ITEM 1. BUSINESS.
Corporate Overview
We were originally incorporated on February 25, 2005 in the State of Nevada under our former name “Crestview Development Corporation.” On April 16, 2007, we changed our name to “Perfectenergy International Limited.”
We conduct operations through our wholly owned subsidiary, Perfectenergy International Limited, a private British Virgin Islands corporation (“Perfectenergy BVI”), and Perfectenergy BVI’s three wholly owned subsidiaries (i) Perfectenergy (Shanghai) Limited, a company organized under the laws of the People’s Republic of China (“Perfectenergy Shanghai”), (ii) Perfectenergy GmbH, a German corporation (“Perfectenergy GmbH”), and (iii) Perfectenergy Solar-Tech (Shanghai) Ltd., a company organized under the laws of the People’s Republic of China (“Perfectenergy Solar-Tech”).
Perfectenergy BVI was incorporated under the laws of the British Virgin Islands as an International Business Company on April 1, 2005. Perfectenergy Shanghai was organized under the laws of the People’s Republic of China on July 8, 2005. Perfectenergy Solar-Tech was incorporated in the PRC on February 28, 2008. Perfectenergy BVI, through Perfectenergy Shanghai and Perfectenergy Solar-Tech, is principally engaged in the research, development, manufacturing, and sale of solar cells, solar modules, and photovoltaic systems.
We conduct sales in Europe through Perfectenergy GmbH, which was formed in Germany on November 9, 2007. The principal function of Perfectenergy GmbH is marketing, installation, and other after-sales services for our PV products.
Our principal offices are located at No. 479 You Dong Road, Xinzhuang Town, Shanghai in the PRC. We also have a German office located at Tannenweg 8, 53757 Sankt Augustin, Germany.
Our Operations
Our operations consist of the research, development, manufacturing, and sale of solar cells, solar modules, and photovoltaic (“PV”) systems. Our manufacturing and research facility is located in Shanghai, China.
We have a 45 megawatt (“MW”) solar cell production line and a 60 MW solar panel lamination line. In our facility’s solar cell and solar panel lamination production lines, we are able to produce different kinds of cells, such as 6-inch cells and 8-inch cells, mono-crystalline cells and multi-crystalline cells, and different types and sizes of solar modules. After the manufacturing process, our products are put through a rigorous quality assurance process. All of our products are strictly in accordance with international standards, such as IEC61215, TUV Safe Class II, and UL1703, in order to maintain our competitiveness in international markets.
We believe that our manufacturing processes allow us to produce PV solar products at a much lower cost than traditional solar cell manufacturing for the same levels of production due to our lower capital cost. Our production line requires less capital investment than traditional solar cell production lines for the same levels of production due to the proprietary nature and in-house manufacturing of our capital equipment, while the competition must import costly capital equipment from Germany and Japan.
We also have a sales and marketing force that is led by our Chief Executive Officer. Our targeted customers, besides our existing customers, are mostly system integrators and distributors in the United States, Europe, and China.
Principal Products and Services
We believe our photovoltaic (“PV”) cells and modules are highly competitive with other products in the solar energy market in terms of efficiency and quality. We expect to continue improving the conversion efficiency and power, and reducing the thickness, of our solar products as we continue to devote significant financial and human resources in our various research and development programs.
PV Cells
We design, manufacture, and market crystalline solar cells (approximately 6 inch squares composed of silicon and glass) sold as crystalline solar modules (metal grid structures housing 72 cells).
A PV cell is a silicon semiconductor device that converts sunlight into electricity by a process known as the photovoltaic effect. The following table sets forth the specifications for samples of two types of PV cells we produce:
The key technical efficiency measurement of PV cells is the conversion efficiency rate. In general, the higher the conversion efficiency rate, the lower the production cost of PV modules per watt because more power can be incorporated into a given size package. The average conversion efficiency rate of our monocrystalline PV cells reached 17.3% in November 2008, representing an increase from 18% in December 2005 when we began producing PV cells. We currently produce a variety of PV cells ranging from 200 microns to 230 microns in thickness.
