China
 
N/A
(Address of principal executive offices)
 
(Zip code)
 
 
(8621) 5488-8436
 
 
(Registrant’s telephone number, including area code)
 

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 ¨

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 than the registrant was required to submit and post such files).  Yes ¨   No ¨

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

Large Accelerated filer  ¨
Non-Accelerated Filer ¨
Accelerated Filer  ¨
Smaller Reporting Company  x

The registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ¨   No x

Indicate the number of shares outstanding of each issuer's classes of common stock, as of the latest practicable date: 29,626,916 issued and outstanding as of June 13, 2011.

 
 

 

TABLE OF CONTENTS
TO QUARTERLY REPORT ON FORM 10-Q
FOR QUARTER ENDED APRIL 30, 2011
 
   
Page
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING INFORMATION
3
     
PART I
FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements
4
     
 
Condensed Consolidated Balance Sheets as of April 30, 2011 and October 31, 2010 (unaudited)
4
     
 
Condensed Consolidated Statements of Operations and Other Comprehensive Loss for the Three and Six Months Ended April 30, 2011 and 2010 (unaudited)
5
     
 
Condensed Consolidated Statements of Cash Flows for the Six Months Ended April 30, 2011 and 2010 (unaudited)
6
     
 
Notes to Condensed Consolidated Financial Statements (unaudited)
7
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
27
     
Item 4.
Controls and Procedures
34
     
PART II
OTHER INFORMATION
 
     
Item 6.
Exhibits
35
   
SIGNATURES
36

 
2

 

CAUTIONARY NOTICE REGARDING FORWARD-LOOKING INFORMATION

All statements contained in this Quarterly Report on Form 10-Q (“Form 10-Q”) for the Company, other than statements of historical facts, that address future activities, events, or developments are forward-looking statements, including, but not limited to, statements containing the words “believe,” “anticipate,” “expect,” and words of similar import.  These statements are based on certain assumptions and analyses made by us in light of our experience and our assessment of historical trends, current conditions, and expected future developments as well as other factors we believe are appropriate under the circumstances.  Whether actual results will conform to the expectations and predictions of management, however, is subject to a number of risks and uncertainties that may cause actual results to differ materially.

Such risks include, among others, the following: international, national, and local general economic and market conditions; our ability to sustain, manage, or forecast our growth; raw material costs and availability; new product development and introduction; existing government regulations and changes in, or the failure to comply with, government regulations; adverse publicity; competition; loss of significant customers or suppliers; fluctuations and difficulty in forecasting operating results; changes in business strategy or development plans; business disruptions; the ability to attract and retain qualified personnel; the ability to protect technology; and other factors referenced in this and previous filings.

Consequently, all of the forward-looking statements made in this Form 10-Q are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated by management will be realized or, even if substantially realized, that they will have the expected consequences to or effects on our business operations.  As used in this Form 10-Q, unless the context requires otherwise, “we” or “us” or “Registrant” or the “Company” means Perfectenergy International Limited, a Nevada corporation, and its subsidiaries.

 
3

 

PART I - FINANCIAL INFORMATION

Item 1.
Financial Statements
 
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
   
April 30,
   
October 31,
 
   
2011
   
2010
 
             
ASSETS
           
             
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 2,814,774     $ 2,392,053  
Accounts receivable, net
    8,734,652       3,992,826  
Other receivables
    746,893       457,943  
Inventories, net
    12,950,117       8,161,566  
Prepayments
    1,360,504       1,245,734  
Total current assets
    26,606,940       16,250,122  
                 
PROPERTY AND EQUIPMENT, NET
    5,336,902       6,032,389  
                 
OTHER ASSETS:
               
Deferred tax assets
    -       10,184  
Advance for equipment purchases
    9,003       420  
Total other assets
    9,003       10,604  
                 
Total assets
  $ 31,952,845     $ 22,293,115  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES:
               
Accounts payable
  $ 17,106,021     $ 7,661,988  
Accrued liabilities
    1,100,980       1,012,588  
Customer deposits
    1,151,579       354,923  
Other payables
    39,055       73,641  
Value-added and other taxes payable
    3,998,185       3,195,366  
Total current liabilities
    23,395,820       12,298,506  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
SHAREHOLDERS' EQUITY:
               
Common stock, $.001 par value, 94,250,000 shares authorized, 29,626,916 shares issued and outstanding as of April 30, 2011 and October 31, 2010
    29,627       29,627  
Additional paid-in capital
    9,442,809       9,408,487  
Statutory reserves
    110,068       110,068  
Retained earnings
    (2,777,331 )     (1,091,021 )
Accumulated other comprehensive income
    1,751,852       1,537,448  
Total shareholders' equity
    8,557,025       9,994,609  
                 
Total liabilities and shareholders' equity
  $ 31,952,845     $ 22,293,115  

See accompanying notes to condensed consolidated financial statements

 
4

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE LOSS
(UNAUDITED)

   
Three months ended
   
Six months ended
 
   
April 30, 2011
   
April 30, 2010
   
April 30, 2011
   
April 30, 2010
 
REVENUES
  $ 15,796,619     $ 19,142,768     $ 24,067,652     $ 36,470,016  
                                 
COST OF REVENUES
    15,835,931       17,184,406       23,348,810       32,798,214  
                                 
GROSS PROFIT
    (39,312 )     1,958,362       718,842       3,671,802  
                                 
OPERATING EXPENSES:
                               
Selling, general and administrative
    941,359       2,239,732       2,304,609       4,089,400  
Research and development
    97,458       74,306       193,057       247,136  
Total operating expenses
    1,038,817       2,314,038       2,497,666       4,336,536  
                                 
LOSS FROM OPERATIONS
    (1,078,129 )     (355,676 )     (1,778,824 )     (664,734 )
                                 
OTHER INCOME (EXPENSE):
                               
Interest expense and other bank charges
    (10,143 )     (9,658 )     (21,554 )     (16,332 )
Interest income
    3,131       8,688       6,269       15,172  
Non-operating income (expense)
    194,280       (16,817 )     205,276       85,474  
Change in fair value of warrants
    0       2,494       0       29,355  
Total other income (expense)
    187,268       (15,293 )     189,991       113,669  
                                 
LOSS BEFORE PROVISION FOR INCOME TAXES
    (890,861 )     (370,969 )     (1,588,833 )     (551,065 )
                                 
PROVISION (BENEFIT) FOR INCOME TAXES
    209,971       349,309       97,477       413,100  
                                 
NET LOSS
    (1,100,832 )     (720,278 )     (1,686,310 )     (964,165 )
                                 
OTHER COMPREHENSIVE INCOME (LOSS):
                               
Foreign currency translation adjustments
    (29,987 )     38,385       214,404       (63,801 )
                                 
COMPREHENSIVE LOSS
  $ (1,130,819 )   $ (681,893 )   $ (1,471,906 )   $ (1,027,966 )
                                 
EARNINGS PER SHARE:
                               
Basic
  $ (0.04 )   $ (0.02 )   $ (0.06 )   $ (0.03 )
Diluted
  $ (0.04 )   $ (0.02 )   $ (0.06 )   $ (0.03 )
                                 
WEIGHTED AVERAGE NUMBER OF SHARES:
                               
Basic
    29,626,916       29,626,916       29,626,916       29,626,916  
Diluted
    29,626,916       29,626,916       29,626,916       29,626,916  

See accompanying notes to condensed consolidated financial statements
 
 
5

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

   
Six months ended
 
   
April 30, 2011
   
April 30, 2010
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
  $ (1,686,310 )   $ (964,165 )
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
               
Depreciation
    901,430       663,277  
Bad debt expense
    -       258,053  
Provision/(Recovery) on obsolete inventory
    118,247       (152,597 )
Loss on disposal
    -       11,375  
Compensation expense for options issued to employees
    34,322       808,054  
Change in fair value of warrants
    -       (29,355 )
Changes in assets and liabilities:
               
Accounts receivable
    (4,554,423 )     (2,606,732 )
Other receivables
    (276,529 )     1,058,943  
Inventories
    (4,404,128 )     802,616  
Prepayments
    (81,527 )     184,534  
Prepaid income taxes
    -       (108,727 )
Deferred tax assets
    10,830       281,864  
Accounts payable
    9,207,377       2,293,680  
Accrued liabilities
    104,674       (245,130 )
Customer deposits
    786,535       (1,788,723 )
Other payables
    (16,488 )     (557,953 )
Value-added and other taxes payable
    668,810       1,828,943  
Net cash provided by operating activities
    812,819       1,737,957  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of property and equipment
    (42,796 )     (473,297 )
Advances on equipment purchases
    (8,572 )     207,636  
Net cash used in investing activities
    (51,368 )     (265,661 )
                 
EFFECT OF EXCHANGE RATE CHANGES ON CASH
    (338,730 )     532,059  
                 
INCREASE IN CASH
    422,721       2,004,355  
                 
Cash and cash equivalents, beginning of period
    2,392,053       3,582,854  
                 
Cash and cash equivalents, end of period
  $ 2,814,774     $ 5,587,209  
                 
Supplemental disclosures:
               
Interest paid
  $ -     $ -  
Income taxes paid
  $ -     $ 28,355  

See accompanying notes to condensed consolidated financial statements

 
6

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 


Note 1 – Summary of Significant Accounting Policies

(a) Organization and Description of Business

Perfectenergy International Limited (“PFGY” or “the Company”) was incorporated in the State of Nevada on February 25, 2005.  The Company, through its subsidiaries, is principally engaged in the research, development, manufacturing, and sale of solar cells, solar modules, and photovoltaic (“PV”) systems.  The Company’s manufacturing and research facility is located in Shanghai, China, and it has sales and service offices in Shanghai, China and Germany.
 
On February 28, 2008, the Company formed Perfectenergy Solar-Tech (Shanghai) Ltd. (“Perfectenergy Solar-Tech”) under the laws of the Peoples Republic of China as a wholly owned subsidiary of Perfectenergy International Limited (“Perfectenergy BVI”), a wholly owned subsidiary of the Company. The Company obtained approval from local authority for a reduction in Perfectenergy Solar-Tech's required registered capital from$20 million to $4 million. All registration documents of Perfectenergy Solar-Tech were completed in early September 2010.
 
The company has incurred recurring operating losses and has an accumulated deficit of $2.78 million as of April 30, 2011. Notwithstanding the foregoing, the Company has positive working capital of $3.2 million as of April 30, 2011. Management anticipates that it will generate sufficient cash flows to fund its operations for the next twelve months by increasing the volume of its product sales. If future sales do not meet the Company’s forecasts, it may be required to fund its operations by raising additional capital. As such, the Company’s ability to achieve its business plan is primarily dependent upon its ability to grow its planned level of operations and/or obtain sufficient additional capital at acceptable costs. With respect to these objectives, the Company cannot provide any assurance that it will be successful. If events or circumstances occur such that the Company is unable to or does not meet its operating plan as expected and/or does not secure additional financing, the Company may be required to significantly curtail or cease its operations. The accompanying financial statements do not include any adjustments that might result from outcome of these uncertainties.
 
(b) Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements of the Company and its wholly owned subsidiaries, Perfectenergy BVI, Perfectenergy (Shanghai) Limited (“Perfectenergy Shanghai”), Perfectenergy GmbH (“Perfectenergy GmbH”), and Perfectenergy Solar-Tech, as of April 30, 2011 and for the three and six month period ended April 30, 2011 and 2010 have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instruction to Form 10-Q and Article 10 of Regulation S-X.  In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments (consisting only of normal recurring accruals) that management considers necessary for a fair presentation of the Company’s financial position, operating results, and cash flows for the interim periods presented. Operating results and cash flows for interim periods are not necessarily indicative of results for the entire year.

 
7

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)


All significant intercompany balances and transactions have been eliminated in consolidation.  The Company has reclassified certain prior year amounts to conform to the current year presentation. These reclassifications have no effect on net loss. The accompanying condensed consolidated financial statements are in U.S. dollars and prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) and include PFGY and each of its wholly owned subsidiaries.

(c) Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the amounts reported in the financial statements and accompanying notes and assumptions that affect various accounts, including but not limited to long-lived assets, income taxes, inventories, revenue recognition and related sales reserves, allowance for doubtful accounts, and stock compensation as reported in the financial statements and accompanying notes.  Management considers many factors in selecting appropriate operational and financial accounting policies and controls, and in developing the assumptions used to prepare these financial statements.  Management must apply significant judgment.  Among the factors, but not fully inclusive of all factors that may be considered by management, are the following: the range of accounting policies permitted by accounting principles generally accepted in the United States of America; management’s understanding of the Company’s business - both historical results and expected future results; the extent to which operational controls exist that provide high degrees of assurance that all desired information to assist in the estimation is available and reliable or whether there is greater uncertainty in the information that is available upon which to base the estimate; expectations of the future performance of the economy, both domestically and globally, within various areas that serve the Company’s principal customers and suppliers of goods and services; expected rates of exchange; sensitivity and volatility associated with the assumptions used in developing estimates; and whether historical trends are expected to be representative of future trends.

The estimation process often times may yield a range of potentially reasonable estimates of the ultimate future outcomes, and management must select an amount that lies within that range of reasonable estimates based upon the quantity, quality, and risks associated with the variability that might be expected from the future outcome and the factors considered in developing the estimate.  This estimation process may result in the selection of estimates that could be viewed as conservative or aggressive by others.  Management attempts to use its business and financial accounting judgment in selecting the most appropriate estimate; actual amounts, however, may differ from those estimates.

 
8

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)


 
(d) Revenue Recognition

The Company recognizes revenue when the following criteria are met: 1) persuasive evidence of an arrangement exists, which is when a signed sales contract or purchase order is received from the customer; 2) delivery has occurred, which is upon shipment when legal title and risk of loss pass to the customer and no other performance obligations remain; 3) the fee is fixed and determinable, and 4) collection is reasonably assured. All of the Company’s products that are sold in the PRC are subject to a Chinese VAT at a rate of 17% of the gross sales price or at a rate approved by the PRC local government. All of the Company’s products that are sold in Germany are subject to a Germany VAT at a rate of 19% of the gross sales price or at a rate approved by the Germany government. The revenue is recognized net of VAT tax, discount and allowance at the time.
  
(e) Fair Value Measurement of Financial Instruments

The accounting standards regarding fair value of financial instruments and related fair value measurements define financial instruments, define fair value, establish a three-level valuation hierarchy for disclosures of fair value measurement, and enhance disclosure requirements for fair value measures. The carrying amounts reported in the consolidated balance sheets for current assets and current liabilities qualify as financial instruments and reflect reasonable estimates of fair value because of the short period of time between the origination of such instruments and their expected realization. The three levels of valuation hierarchy are defined as follows:

 
·
Level 1 inputs to the valuation methodology, which are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 
·
Level 2 inputs to the valuation methodology that includes quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, substantially for the full term of the financial instrument.

 
·
Level 3 inputs to the valuation methodology that are unobservable and significant to the fair value measurement.

The Company did not identify any asset and liability that is required to be presented on the balance sheet at fair value in accordance with this accounting standard.

 
9

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

(f) Foreign Currency Translation

The reporting currency of the Company is the U.S. dollar.  The Company’s principal operating subsidiaries established in the PRC use the local currency, Renminbi (“RMB”), as their functional currency.  The Company’s sales offices in Germany use the Euro (“EUR”) as their functional currency.  The assets and liabilities of the Company’s Chinese subsidiaries at April 30, 2011 were translated at 6.50 RMB to $1.00 as compared to 6.67 RMB to $1.00 at October 31, 2010.  The assets and liabilities of the Company’s German subsidiary at April 30, 2011 were translated at €0.67 to $1.00 as compared to €0.72 to $1.00 at October 31, 2010.  Equity accounts were stated at their historical rate.  The average translation rates applied to statement of operations accounts of the Company’s Chinese subsidiaries for the six months ended April 30, 2011 and 2010 were 6.61 RMB and 6.82 RMB to $1.00, respectively. The average translation rates applied to statement of operations accounts of the Company’s German subsidiary for the six months ended April 30, 2011 and 2010 were €0.73 and €0.74 to $1.00, respectively.  For the periods presented, adjustments resulting from translating financial statements into U.S. dollars are reported as cumulative translation adjustments and are shown as a separate component of other comprehensive income (loss).  Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

In accordance with the accounting standard regarding "Statement of Cash Flows," cash flows from the Company's operations are calculated based upon the local currencies using the average translation rate. As a result, amounts related to assets and liabilities reported on the consolidated statements of cash flows will not necessarily agree with changes in the corresponding balances on the consolidated balance sheets.

(g) Cash and Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

(h) Accounts Receivable

The Company conducts its business operations in the PRC, and it has sales offices in Germany. Management reviews its accounts receivable on a regular basis and analyzes historical bad debts, customer credit worthiness, current economic trends, and changes in customer payment patterns to determine if the allowance for doubtful account is adequate and adjusts the allowance when necessary. The allowance for doubtful accounts reflects the Company’s best estimate of probable losses inherent in the accounts receivable balance and ultimate losses may vary from current estimates.  As adjustments to these estimates, become necessary, they are reported in operations in the periods that they become known.  If all attempts to collect a receivable fail, the receivable is written off against the allowance.

 
10

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

 
(i) Other Receivables

Other receivables consist of advanced payment to be refunded by the Company’s suppliers and intercompany transfer of foreign currencies held by the Company’s export agents.  Due to the passage of time, advanced payment to be refunded by the Company’s suppliers has been reclassified as a non-current asset. Refer to Note 4.  Management reviews its other receivables on a regular basis and analyzes the financial conditions of the Company’s suppliers and export agents to determine if the allowance for doubtful account is adequate and adjusts the allowance when necessary.  An estimate for doubtful accounts is recorded when collection of the full amount is no longer probable.