PV Modules
A PV module is an assembly of PV cells that is electrically interconnected and laminated in a durable and weatherproof package. Our solar cells are often sold as components of assembled modules. We are also developing PV modules with higher power to meet the rising expansion of on-grid configurations. The majority of the PV modules we currently offer to our customers range in power between 170W and 230W. We also perform limited original equipment manufacturing work for other solar cell producers, such as selling standalone solar modules. We sell approximately 90% of our PV modules under our “Perfectenergy” brand and approximately 10% of our PV modules under the brand names of our customers.
Distribution
We sell our products to a number of systems integrators and distributors, primarily located in Germany, who purchase their solar modules, purchase software, and hardware from other vendors and integrate and install the end-product for customers. Many of our customers, in turn, sell turnkey solar systems to end-users that include individual owners of agricultural buildings; owners of commercial warehouses, offices, and industrial buildings; public agencies and municipal government authorities that own buildings suitable for solar system deployment; owners of land designated as former agricultural land, waste land, or conversion land, such as former military bases or industrial areas; and financial investors that desire to own large scale solar projects.
Market and Industry Overview
The solar power market has experienced rapid growth in the past several years. According to Solarbuzz LLC, an independent solar energy research firm, the global solar PV market size reached about 16 GW in 2010, and the estimated market size is expected to be more than 20 GW in 2011. Also according to a Solarbuzz forecast, even in the slowest growth scenario, the global market is expected to be 2.5 times its current size by 2014.
We believe the solar power market will continue to grow as a result of the growing adoption of government incentives for solar energy sources, rising energy demand and limited fossil energy sources, and the growing awareness of the advantages of solar energy, all of which are discussed below.
Growing Adoption of Government Incentives for Solar and Other Renewable Energy Sources
In response to the increasing environmental concerns worldwide, many governments have promulgated regulations and implemented policies to limit the release of hazardous and greenhouse gases, such as carbon dioxide, and to encourage the use of renewable energy sources. Due to the fact that most renewable energy sources are currently less cost competitive than traditional energy sources, a growing number of countries have created incentive programs for the solar sector, including:
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direct subsidies to end users to counter costs of equipment and installation;
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net metering laws enabling on-grid end users to sell electricity back to the grid at retail prices;
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government standards mandating minimum consumption levels of renewable energy sources; and
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low interest loans and tax incentives to finance solar power systems.
Due to government support in the past decade, solar energy has become an attractive alternative to traditional energy sources. Set forth below are brief descriptions of the incentive programs adopted by the following selected countries:
China. With cheaper raw materials and PV technology innovation, however, solar electricity cost in China was reduced by 50% from 2008 to 2010, making solar power a strong candidate to become a major energy resource. Falling solar power generation cost and rising demand as the main drivers for the uptake, China revised its 2020 target for solar power capacity from 1.8 GW to 20 GW. In February 2005, China enacted the Renewable Energy Law, which became effective in January 2006. This law provides certain financial incentives for the development of renewable energy projects. Various local authorities have also introduced initiatives to encourage the adoption of renewable energy, including solar energy. In addition, the government has enacted several policies to support the solar industry, including a regional feed-in tariff and national subsidies for solar PV installations such as subsidy scheme on rooftop projects. We expect that the increase in solar energy consumption in local municipalities will encourage further growth of the solar energy industry in China.
The Company was entitled to receive a 50% reduction from the regular income tax rate of 25% in 2009, and we are entitled to the preferential tax rate of 15% for having been granted a high technology certification from the local tax authority in 2010. The Chinese government also granted us a refund on value added taxes (“VAT”), which are imposed on exported goods at a 17% rate. Enterprises or individuals who sell products, engage in repair and maintenance, or import and export goods in China are subject to VAT in accordance with Chinese laws. The standard VAT is 17% of the gross sales price. To the best of our knowledge, we are not eligible to receive similar subsidies or incentives from any other government.
Germany. Under its Renewable Energy Sources Act, Germany aims to increase the share of electricity from renewable energy to 12.5% by 2010 and 20% by 2020. In particular, the Renewable Energy Sources Act requires electricity transmission grid operators to connect various renewable energy sources to their electricity transmission grids and to purchase all electricity generated by such sources at guaranteed feed-in tariffs. Additional regulatory support measures include investment cost subsidies, low-interest loans, and tax relief to end users of renewable energy.
Italy. Before 2005, the Italian PV market benefited primarily from regional support for PV installations with grants of up to 65% of investment in the absence of national incentive funds. In 2005, Italy passed a new law that set fixed feed-in tariffs for electricity produced from renewable energy sources. The incentives are available to individuals, companies, and public bodies. In January 2006, the Italian government approved various measures relating to PV feed-in tariffs, including increasing the PV feed-in tariff cap to 500 MW by 2015.