(j) Inventories

Inventories are stated at the lower of cost or market using a weighted average cost method.  The Company reviews its inventory periodically for possible obsolete goods to determine if any reserves are necessary for potential obsolescence.  The Company provides for slow moving inventory based on an analysis of the aging and utility of the inventory.   The Company believes that the reserve is adequate to provide for expected losses.

(k) Prepayments

Prepayments are prepayments to the Company’s suppliers. Some of the Company’s suppliers require advanced payment before a delivery is made. Such prepayments are recorded in the financial statements as prepayments until delivery has occurred.

(l) Property and equipment, net

Equipment and leasehold improvements are stated at cost.  Depreciation is computed by using the straight-line method at rates based on the estimated useful lives of the various classes of property.  Estimates of useful lives are based upon a variety of factors including durability of the asset, the amount of usage that is expected from the asset, the rate of technological change, and the Company’s business plans for the asset.  Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset.  Should the Company change its plans with respect to the use and productivity of property and equipment, it may require a change in the useful life of the asset or incur a charge to reflect the difference between the carrying value of the asset and the proceeds expected to be realized upon the asset’s sale or abandonment.  Expenditures for maintenance and repairs are expensed as incurred and significant major improvements are capitalized.

 
11

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

Estimated useful lives of the Company’s assets are as follows:
 
 
Useful Life
 
Leasehold improvements
Lease term
 
Transportation equipment
5 years
 
Machinery
5 - 10 years
 
Office equipment
5 years
 
 
(m) Impairment of Long-Lived Assets

The Company evaluates long-lived assets for impairment annually, and more often if an event or circumstance occurs that triggers an impairment test.  Substantial judgment is necessary in the determination as to whether an event or circumstance has occurred that may trigger an impairment analysis and in the determination of the related cash flows from the asset.  Estimating cash flows related to long-lived assets is a difficult and subjective process that applies historical experience and future business expectations to revenues and related operating costs of assets.  Should impairment appear to be necessary, subjective judgment must be applied to estimate the fair value of the asset, for which there may be no ready market, which oftentimes results in the use of discounted cash flow analysis and judgmental selection of discount rates to be used in the discounting process.  If the Company determines an asset has been impaired based on the projected undiscounted cash flows of the related asset or the business unit over the remaining amortization period, and if the cash flow analysis indicates that the carrying amount of an asset exceeds related undiscounted cash flows, the carrying value is reduced to the estimated fair value of the asset or the present value of the expected future cash flows.  As of April 30, 2011, the Company expects these assets to be fully recoverable.
  
(n) Customer Deposits

Customer deposits are prepayments from our customers.  Some of our sales require customers to prepay before delivery is made.  Such prepayments are recorded in our financial statements as customer deposits until delivery has occurred.

(o) Value Added Tax (“VAT”)

The Company’s sales of products in the PRC and Germany are subject to a value added tax (“VAT”) in accordance with tax laws.  The VAT applied is 17% in the PRC and 19% in Germany of the gross sales price.  A credit is available whereby VAT paid on the purchases of semi-finished products or raw materials used in the production of the Company’s finished products and payment of freight expenses can be used to offset the VAT due on sales of the finished products.

 
12

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

 
(p) Provision for Income Taxes

The Company accounts for income taxes in accordance with the Financial Accounting Standards Board’s (“FASB”) accounting standard for income taxes. Under the asset and liability method as required by this accounting standard, the Company must recognize deferred income tax liabilities and assets for the expected future tax consequences of temporary differences between income tax basis and financial reporting basis of assets and liabilities.  Provision for income taxes consist of taxes currently due plus deferred taxes.

The Company adopted FASB’s accounting standard for Accounting for Uncertainty in Income Taxes.  A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.  For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.  The accounting standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition. The Company accounts for interest and penalties related to uncertain tax positions as income tax expenses.

The Company accounts for income taxes using the asset and liability method.  Deferred tax liabilities and assets are determined based on temporary differences between the basis of assets and liabilities for income tax and financial reporting purpose of the Company.  The deferred tax assets and liabilities are classified according to the financial statement classification of the assets and liabilities generating the differences.  Valuation allowances are established when necessary based upon the judgment of management to reduce deferred tax assets to the amount expected to be realized and could be necessary based upon estimates of future profitability and expenditure levels over specific time horizons in particular tax jurisdictions. Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In the event that the Company changes 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.
 
(q) Shipping and Handling

Costs related to shipping and handling of the products sold is included in selling, general and administrative expenses.  Shipping and handling expense of sales amounted to $462,791 and $1,024,356 for the six months ended April 30, 2011 and 2010, respectively, and $241,471 and $842,068 for the three months ended April 30, 2011 and 2010, respectively.

 
13

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)


(r) Advertising

Advertising and promotion expenses are expensed as incurred, and the expense was immaterial for the three and six months ended April 30, 2011 and 2010.

(s) Research and Development Costs

Research and development expenses are expensed as incurred.  Research and development expenses include salaries, consultant fees, supplies, and materials, as well as costs related to other overhead such as facilities, utilities, and other departmental expenses.  The costs the Company incurs with respect to internally developed technology and engineering services are included in research and development expenses.

(t) Loss per Share

The Company reports earnings per share in accordance with the provisions of FASB’s related accounting standard. This standard requires the presentation of earnings per share (EPS) as basic EPS and diluted EPS in conjunction with the disclosure of the methodology used in computing such earnings per share.  Basic EPS excludes dilution and is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding for the period.  Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.

The following is a reconciliation of the basic and diluted earnings per share computation:
   
Three Months Ended
April 30,
   
Six Months Ended
April 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
Net loss for basic earnings per share computation
  $ (1,100,832 )     (720,278 )   $ (1,686,310 )     (964,165 )
                                 
Weighted average shares used in basic computation
    29,626,916       29,626,916       29,626,916       29,626,916  
Diluted effect of options and warrants
    -       -       -       -  
Weighted average shares used in diluted computation
    29,626,916       29,626,916       29,626,916       29,626,916  
                                 
Weighted Average Earnings per share
                               
Basic
  $ (0.04 )     (0.02 )   $ (0.06 )     (0.03 )
Diluted
  $ (0.04 )     (0.02 )   $ (0.06 )     (0.03 )

 
14

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

For the three and six months ended April 30, 2011 and 2010, none of the issued and outstanding warrants and options were included in the calculation of diluted earnings per share since their effect would be anti-dilutive.

(u) Stock-Based Compensation

The Company records and reports stock based compensation pursuant to FASB’s related accounting standard which defines a fair-value-based method of accounting for stock based employee compensation and transactions in which an entity issues its equity instruments to acquire goods and services from non-employees.  Stock compensation for stock granted to non-employees has also been determined in accordance with FASB’s related accounting standard as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

Note 2 – Recently Issued Accounting Standards
 
In April 2010, the FASB issued ASU 2010-13, “Compensation—Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades.” ASU 2010-13 provides amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in currency of a market in which a substantial porting of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010.  The adoption of this ASU did not have a material impact on its consolidated financial statements.

In December 2010, the FASB issued Accounting Standards Update 2010-28 which amend “Intangibles- Goodwill and Other” (Topic 350). The ASU modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting entities, they are required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. An entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. The qualitative factors are consistent with the existing guidance in Topic 350, which requires that goodwill of a reporting unit be tested for impairment between annual testes if an event occurs or circumstances changes that would more likely than not reduce the faire value of a reporting unit below its carrying amount. ASU 2010-28 is effective for fiscal years, and interim periods within those years beginning after December 15, 2010. The adoption of this ASU did not have a material impact on its consolidated financial statements.

 
15

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)


In December 2010, the FASB issued Accounting Standards Update 2010-29 which address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations (Topic 805). This ASU specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. This ASU also expands the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro-forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  The adoption of this ASU did not have a material impact on its consolidated financial statements, but expects the adoption of this ASU will have an impact on its future business combinations.

Note 3 – Accounts Receivable

Accounts receivable consisted of the following:
 
   
April 30, 2011
   
October 31, 2010
 
Accounts receivable  
 
$
8,734,652
   
$
3,992,826
 
Less: allowance for doubtful accounts  
   
     
 
Total  
 
$
8,734,652
   
$
3,992,826
 

At April 30, 2011 and October 31, 2010, there was no allowance for doubtful accounts as management believes all accounts balances were considered to be collectible.

Note 4 – Other Receivables

Other receivables consisted of the following:
 
   
April 30, 2011
   
October 31, 2010
 
Other receivables - Current
 
$
746,893
   
$
457,943
 
Other receivables - Noncurrent
   
3,803,387
     
3,803,387
 
Less: allowance for doubtful accounts
   
(3,803,387
   
(3,803,387
Total
 
$
746,893
   
$
457,943
 

In June and July 2008, Perfectenergy Shanghai entered into three purchase contracts for purchasing original MEMC granular polysilicon from Sun Materials GmbH (“Sun Materials”).  In accordance with the terms of the purchase contracts, Perfectenergy Shanghai paid 100% of the advance payments to Sun Materials totaling approximately $3.8 million. However, as of April 30, 2011, Sun Materials was unable to either deliver the goods or return most of the advancement. Followed by an abstract debt acknowledgement and repayment agreement between Sun Materials and Regus Management Corp., British Virgin Island (“Regus BVI”), its original supplier for the MEMC granular polysilicon, Regus BVI was obligated to repay the prepayments in five installments.  Regus BVI made a small initial repayment, which was not in accordance with the terms established in the repayment agreement.  There have been no payments from any parties involved.  Based on the current status, management estimated that a 100% provision (approximately $3.8 million) is necessary against the full amount.  The Company will continue to assess the collectability and make necessary adjustment if circumstances dictate.

 
16

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)


 
Note 5 – Inventories

Inventories consisted of the following: 
   
April 30, 2011
   
October 31, 2010
 
Raw materials
  $ 679,478     $ 703,452  
Finished goods
    12,203,740       7,726,441  
Work in progress
    744,545       277,760  
Supplies
    17,387       15,709  
Less inventory reserve
    (695,033 )     (561,796 )
Total
  $ 12,950,117     $ 8,161,566  

Movement on inventory reserve:

   
April 30, 2011
   
October 31, 2010
 
Beginning balance
 
$
561,796
   
$
637,335
 
Additions charged to costs of goods sold
   
118,246
     
84,389
 
Recovery on obsolete inventory
   
-
     
(172,274
)
Foreign currency translation adjustments
   
14,991
     
12,346
 
Ending balance
 
$
695,033
   
$
561,796
 

Note 6 – Prepayments

Prepayments are mostly monies deposited or advanced to outside vendors on future inventory purchases.  Some of the Company’s vendors require a certain amount of money to be deposited with them as a guarantee that the Company will receive their purchase on a timely basis and lower than market price.  This amount is refundable and bears no interest.  Total outstanding prepayments for inventory purchases were $1,260,373 and $1,197,636 as of April 30, 2011 and October 31, 2010, respectively.

 
17

 
 
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

Note 7 – Property and equipment, net

Property and equipment consisted of the following:


   
April 30, 2011
   
October 31, 
2010
 
Leasehold Improvements
  $ 2,036,177     $ 1,959,528  
Transportation equipment
    331,215       321,774  
Machinery
    7,518,793       7,321,695  
Office equipment
    245,290       219,731  
Total
    10,131,476       9,822,728  
Less: accumulated depreciation
    (4,794,574 )     (3,790,339
Total
  $ 5,336,902     $ 6,032,389  

Depreciation expense for the six months ended April 30, 2011 and 2010 amounted to $901,430 and $663,277, respectively, and for the three months ended April 30, 2011 and 2010 amounted to $422,889 and $451,145, respectively.

Note 8 – Late Registration Penalties

In connection with the issuance of common stock and warrants (“Investor Warrants,” and together with the common stock, the “Securities”) on August 8, 2007, pursuant to Section 1(b) of the Registration Rights Agreement between the holder of the Securities (“Investors”) and the Company, the Company was required to have a registration statement relating to the resale of the Securities declared effective by the SEC by January 5, 2008.  A late registration entitled the Investors to a payment by the Company of an amount equal to 2% of the purchase price paid for the Securities due for January 7, 2008 and each 30 days thereafter, not to exceed in the aggregate 15% of the purchase price of the Securities.  The registration statement was declared effective on March 5, 2008.  The Company owed the Investors a total of $1,079,467 as a late registration payment, which was accrued and charged to general and administrative expenses during the year ended October 31, 2008.

In lieu of making cash payments, the Company offered to issue restricted common stock at a valuation of $4.00 per share for the first 30 days that the registration statement was late in being declared effective by the SEC, to which certain of the Investors agreed.  Thus, the Company owed the Investors taking cash payments a total of $912,347 as late registration payments.  As of April 30, 2011, the Company paid $390,744 to the Investors and issued aggregate 41,780 shares of common stock valued at $167,120 to seven of the Investors in lieu of a cash payment.  The settlement of the remaining $521,603 is still in progress and is recorded in accrued liabilities, and the expected final payment date is pending by the Company’s Board of Directors.

 
18

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)


Note 9 – Retirement Benefit Plans

Regulations in the PRC require the Company to contribute to a defined contribution retirement plan for all permanent employees.  All permanent employees are entitled to an annual pension equal to their basic salaries at retirement.  The PRC government is responsible for the benefit liability to these retired employees.  The Company is required to make contributions to the state retirement plan at 22% of the monthly basic salaries of the current employees. For the six months ended April 30, 2011 and 2010, the Company made pension contributions in amount of $170,143 and $116,289, respectively, and for each of the three months ended April 30, 2011 and 2010, the Company made pension contributions in the amount of $66,222 and $53,526, respectively.

Note 10 – Accounting for Stock-Based Compensation

PFGY Stock Options

On September 5, 2007, the Company adopted the “Perfectenergy International Limited 2007 Stock Incentive Plan” (the “Stock Incentive Plan”). The Company reserved 1,500,000 shares of its common stock pursuant to the Stock Incentive Plan. During the ten months ended October 31, 2007, under the Stock Incentive Plan, the Company issued 1,282,358 options to employees and directors, of which 164,298 options were cancelled in December 2007, 25,000 were cancelled in March 2008, 39,298 were forfeited in July 2010, and 9,375 were exercised in April 2008. The Company used the Cox-Ross-Rubinstein binomial model to value the options at the time they were issued, based on volatility of 70%, dividend yield of 0%, the stated exercise prices and expiration dates of the instruments, and using an average risk-free rate of 4.5%. The fair value of such options was $4,641,629 as of the grant date. The cost of the options had been amortized evenly over the vesting period, which was three years ended in October 2010.

On February 1, 2008, the Company issued 125,000 options to the Company’s Chief Financial Officer. These options vested evenly on an annual basis over the three years following the date of grant. The Company used the Cox-Ross-Rubinstein binomial model to value the options at the time they were issued, based on volatility of 70%, dividend yield of 0%, the stated exercise prices of the instruments, and using an average risk-free rate of 2.36%. The fair value of such options was $328,117 as of the grant date. The cost of the options had been amortized evenly over the vesting period, which was three years ended in January 2011.

On April 7, 2010, the Company granted a total of 200,000 stock options to three executives and four directors. The shares were valued at the market price on the date of grant. The estimated fair value of stock options granted was $0.19 per share. On April 7, 2011, 1/3 of the granted stock options vested and became exercisable, and the remaining 2/3 of the granted stock options vest evenly on April 7, 2012 and April 7, 2013, respectively.

The fair value is determined using the Black-Scholes option pricing model and the following assumptions
 
   
April 7, 2010
 
Expected volatility
    170.00 %
Risk-free interest rate
    2.98 %
Expected dividend
    -  
Expected forfeiture rate
    -  
Expected life (in years)
    6.50  

 
19

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

 
The volatility of the Company’s common stock was estimated by management based on the historical volatility of the Company’s common stock, the risk free interest rate based on Treasury Constant Maturity Rates published by the U.S. Federal Reserve for periods applicable to the estimated life of the options, and the expected dividend yield based on the current and expected dividend policy. The Company has never declared or paid cash dividends and does not plan to pay cash dividends in the foreseeable future; therefore, the Company used an expected dividend yield of zero. Forfeiture is estimated at the time of grant. The Company’s estimate is zero at April 7, 2010 because of the small number of employees involved, and there is no expected future employee terminations prior to vesting.  The expected life represents the weighted-average period of time that options granted are expected to be outstanding giving consideration to vesting schedules. Because the Company does not have a history of employee stock options, the estimated life is based on one-half of the sum of the vesting period and the contractual life of each option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.

Stock-based award activity was as follows:

   
Option 
Available
for Grant
   
Options
Outstanding
   
Weighted
Average
Exercise
Price
   
Weighted
Average
Remaining
Contractual
Term
(In years)
   
Aggregeate
Intrinsic Value
 
Outstanding at October 31, 2010
    121,238       1,369,387     $ 2.52       6.76     $  
Granted
                                 
Cancelled
                                 
Exercised
                                 
Outstanding at April 30, 2011 
    121,238       1,369,387     $ 2.52       6.26     $  
                                         
Exercisable at April 30, 2011
            1,236,054     $ 2.79       5.97      —  

As of April 30, 2011, approximately $24,825 of estimated expense with respect to non-vested stock-based awards has yet to be recognized and will be recognized as an expense over the employee’s remaining weighted average service period of approximately 1 year.  The following table shows the share-based compensation for the three and six months ended April 30, 2011and 2010.
 