Japan. The Japanese government has implemented a series of incentive programs, including the “PV 2030” roadmap that outlines government policies to support solar power electricity. Japan also provides government subsidies for research and development.
Spain. The incentive regime in Spain includes a national net metering program and favorable interest loans. The actual feed-in tariff for solar energy in Spain is fully guaranteed for 25 years and guaranteed at 80% for subsequent years.
United States. At the federal level, several recent developments are favorable to the PV industry in general in the United States. The United States Congress approved the Energy Policy Act of 2005, which provides a 30% investment tax credit for PV installations. With the “Extension and Modification of Solar Energy and Fuel Cell Investment Tax Credit” bill passed by Congress in 2008, the tax credit for PV installation was extended through 2016. This bill lifted a limitation that prevented public utilities from claiming the investment tax credit, which may increase solar panel sales to U.S. utilities that now qualify to receive a 30% tax credit for their first PV installation. The bill also allows these credits to be used to offset the alternative minimum tax (AMT). Further, President Obama’s New Energy for America plan set forth the goal for 10% of electricity generated in the U.S. to come from renewable energy sources by 2012 and 25% by 2025. In addition, a number of states, including California and New Jersey, have committed substantial resources to developing and implementing renewable energy programs. Under the California Solar Initiative, an investment of $3.2 billion will be made from 2006 to 2017 for the installation of 1 million PV plants with the total output of more than 3,000MW. Investors in these PV plants will get refunds from the state and federal governments of approximately 75% of their total investment, and the investors are to receive a guaranteed profit of 12% on average for the electricity produced by their PV plants with certificates of green power. In April 2006, the New Jersey Board of Public Utilities voted to approve new regulations which expand the state’s Renewable Portfolio Standard by extending the existing goals out to 2020 and increasing the required amount of renewable energy and solar energy. Under the newly adopted regulations, 20% of New Jersey’s electricity must come from renewable sources by 2020. The New Jersey regulations also include a 2% solar set aside, which is forecast to require 1,500MW of electricity to be generated through solar power, the largest solar commitment relative to population and electricity consumption in the United States.
Rising Energy Demand and Limited Fossil Energy Sources with Increasing Prices
In recent years, global economic development has resulted in surging energy demand and rising energy prices. Electric power demand is expected to increase from 16.1 trillion kilowatt hours in 2002 to 31.7 trillion kilowatt hours by 2030 globally. Meanwhile, the generation of electric power is capacity-constrained and dependent upon fossil fuel feedstock. The situation is compounded by the finite supply of traditional energy sources, such as natural gas, coal, and petroleum. In addition, petroleum prices have risen dramatically because of war, political instability, labor unrest, and the threat of terrorism in oil-producing regions. Further, for national security reasons, many governments seek to further develop domestic sources of energy. Thus, future energy demand is increasingly expected to be met by renewable energy sources, such as solar energy.
Growing Awareness of the Advantages of Solar Power
Solar power offers a variety of advantages over other sources of power, including an absence of the need for fuel, environmental cleanliness, location based energy production, greater efficiency during peak demand periods, high reliability, and modularity. These advantages include the following:
No fossil fuel requirement. Solar power relies solely on sunlight rather than traditional fossil fuels that have historically experienced supply constraints, volatile pricing and delivery risk.
Clean energy production. Unlike traditional fossil fuel energy sources and many other renewable energy sources, solar power systems generate electricity with no emissions or noise impact.
Location-based energy production. Solar power is a distributed energy source, meaning that the electricity can be generated at the site of consumption. This provides a significant advantage to the end user who is not reliant upon the traditional electricity infrastructure for delivery of electricity to the site of use.
Energy generated to match peak usage times. Peak energy usage and high electricity costs typically occur mid-day, which also generally corresponds to peak sunlight hours and solar power electricity generation.
Reliable Source of Electricity. Solar power systems generally do not contain moving parts, nor do they require significant ongoing maintenance.
Modular. Solar power systems are made from interconnecting and laminating solar cells into solar modules. Given this method of construction, solar power products can be deployed in many different sizes and configurations to meet specific customer needs.