 
Three Months Ended April 30,
 
Six Months Ended April 30,
 
  
2011
 
2010
 
2011
 
2010
 
                 
Selling, general and administrative
$ 3,240     $ 397,742   $ 34,322   $ 808,054  
Research and development
                 
  $ 3,240     $ 397,742   $ 34,322   $ 808,054  
 
 
20

 
 
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)


 
The following table summarizes ranges of outstanding and exercisable stock-based award as of April 30, 2011:

Outstanding Options
   
Exercisable Options
 
           
Average
               
Average
 
     
   
   
Remaining
         
 
   
Remaining
 
 
   
Average
   
Contractual
   
 
   
Average
   
Contractual
 
Number
    Exercise     
Life
   
Number
   
Exercise
   
Life
 
of Options
   
Price
   
(in years)
   
of Options
   
Price
   
(in years)
 
                                 
  1,044,387     $ 2.8       6.28       1,044,387     $ 2.8       6.28  
  125,000     $ 4.08       1.75       125,000     $ 4.08       1.75  
  200,000     $ 0.2       8.93       66,667     $ 0.2       8.93  
  1,369,387     $ 2.52       6.26       1,236,054     $ 2.79       5.97  
 
Note 11 – Statutory Reserves

The laws and regulations of the PRC require that before an enterprise distributes profits to its owners, it must first satisfy all tax liabilities, provide for losses in previous years, and make allocations to investors, in proportions determined at the discretion of the board of directors, after the statutory reserve.  The statutory reserve includes the surplus reserve fund and the enterprise fund.  The statutory reserve represents restricted retained earnings.

Surplus Reserve Fund

Pursuant to the PRC’s accounting standards, Perfectenergy Shanghai and Perfectenergy Solar-Tech are required to set aside 10% of their after-tax profit each year to their general reserves until the accumulative amount of such general reserves reaches 50% of their respective registered capital.  These allocations must be made before Perfectenergy Shanghai or Perfectenergy Solar-Tech can distribute any cash dividends to each of their sole shareholder, Perfectenergy BVI.

 
21

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

In addition to using the funds in their surplus reserves to distribute cash dividends to their shareholders, Perfectenergy Shanghai and Perfectenergy Solar-Tech may also use such funds (i) during a liquidation, (ii) to cover a previous years’ losses, if any, (iii) for business expansion, or (iv) for conversion to registered capital by issuing new shares to existing shareholders in proportion to their holdings, provided that the remaining surplus reserve fund balance after such issue is not less than 25% of each of their registered capital, or by increasing the par value of the shares currently held by existing shareholders.  For the three months ended April 30, 2011 and 2010, neither Perfectenergy Shanghai nor Perfectenergy Solar-Tech made any contribution to their respective surplus reserve fund.

Enterprise Fund

The enterprise fund may be used to acquire plant and equipment or to increase working capital to expand on production and business operations.  No minimum contribution is required, and neither Perfectenergy Shanghai nor Perfectenergy Solar-Tech made any contributions to their respective enterprise fund for the three and six months ended April 30, 2011 and 2010.

Note 12 – Income Taxes
 
Perfectenergy (Shanghai) Ltd. (“Perfectenergy Shanghai”)

As a manufacturing-related foreign-invested enterprise, Perfectenergy Shanghai locates in Shanghai, China. Under the new enterprises income tax (“EIT”) law was enacted in China from January 1, 2008, the statutory EIT rate is 25%. Perfectenergy Shanghai was granted a two-year income tax exemption and a three-year 50%-reduction starting from January 1, 2005. On January 1, 2008, Perfectenergy Shanghai received the high technology certification from the tax authority. The certification allows Perfectenergy Shanghai to receive the 15% preferential income tax rate for a period of three years from January 1, 2008 to December 31, 2010. The applicable income tax rates are summarized as follows:

Calendar Year
 
Tax program
 
Applicable tax rate
 
2008
 
Tax Holiday
    12.5 %
2009
 
Tax Holiday
    12.5 %
2010
 
Preferential income tax rate
    15 %
2011
 
Preferential income tax rate
    25 %*
2012
 
Preferential income tax rate
    25 %*
* Perfectenergy Shanghai is in the progress of extending the high technology certification for another three years from 2011 and the income tax rate will be 15% once the certification is granted from authority.
 
According to the new PRC EIT law, the losses can be carried forward to offset income for the next 5 years successively without any other limitation.

 
22

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)



Perfectenergy Solar-tech (Shanghai) Ltd. (“Perfectenergy Solar-tech”)
 
Perfectenergy Solar-tech is located in Shanghai, China. The applicable tax rate is 25%.

Perfectenergy International Ltd. (U.S.) (“Perfectenergy US”)
 
The Company’s intermediate holding company, Perfectenergy US, is incorporated in the United States. U.S. federal marginal income tax rate of 34% is levied on Perfectenergy US. Under the U.S. tax code, Perfectenergy US’s operating loss carryforwards will expire, if not utilized, between 2027 and 2031.

Perfectenergy International Ltd. (British Virgin Islands) (“Perfectenergy BVI”)
 
Perfectenergy BVI is incorporated in British Virgin Islands and is not subject to income tax under the current applicable tax law.

Perfectenergy GmbH
 
Perfectenergy GmbH is a wholly-owned subsidiary of Perfectenergy BVI located in Germany. Perfectenergy GmbH’s aggregated tax burden, including corporate income tax plus solidarity surcharge and trade tax is 31.5%. German corporations will now be subject to limitation on the utilization of loss carry forwards for corporation tax. The first €1 million of net operating loss is allowed to carry forward to offset taxable income, while any utilization above that threshold will generally be limited to 60% of taxable income. There is no expiration date for the utilization of net operating loss.

The income tax expense is summarized as follows:

   
Three months ended April 30,
   
Six months ended April 30,
 
   
2011
   
2010
   
2011
   
2010
 
Current:
                       
PRC
  $ 86,972     $     $ 87,462     $  
U.S.
  $     $     $     $  
German
  $     $ 133,504     $     $ 117,632  
    $ 86,972     $ 133,504     $ 87,462     $ 117,632  
Deferred:
                               
PRC
  $ 79,038     $ (10,152 )   $     $ 14,467  
U.S.
  $     $     $     $  
German
  $ 43,961     $ 225,956     $ 10,015     $ 281,001  
    $ 122,999     $ 215,804     $ 10,015     $ 295,468  
Income tax expense
  $ 209,971     $ 349,308     $ 97,477     $ 413,100  

Perfectenergy US, Perfectenergy GmbH, Perfectenergy Shanghai, and Perfectenergy Solar-tech all suffered an operating loss for the fiscal year ended October 31, 2010 and for the six months ended April 30, 2011 as well. Management reviews the valuation allowance periodically. As a result, a full valuation allowance has been recognized on the deferred tax asset benefit to reduce the asset to zero, since the Company determined that it was more likely than not that the deferred tax assets would not be utilized based on the Company’s limited operating history and future operating projections.

 
23

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

Significant components of the Company’s deferred tax assets are as follows:

   
As of April 30, 
2011
   
As of October 31, 
2010
 
Deferred tax assets
           
Losses carried forward (PRC)
  $ 110,792     $ -  
Losses carried forward (U.S.)
  $ 135,000     $ -  
Losses carried forward (German)
  $ 158,207     $ 10,184  
Less: valuation allowance
  $ (403,999 )   $ -  
Deferred tax asset, net
  $ -     $ 10,184  
Non-current portion
  $ -     $ 10,184  

There was no material effect to loss per share if the statutory income tax had been applied.

The Company also recognizes the tax benefit of an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by tax authorities, based solely on the technical merits of the position. The Company has made the assessment at the level of tax authority for each tax position (including the potential application of interest and penalties) based on the technical merits. As a result, the Company determined that there were no material unrecognized tax benefits as of April 30, 2011.

Note 13 – Concentration of Risk

Cash and cash equivalents

Cash and cash equivalents includes cash on hand and demand deposits in accounts maintained with either state owned banks or renowned local banks within the PRC, the United States, Hong Kong, and Germany.  Certain financial instruments, which subject the Company to concentration of credit risk, consist of cash.  The Company maintains cash balances at financial institutions which, from time to time, may exceed Federal Deposit Insurance Corporation insured limits for the banks located in the United States, may exceed Hong Kong Deposit Protection Board insured limits for the banks located in Hong Kong, or may exceed Compensation Scheme of German Banks and Deposit Protection Fund of Association of German Banks insured limits for the banks located in Germany (amounts up to €1.5 million per depositor are fully protected in German Banks).  Balances at financial institutions or state owned banks within the PRC are not covered by insurance.  Total cash in banks at which the Company’s deposits are not covered by insurance amounted to $236,969 and $1,170,245 at April 30, 2011 and October 31, 2010, respectively.  The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.

 
24

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

 
Major Customers

For the three months ended April 30, 2011 and 2010, five customers accounted for approximately 73% and 69%, respectively, of the Company’s sales. These customers accounted for approximately 71% and 55% of the Company’s accounts receivable as of April 30, 2011 and 2010, respectively. For the six months ended April 30, 2011 and 2010, five customers together accounted for approximately 74% and 69%, respectively, of the Company’s sales. These customers accounted for approximately 71% and 55% of the Company’s accounts receivable as of April 30, 2011 and 2010, respectively.