Challenges Facing the Solar Power Industry
Although solar power has several advantages and is an attractive alternative to traditional energy sources, there remain certain key challenges that the solar power industry must overcome to accomplish broad commercialization of its products, including the following:
Possible Reduction or Elimination of Government Subsidies and Incentives. The current growth of the solar power industry substantially relies on the availability and size of government subsidies and economic incentives, such as capital cost rebates, reduced tariffs, tax credits, net metering, and other incentives. Governments may eventually decide to reduce or eliminate these subsidies and economic incentives. It remains a challenge for the solar power industry to reach sufficient scale to be cost-effective in a non-subsidized marketplace.
High Cost of Solar Power. Generally, the per kilowatt-hour cost of generating solar electricity, including the upfront capital costs, is greater than retail electricity rates. While government policy mechanisms and heightened consumer awareness are driving solar power adoption, the cost of solar power products remains an impediment to growth. To address this issue, manufacturers must improve the cost efficiency of solar power systems through innovation and continuous improvement of production techniques. For example, improving conversion efficiencies of solar cells will reduce raw material requirements and lower costs required to manufacture a solar power system with a given output. Higher conversion efficiencies also decrease the size of the solar power system, and thereby lower the system installation costs.
Shortages of Raw Materials. Polysilicon is the main raw material used in manufacturing our solar cells. Currently, there is some relief in the supply shortage of polysilicon in the industry. However, due to strong demands in the PV products in next few years, we believe that the industry-wide shortage of polysilicon will continue to have a material impact on our liquidity because suppliers will likely require more advance payments for the polysilicon that they supply to us as our production expands. Further, a shortage may also have a material effect on our results of operations because a shortage will likely cause the price of polysilicon to rise. Such increase will likely cause an increase in the cost of producing our products especially if we must obtain more polysilicon in the market to produce our products as our production expands in the future. In addition, we believe effective supply chain management is critical to ensure continued growth for the industry.
Competition
The global solar power market is highly competitive and has rapidly evolved. Various government incentive and subsidy programs implemented in the United States, Europe, China, Japan, and other countries in recent years have further induced competition in solar energy product marketplace. In particular, a large number of manufacturers have entered the solar market.
Our main overseas competitors, including those in the United States, include BP Solar, Kyocera Corporation, Mitsubishi Electric Corporation, Motech Industries Inc., Sharp Corporation, Q-Cells AG, Sanyo Electric Co., Ltd., and Sunpower Corporation. Our primary competitors in China include Suntech Power Holding’s Co., Ltd., Baoding Tianwei Yingli New Energy Resources Co., Ltd., and Nanjing PV-Tech Co., Ltd.
We compete primarily on the basis of the power efficiency, quality, performance, and appearance of our products, price, strength of supply chain and distribution network, after-sales service, and brand image. Many of our competitors, however, have longer operating histories and significantly greater financial or technological resources than we do and enjoy greater brand recognition. Some of our competitors are vertically integrated and design and produce upstream silicon wafers, mid-stream PV cells and modules, and downstream solar application systems, which provide them with greater synergies to achieve lower production costs. During periods when there is a shortage of silicon and silicon wafers, we compete intensely with our competitors in obtaining adequate supplies of silicon wafers. Moreover, many of our competitors are developing next-generation products based on new PV technologies, including amorphous silicon, transparent conductive oxide thin film, carbon material, and nano-crystalline technologies, which, if successful, will compete with the crystalline silicon technology we currently use in our manufacturing processes. We are seeking to develop new technologies and products through our research collaborations.
We, like other solar energy companies, also face competition from traditional non-solar energy industries, such as the petroleum and coal industries. The production cost per watt of solar energy is significantly higher than other types of energy. As a result, we cannot provide assurances that solar energy will be able to compete with other energy industries in the long-term, especially if there is a reduction or termination of government incentives and other forms of support for solar energy.
Sources and Availability of Raw Materials
Our manufacturing process uses approximately 20 types of raw materials and components that undergo a qualification process to construct a complete solar module. We currently source these raw materials and components from domestic suppliers in China, and most of our critical materials and components are either sourced from only one supplier or supplied by a limited number of suppliers. Supply of these materials is stable for the most part as a result of the maturity of solar related production in China.