Major Vendors

For the three months ended April 30, 2011 and 2010, the Company purchased approximately 59% and 47%, respectively, of their raw materials from three major suppliers. These suppliers represented 0% and 51% of the Company’s total accounts payable as of April 30, 2011 and 2010, respectively. For the six months ended April 30, 2011 and 2010, the Company purchased approximately 58% and 40% raw materials from three major suppliers. These suppliers represented 0% and 34% of the Company’s total accounts payable as of April 30, 2011 and 2010, respectively.

Political and Economic Risk

The Company's major operations are carried out in the PRC.  Accordingly, the Company’s business, financial condition, and results of operations may be influenced by the political, economic, and legal circumstances in the PRC and by the general state of the PRC's economy.

The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe.  These include risks associated with, among other things, the political, economic, and legal environments and foreign currency exchange.  The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

Revenue by Geographic Area

Revenues are attributed to geographic areas based on the final shipping destination of the Company’s products.  The following table summarizes the financial information for the Company’s revenues based on geographic area:

 
25

 

PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2011
(UNAUDITED)
 

 
Net revenues: 
 
Three Months Ended
April 30,
   
Six Months Ended
April 30,
 
   
2011
 
2010
   
2011
 
2010
 
China
  $ 21,957     $ 745,779     $ 31,010     $ 1,032,348  
Germany
    15,774,662       18,396,989       24,036,642       35,437,668  
Total revenues
  $ 15,796,619     $ 19,142,768     $ 24,067,652     $ 36,470,016  

Note 14 – Commitments

Operating Lease Commitments

The Company’s office lease for Perfectenergy Shanghai is under a five-year term expiring May 31, 2011 with a monthly rent of approximately $17,000 (RMB 115,199) and extend the lease for another 5 years with monthly rent of approximately $26,000 (RMB170,000) until May 31, 2016.   The Company entered into a three-year office lease for Perfectenergy GmbH expiring February 28, 2014 with a monthly rent of approximately $5,720 (approximately EUR 3,855).  The Company entered into a two-year lease for Perfectenergy Solar-Tech that expired March 14, 2010 with a monthly rent of $5,900 (approximately RMB 40,000), which lease was extended through the end of 2011 based on an oral agreement with the landlord.  At April 30, 2011, total future minimum lease payments under an operating lease were as follows: 

Period Ended April 30, 2011
 
Amount
 
2011
 
177,335
 
2012
   
383,053
 
Thereafter
   
1,253,091
 

Total rent expense for the three months ended April 30, 2011 and 2010 amounted to $78,594 and $80,720, respectively, and total rent expense for the six months ended April 30, 2011 and 2010 amounted to $156,471 and $162,387, respectively.

Note 15 – Subsequent Event

On June 2, 2011, Tianjin Zhonghuan Co., Ltd. (“Tianjin Zhonghuan”), an A-share listed company in China’s Shenzhen Stock Exchange announced that its Board of Directors approved the purchase of shares of the Company’s common stock for an aggregate purchase price of not more than $6.3 million. Upon closing, Tianjin Zhonghuan will own a 35% stake in the Company. A definitive agreement has not been entered into, and the Company is in negotiations with Tianjin Zhonghuan to enter into a definitive agreement for this sale.  There is no assurance that the sale will be consummated.

 
26

 
 
Item 2. Management’s Discussion and Analysis or Plan of Operation.

The following discussion and analysis of the financial condition of the Company should be read in conjunction with our financial statements and the notes to those financial statements that are included above.  Our discussion includes forward-looking statements based on current expectations that involve risks and uncertainties, such as our plans, objectives, expectations, and intentions.  Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Cautionary Notice Regarding Forward-Looking Information and Results of Operations sections in this Quarterly Report on Form 10-Q.  We use words such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions to identify forward-looking statements.

OVERVIEW

We were originally incorporated on February 25, 2005 in the State of Nevada under our former name “Crestview Development Corporation.”  As a result of a share exchange transaction that closed on August 8, 2007, our business is the research, development, manufacturing, and sale of solar cells, solar modules, and photovoltaic (“PV”) systems through our direct and indirect wholly owned subsidiaries.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

This discussion and analysis is based on our financial statements that have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported net sales and expenses during the reporting periods.  On an ongoing basis, we evaluate our estimates and assumptions.  We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are described in Note 1 to our financial statements under the section above titled “Financial Statements,” we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating this management discussion and analysis:
  
Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements of the Company and its wholly owned subsidiaries, as of April 30, 2011 and for the three and six month period ended April 30, 2011 and 2010 have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instruction to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments (consisting only of normal recurring accruals) that management considers necessary for a fair presentation of the Company’s financial position, operating results, and cash flows for the interim periods presented. Operating results and cash flows for interim periods are not necessarily indicative of results for the entire year.

All significant intercompany balances and transactions have been eliminated in consolidation. The Company has reclassified certain prior year amounts to conform to the current year presentation. These reclassifications have no effect on net loss. The accompanying condensed consolidated financial statements are in U.S. dollars and prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) and include PFGY and each of its wholly owned subsidiaries.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the amounts reported in the financial statements and accompanying notes and assumptions that affect various accounts, including but not limited to long-lived assets, income taxes, inventories, revenue recognition and related sales reserves, allowance for doubtful accounts, and stock compensation as reported in the financial statements and accompanying notes. Management considers many factors in selecting appropriate operational and financial accounting policies and controls, and in developing the assumptions used to prepare these financial statements. Management must apply significant judgment. Among the factors, but not fully inclusive of all factors that may be considered by management, are the following: the range of accounting policies permitted by accounting principles generally accepted in the United States of America; management’s understanding of the Company’s business - both historical results and expected future results; the extent to which operational controls exist that provide high degrees of assurance that all desired information to assist in the estimation is available and reliable or whether there is greater uncertainty in the information that is available upon which to base the estimate; expectations of the future performance of the economy, both domestically and globally, within various areas that serve the Company’s principal customers and suppliers of goods and services; expected rates of exchange; sensitivity and volatility associated with the assumptions used in developing estimates; and whether historical trends are expected to be representative of future trends.  The estimation process often times may yield a range of potentially reasonable estimates of the ultimate future outcomes, and management must select an amount that lies within that range of reasonable estimates based upon the quantity, quality, and risks associated with the variability that might be expected from the future outcome and the factors considered in developing the estimate. This estimation process may result in the selection of estimates that could be viewed as conservative or aggressive by others. Management attempts to use its business and financial accounting judgment in selecting the most appropriate estimate; actual amounts, however, may differ from those estimates.
 
 
27

 

Fair Value Measurement of Financial Instruments

The accounting standards regarding fair value of financial instruments and related fair value measurements define financial instruments, define fair value, establish a three-level valuation hierarchy for disclosures of fair value measurement, and enhance disclosure requirements for fair value measures. The carrying amounts reported in the consolidated balance sheets for current assets and current liabilities qualify as financial instruments and reflect reasonable estimates of fair value because of the short period of time between the origination of such instruments and their expected realization. The three levels of valuation hierarchy are defined as follows:

 
Level 1 inputs to the valuation methodology, which are quoted prices (unadjusted) for identical assets or liabilities in active markets.
 
Level 2 inputs to the valuation methodology that includes quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, substantially for the full term of the financial instrument.
 
Level 3 inputs to the valuation methodology that are unobservable and significant to the fair value measurement.

 Other Receivables

Other receivables consist of advanced payment to be refunded by the Company’s suppliers and intercompany transfer of foreign currencies held by the Company’s export agents. Due to the passage of time, advanced payment to be refunded by the Company’s suppliers has been reclassified as a non-current asset. Management reviews its other receivables on a regular basis and analyzes the financial conditions of the Company’s suppliers and export agents to determine if the allowance for doubtful account is adequate and adjusts the allowance when necessary. An estimate for doubtful accounts is recorded when collection of the full amount is no longer probable.

Property and Equipment

Equipment and leasehold improvements are stated at cost. Depreciation is computed by using the straight-line method at rates based on the estimated useful lives of the various classes of property. Estimates of useful lives are based upon a variety of factors including durability of the asset, the amount of usage that is expected from the asset, the rate of technological change, and the Company’s business plans for the asset. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset. Should the Company change its plans with respect to the use and productivity of property and equipment, it may require a change in the useful life of the asset or incur a charge to reflect the difference between the carrying value of the asset and the proceeds expected to be realized upon the asset’s sale or abandonment. Expenditures for maintenance and repairs are expensed as incurred and significant major improvements are capitalized.