One key raw material in our production process is silicon wafers. We purchase all of our silicon wafers from a limited number of suppliers. We have long term supply contracts with two major suppliers, which provides for monthly price adjustments based on the spot rate of silicon. These contracts are more fully described below under “Principal Suppliers.”
Principal Suppliers
Silicon is essential for manufacturing our products and, as noted above, silicon manufacturers are not currently able to keep up with demand. We have a long-term silicon supply agreement with Chengdu Jiayang Silicon Technology, Inc., Ltd. (“Chengdu”). Our purchase obligations under this agreement were 1 million silicon wafers in 2010 and are 1.2 million silicon wafers in 2011 and 1.5 million silicon wafers in 2012. Due to fluctuations in the silicon supply market, the purchasing price of these silicon wafers is based on market conditions.
Other materials needed to produce cells and modules, such as chemicals, special-made glasses, etc. are relatively easy to purchase from multiple vendors, and we intend to work with two to three vendors to ensure the best pricing and quality of these supplies.
Customers
We sell our products to a number of systems integrators and distributors, mostly located in Europe and China, who purchase solar cells and solar modules from us, software and hardware from other vendors, and then integrate and install the end-product for their customers. These systems integrators sell turnkey solar systems to end-users that include the following:
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Individual owners of agricultural buildings,
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Owners of commercial warehouses, offices, and industrial buildings,
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Public agencies and municipal government authorities,
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Owners of land designated as former agricultural land, waste land, or conversion land, such as former military bases or industrial areas, and
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Financial investors interested in owning large scale solar projects.
Our top three customers by value, who accounted for 50% of our revenue during the fiscal year ended October 31, 2010 are as follows:
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Alpensolar GmbH, accounting for 24% of revenue;
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B&W Energy GmbH, accounting for 19% of revenue; and
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ProsolarTech GmbH, accounting for 7% of revenue.
Intellectual Properties and Licenses
The following table describes the intellectual property owned by the Company:
Type
Name
Issued by
Duration
Description
Trademark
Trademark Bureau of the People’s Republic of China
Ten years from 2009 to 2019 (and renewable within six months prior to the end of each ten-year term for additional ten-year periods)
Logo, brand name used in our products
Trademark
Trademark Bureau of the People’s Republic of China
August 21, 2010 to August 20, 2020
Logo, brand name used in our products
Patent
Solar cell fire furnace equipment
Intellectual Property Bureau of the People’s Republic of China
May 25, 2006 to May 25, 2016 (10 years)
To increase cell efficiency with proper cell production technique
Patent
Solar wafer drying equipment
Intellectual Property Bureau of the People’s Republic of China
May 17, 2006 to May 17, 2016 (10 years)
To dry wafers more effectively, thus improving quality and increasing yield
Patent
Preparation method of Chalcogenide Glass (with Rare Earth elements)
Intellectual Property Bureau of the People’s Republic of China
July 11, 2003 to July 10, 2013
To improve efficiency in absorption of sunlight to PV module system
We are certified by IEC61215 and Safety Class II for TUV. Both IEC and TUV are international standards for electronic appliances. We also applied for UL certification (standards for electronic appliance in the United States), and we expect this certification process to be completed in early 2011.
We have also filed applications for three patents in Shanghai, which are currently being reviewed by local authority.
Research and Development
During the fiscal years ended October 31, 2010 and October 31, 2009, we incurred $509,181 and $409,148, respectively, for research and development primarily related to the development of new types of crystalline PV cells as well as improvement on the conversion efficiency of PV cell and module products.
Environmental Matters
Our manufacturing processes generate noise, wastewater, gaseous wastes, and other industrial wastes. We have various types of anti-pollution equipment installed in our facilities to reduce, treat, and, where feasible, recycle the wastes generated in our manufacturing process. We outsource the treatment of some of our wastewater and other liquid wastes to third-party contractors.
Our operations are subject to regulation and periodic monitoring by local environmental protection authorities in Shanghai. In conjunction with our efforts with the construction of our new solar cell production facility, we are planning to further improve management of the environmental issues relating to our operations, including consultations with local environmental protection authorities and compliance with regulations. Management believes that we have all environmental permits necessary to conduct our business and have obtained all necessary environmental permits for our facility in Shanghai. Management also believes that we have properly handled our hazardous materials and wastes and have appropriately remediated any contamination at any of our premises. We are not aware of any pending or threatened environmental investigation, proceeding, or action by foreign, federal, state, or local agencies or third parties involving our current facilities. Any failure by us to control the use of or to restrict adequately the discharge of, hazardous substances could subject us to substantial financial liabilities, operational interruptions and adverse publicity, any of which could materially and adversely affect our business, results of operations, and financial condition.