Impairment of Long-Lived Assets

The Company evaluates long-lived assets for impairment annually, and more often if an event or circumstance occurs that triggers an impairment test. Substantial judgment is necessary in the determination as to whether an event or circumstance has occurred that may trigger an impairment analysis and in the determination of the related cash flows from the asset. Estimating cash flows related to long-lived assets is a difficult and subjective process that applies historical experience and future business expectations to revenues and related operating costs of assets. Should impairment appear to be necessary, subjective judgment must be applied to estimate the fair value of the asset, for which there may be no ready market, which oftentimes results in the use of discounted cash flow analysis and judgmental selection of discount rates to be used in the discounting process. If the Company determines an asset has been impaired based on the projected undiscounted cash flows of the related asset or the business unit over the remaining amortization period, and if the cash flow analysis indicates that the carrying amount of an asset exceeds related undiscounted cash flows, the carrying value is reduced to the estimated fair value of the asset or the present
value of the expected future cash flows.
 
Revenue Recognition

The Company recognizes revenue when the following criteria are met: 1) persuasive evidence of an arrangement exists, which is when a signed sales contract or purchase order is received from the customer; 2) delivery has occurred, which is upon shipment when legal title and risk of loss pass to the customer and no other performance obligations remain; 3) the fee is fixed and determinable, and 4) collection is reasonably assured. All of the Company’s products that are sold in the PRC are subject to a Chinese VAT at a rate of 17% of the gross sales price or at a rate approved by the PRC local government. All of the Company’s products that are sold in Germany are subject to a Germany VAT at a rate of 19% of the gross sales price or at a rate approved by the Germany government. The revenue is recognized net of VAT tax, discount and allowance at the time.

Loss per Share

The Company reports earnings per share in accordance with the provisions of FASB’s related accounting standard. This standard requires the presentation of earnings per share (EPS) as basic EPS and diluted EPS in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic EPS excludes dilution and is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.
 
 
28

 

RESULTS OF OPERATIONS

Comparison of Three Months Ended April 30, 2011 and April 30, 2010

The following table sets forth the results of our operations for the periods indicated:
 
    
Three Months
         
Three Months
       
   
Ended
   
% of
   
Ended
   
% of
 
   
April 30, 2011
   
Revenues
   
April 30, 2010
   
Revenues
 
Revenues
  $ 15,796,619       100 %   $ 19,142,768       100.0 %
                                 
Cost of Revenues
    15,835,931       100.2 %     17,184,406       89.8 %
                                 
Gross Profit (Loss)
    (39,312 )     (0.2 %)     1,958,362       10.2 %
                                 
Selling, General, and Administrative Expenses
    941,359       6.0 %     2,239,732       11.7 %
                                 
Research and Development
    97,458       0.6 %     74,306       0.4 %
                                 
Loss from Operations
    (1,078,129 )     (6.8 %)     (355,676 )     (1.9 %)
                                 
Other Income (Expense)
    187,268       1.2 %     (15,293 )     (0.1 %)
                                 
Income (Loss) Before Provision for Income Taxes
    (890,861 )     (5.6 %)     (370,969 )     (1.9 %)
                                 
Provision for Income Taxes
    209,971       1.3 %     349,309       1.8 %
                                 
Net Income (Loss)
    (1,100,832 )     (7.0 %)     (720,278 )     (3.8 %)
                                 
Foreign Currency Translation Adjustment
    (29,987 )     (0.2 %)     38,385       0.2 %
                                 
Comprehensive Income (Loss)
    (1,130,819 )     (7.2 %)     (681,893 )     (3.6 %)

Revenues. During the three months ended April 30, 2011, we had revenues of approximately $15.8 million compared to revenues of approximately $19.1 million for the three months ended April 30, 2010, a decrease of 17%. This change is attributable to a slow-down in production due to adverse weather conditions in Europe and decreased demand in the market conditions during February 2011 that did not occur during the same months in 2010. Another significant factor was the reduction is average sales prices in Europe, which is our dominant geographic market, of our PV modules from €1.28 per watt to €1.16 watt to stay competitive in response to reductions in sales prices by our competitors.

 
29

 

Cost of Revenues.  Cost of revenues for the three months ended April 30, 2011 decreased to approximately $15.8 million from approximately $17.1 million for the three months ended April 30, 2010, a decrease of 8%.  Silicon wafer costs remained relatively stable compared to the same period last year. Also due to lower production levels in January and February, our fixed production costs were higher in the second quarter of 2011 compared to the same period last year, which offset the benefits resulting from an improved efficiency rate.  In response to lower product sales from January and February 2011, we made adjustments to our production and shipment patterns in an effort to reduce costs and attain profitability.

Gross Profit (Loss).  Gross loss was approximately $39,000 for the three months ended April 30, 2011 as compared to gross profit of approximately $2.0 million for the three months ended April 30, 2010, representing a gross margin of (0.2)% in 2011 and 10.2% in 2010.  The decrease in gross profit was primarily due to reduced average sales prices by about 10%.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses totaled approximately $0.9 million for the three months ended April 30, 2011 compared to approximately $2.2 million for the three months ended April 30, 2010, a decrease of 58%.  The decrease is primarily attributable to significantly reduced transportation costs due to a decrease in shipments, which resulted from decreased market demands, as well as decreased stock-based compensation expenses compared to the same period last year.

Research and Development Costs.  Research and development costs, which include development expenses such as salaries, consultant fees, cost of supplies, and materials for samples and costs related to other overhead such as facilities, utilities, and other departmental expenses, totaled approximately $97,000 for the three months ended April 30, 2011 compared to approximately $74,000 for the three months ended April 30, 2010.  Our specific R&D activities during the last quarter included fine-tuning of our production process and experiments with new raw materials to improve efficiency or meet specific customer specifications. The 31% increase between the two periods is attributable to tests conducted during the period that were not conducted during the same period last year.

Other Income (Expense).  We had other income of $187,268 for the three months ended April 30, 2011 compared to other expense of $15,293 for the three months ended April 30, 2010.  This increase in other income was mainly due to an exchange gain from the fluctuation of European sales in the second quarter of 2011.

Net Loss.  Our net loss for the three months ended April 30, 2011 was approximately $1.1 million compared to net loss of approximately $0.7 million for the three months ended April 30, 2010.  The increase in net loss is attributable to a decrease in sales margin as a result of market conditions and a slow-down in production despite a significant decrease in our selling, general and administrative expenses.

 
30

 

Comparison of Six Months Ended April 30, 2011 and April 30, 2010

The following table sets forth the results of our operations for the periods indicated:
 
   
Six Months 
Ended
April 30, 2011
   
% of 
Revenues
   
Six Months 
Ended
April 30, 2010
   
% of 
Revenues
 
Revenues
  $ 24,067,652       100 %   $ 36,470,016       100 %
                                 
Cost of Revenues
    23,348,810       97.0 %     32,798,214       89.9 %
                                 
Gross Profit (Loss)
    718,842       3.0 %     3,671,802       10.1 %
                                 
Selling, General, and Administrative Expenses
    2,304,609       9.6 %     4,089,400       11.2 %
                                 
Research and Development
    193,057       0.8 %     247,136       0.7 %
                                 
Loss from Operations
    (1,778,824 )     (7.4 %)     (664,734 )     (1.8 %)
                                 
Other Income (Expense)
    189,991       0.8 %     113,669       0.3 %
                                 
Income (Loss) Before Provision for Income Taxes
    (1,588,833 )     (6.6 %)     (551,065 )     (1.5 %)
                                 
Provision for Income Taxes
    97,477       0.4 %     413,100       1.1 %
                                 
Net Income (Loss)
    (1,686,310 )     (7.02 %)     (964,165 )     (2.6 %)
                                 
Foreign Currency Translation Adjustment
    214,404       0.9 %     (63,801 )     (0.2 %)
                                 
Comprehensive Income (Loss)
    (1,471,906 )     (6.1 %)     (1,027,966 )     (2.8 %)

 
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Revenues.  Our revenues are generated by sales of solar cells and solar modules.  During the six months ended April 30, 2011, we had revenues of approximately $24.1 million compared to revenues of approximately $36.5 million for the six months ended April 30, 2010, a decrease of 34%.  This change is attributable to a slow-down in production due to adverse weather conditions in Europe and decreased demand in the market during January and February 2011 that did not occur during the same months in 2010.  The decrease is also attributable to reduced sales prices of our PV modules in Europe, which is our dominant geographic market, in order to stay competitive with our competitors who reduced their sales prices.

Cost of Revenues.  Cost of revenues for the six months ended April 30, 2011 decreased to approximately $23.3 million from approximately $32.8 million for the six months ended April 30, 2010, a decrease of 29%.  The unit purchasing price of silicon wafer/cells remained relatively stable between the periods. The decrease is mostly in line with the decrease in our sales between the two periods but can also be explained by increased production costs in January and February of 2011 due to unabsorbed fixed costs incurred for low production levels during those months.

Gross Profit.  Gross profit was approximately $0.7 million for the six months ended April 30, 2011 as compared to gross profit of approximately $3.7 million for the six months ended April 30, 2010, representing a gross margin of 3.0% in 2011 and gross margin of 10.1% in 2010.  The decrease in gross profit was primarily due to the decrease in average sales prices by 6% compared to the same period last year.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses totaled approximately $2.3 million for the six months ended April 30, 2011 compared to approximately $4.1 million for the six months ended April 30, 2010, a decrease of 44%.  The decrease is in line with decreased sales activities, which include shipping and transportation cost related to exports to Europe and reduced stock-compensation expenses and bad debts expenses incurred during the period. The compensation expense decrease for the same period in current year is resulted from the fully amortization of stock-based compensation and no new options were granted to employee during the period.

Research and Development Costs.  Research and development costs, which include development expenses such as salaries, consultant fees, cost of supplies, and materials for samples and costs related to other overhead such as facilities, utilities, and other departmental expenses, totaled approximately $193,000 for the six months ended April 30, 2011 compared to approximately $247,000 for the six months ended April 30, 2010.  The 22% decrease between the two periods is attributable to overall cost-savings efforts in operational activities along with a reduced production level in early 2011, both of which affect our R&D costs.

 
32

 
 
Other Income.  We had other income of approximately $190,000 for the six months ended April 30, 2011 compared to other income of approximately $114,000 for the six months ended April 30, 2010.  The increase in other income is mainly from exchange gains recognized for our European sales.

Net Income (Loss).  Our net loss for the six months ended April 30, 2011 was approximately $1.7 million compared to net loss of approximately $964,000 for the six months ended April 30, 2010.  The increase in net loss is attributable to decreased gross margins offset by reduced sales-related expenses during the periods.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows – Six Months Ended April 30, 2011

Net cash provided by operating activities was $812,819 during the six months ended April 30, 2011, while net cash provided by operating activities was $1.7 million during the six months ended April 30, 2010.  The decrease in cash flow from operating activities during the periods was mainly due to increased operational losses and increased working capital requirements for additional business activities mostly carried out by our German subsidiary since March and April 2011.  These business activities involved direct contracting to PV module manufacturers in China and re-sale to European customers.  Increased sales activities of our German subsidiary resulted in increased accounts receivable and inventory level of the German subsidiary during the quarter ended April 30, 2011 compared to the same period last year.  These increases in accounts receivable and inventory were offset by increased accounts payable and customer deposits due to changes in trade terms in the supply market and additional customer deposits from new business.

Net cash used in investing activities was $51,368 during the six months ended April 30, 2011, while net cash used in investing activities was $266,000 during the six months ended April 30, 2010.  Uses of cash in investing activities included equipment purchases. The decrease in net cash used in investing activities between the two periods is attributed to controlled spending on capital expenditures during the period.

There was no cash provided by or used in financing activities during the six months ended April 30, 2011 and 2010.

Liquidity and Capital Resources

As of April 30, 2011, we had cash and cash equivalents of $2.8 million as compared to $5.6 million at April 30, 2010. We will require a significant amount of cash to fund expansion of our operations. Despite a reduction in revenues in the current quarter, management projects growth of our business in future periods. Reduced revenue and profitability, which under present facts and circumstances management believes are temporary, have led us to revise our plans for capital spending and expansion to defer certain steps until we achieve greater profitability or obtain access to capital on terms attractive to us. Further changes in our operating plans, an increase in our inventory, increased expenses, or other events, may prompt us to seek additional equity or debt financing. If we are unable to successfully generate enough sales to cover our costs, we only have limited cash resources to bear operating losses; meanwhile, we will need to continue to generate new sales while controlling our costs.
 
We have incurred recurring operating losses and had an accumulated deficit of $2.78 million as of April 30, 2011. Notwithstanding the foregoing, we had positive working capital of $3.2 million as of April 30, 2011. Management anticipates that we will generate sufficient cash flows to fund our operations for the next twelve months by increasing the volume of our product sales. If future sales do not meet our forecasts, we may be required to fund operations by raising additional capital. As such, our ability to achieve our business plan is primarily dependent upon our ability to grow our planned level of operations and/or obtain sufficient additional capital at acceptable costs. With respect to these objectives, we cannot provide any assurance that we will succeed. If events or circumstances occur such that we are unable to or do not meet our operating plan as expected and/or do not secure additional financing, we may be required to significantly curtail or cease operations.
 
We currently do not have any binding commitments for, or readily available sources of, additional financing. We may require additional cash due to changes in business conditions or other future developments, including any investments or acquisitions we may decide to pursue.  To the extent it becomes necessary to raise additional cash in the future, we may seek to raise it through the sale of debt or equity securities, funding from joint-venture or strategic partners, debt financing or loans, issuance of common stock, or a combination of the foregoing.  We cannot provide any assurances that we will be able to secure the additional cash or working capital we may require to continue our operations, either now or in the future.

 
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On June 2, 2011, Tianjin Zhonghuan Co., Ltd. (“Tianjin Zhonghuan”), an A-share listed company on China’s Shenzhen Stock Exchange announced that its Board of Directors approved the purchase of shares of our common stock for an aggregate purchase price of not more than $6.3 million.  Upon closing, Tianjin Zhonghuan will own a 35% stake in the Company. A definitive agreement has not been entered into, and the Company is in negotiations with Tianjin Zhonghuan to enter into a definitive agreement for this sale. There is no assurance that the sale will be consummated.

Off-Balance Sheet Arrangements

We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties.  We have not entered into any derivative contracts that are indexed to our shares and classified as stockholder’s equity or that are not reflected in our consolidated financial statements.  Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity, or market risk support to such entity.  We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk, or credit support to us or engages in leasing, hedging, or research and development services with us.

Item 4. Controls and Procedures
   
Disclosure Controls and Procedures
  
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer (Chief Executive Officer) and principal financial officer (Chief Financial Officer), of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
 
Based on that evaluation, as of April 30, 2011, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as defined in Rules13a-15(e) and 15d-15(e) under the Exchange Act, were not effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and (ii) is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosures due to the following material weaknesses in internal control identified by management in our financial statement reporting process:

 
 
(i)
Lack of sufficient communications between our headquarters in Shanghai and our German subsidiary for timely resolutions on daily accounting issues and deficiencies in controls of financial reporting process; and

 
(ii)
Lack of sufficient U.S. GAAP knowledge, including experience and skills, of our accounting personnel for the accurate accounting of various business issues.

The material weaknesses were identified in October 2010. Management believes that these weaknesses continued as a direct result of a continued significant increase in operating activities in 2011. We have taken the following measures to remediate these material weaknesses:
 
 
(i)
Developed a rigorous process of communications between all persons involved in the financial reporting process and improved the quality of review of financial statements;
 
 
(ii)
Hired and outsourced additional financial reporting and accounting personnel with relevant account experience, skills, and knowledge in the preparation of financial statements under the requirements of U.S. GAAP and financial reporting disclosure pursuant to SEC rules; and
 
 
(iii)
Provided additional training and cross-training to our accounting personnel, including in the areas of new and emerging accounting standards.

We plan on continuing to identify and implement remedial measures.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 
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PART II - OTHER INFORMATION

Item 6.  Exhibits.
 
Exhibit
Number
 
Description
3.1
 
Articles of Incorporation (2)
     
3.2
 
Bylaws (1)
     
10.1
 
Salary Adjustment Letter for Wennan (Jack) Li, dated March 25, 2011 (3)
     
10.2
 
Salary Adjustment Letter for Xiaolin (Edward) Zhuang, dated March 25, 2011 (3)
     
10.3
 
Employment Agreement between Perfectenergy International Limited and Xiaolin (Edward) Zhuang, dated March 25, 2011 (3)
     
10.4
 
Salary Adjustment Letter for Diping Zhou, dated March 25, 2011 (3)
     
10.5
 
Director Agreement with Adam Roseman, dated February 11, 2011*
     
31.1
 
Section 302 Certification by the Company’s Chief Executive Officer *
     
31.2
 
Section 302 Certification by the Company’s Chief Financial Officer *
     
32.1
 
Section 906 Certification by the Company’s Chief Executive Officer *
     
32.2
 
Section 906 Certification by the Company’s Chief Financial Officer *

*
Filed herewith.

(1)
Filed on December 8, 2005 as an exhibit to our Registration Statement on Form SB-2 and incorporated herein by reference.

(2)
Filed on June 14, 2010 as an exhibit to our Quarterly Report on Form 10-Q and incorporated herein by reference.

(3)
Filed on March 30, 2011 as an exhibit to our Current Report on Form 8-K and incorporated herein by reference.

 
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SIGNATURES

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

 
Perfectenergy International Limited
(Registrant)
     
Date: June 14, 2011
By:
/s/ Wennan Li
   
Wennan Li
   
Chief Executive Officer
(Authorized Officer)
     
Date: June 14, 2011
By:
/s/ Xiaolin Zhuang
   
Xiaolin Zhuang
   
Chief Financial Officer
(Principal Financial Officer)
 
 
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