Employees
As of January 31, 2011, we had approximately 150 employees, all of which are full-time employees.
ITEM 2.
ITEM 2. PROPERTIES.
Offices and Facilities
The table below provides a general description of our offices and facilities:
(1)
This lease is currently expired, but we are negotiating a renewal with the landlord. During negotiations, we have an oral agreement with the landlord to continue the terms of the expired leases.
We lease the space for our headquarters and factory premises under a property lease agreement that expires on May 31, 2011, with an option to renew the lease. We lease the space for our sales and marketing office in Germany under a property lease agreement that expired in November 2010. The additional production facility used by Perfectenergy Solar-Tech is leased under a property lease agreement that also expired in March 2010. The terms of both expired leases are still in effect under an oral agreement with the landlords during negotiations to renew the expired leases. At October 31, 2010, minimum future commitments under the lease agreements were as follows:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
We know of no material, existing or pending legal proceedings against us, nor are we involved as a plaintiff in any material proceeding or pending litigation. To the best of our knowledge, there are no proceedings in which any of our directors, officers, or affiliates, or any registered or beneficial holder of more than 5% of our voting securities, or any associate of such persons, is an adverse party or has a material interest adverse to the Company.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock is quoted on the Over-the-Counter Bulletin Board under the symbol “PFGY.” The following table sets forth, for the periods indicated, the reported high and low closing bid quotations for our common stock as reported on the OTC Bulletin Board for each quarterly period within our two most recent fiscal years. The bid prices reflect inter-dealer quotations, do not include retail markups, markdowns, or commissions, and do not necessarily reflect actual transactions.
Common Stock
As of January 27, 2011, the closing sales price for shares of our common stock was $0.09 per share on the OTC Bulletin Board.
Holders
As of January 28, 2011, we have 23 stockholders of record of our issued and outstanding common stock based upon a shareholder list provided by our transfer agent. Our transfer agent is Holladay Stock Transfer, Inc. located at 2939 North 67th Place, Suite C, Scottsdale, Arizona 85251, and their telephone number is (480) 481-3940.
Dividend Policy
We do not currently intend to pay any cash dividends in the foreseeable future on our common stock and, instead, intend to retain earnings, if any, for operations. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions, and other factors that our board of directors may deem relevant.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth, as of October 31, 2010, certain information related to our compensation plans under which shares of our common stock are authorized for issuance.
(1)
Includes outstanding options granted pursuant to the Company’s 2007 Stock Incentive Plan.
(2)
Includes shares remaining available for future issuance under the Company’s 2007 Stock Incentive Plan.
On September 5, 2007, our board of directors approved the 2007 Stock Incentive Plan (the “Plan”), which was also approved by a majority of our shareholders at our annual shareholder meeting held on September 2, 2008. All of our employees, officers, and directors, and those of our consultants and advisors who (i) are natural persons and (ii) provide bona fide services to the Company not connected to a capital raising transaction or the promotion or creation of a market for our securities are eligible to be granted options or restricted stock awards (each, an “Award”) under the Plan. The Plan is administered by our board, and the board establishes certain terms of option awards, including the exercise price and duration, in the applicable option agreement. Awards may be made under the Plan for up to 1,500,000 shares of our common stock, and the maximum number of shares of common stock with respect to which Awards may be granted to any participant under the Plan is 500,000 shares of common stock. The Plan allows for adjustments for changes in common stock and certain other events, including, but not limited to, any stock split, reverse stock split, stock dividend, recapitalization, combination of shares, reclassification of shares, spin-off, any distribution to holders of common stock other than a normal cash dividend, and liquidation or dissolution.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis of the results of operations and financial condition of Perfectenergy International Limited for the fiscal years ended October 31, 2010 and 2009 should be read in conjunction with our financial statements and the notes to those financial statements that are included elsewhere in this report. Our discussion includes forward-looking statements based upon 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 Statement Regarding Forward-Looking Information and Business sections in this report. 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 are based on our consolidated financial statements, which 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.
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.
Revenue Recognition
The Company’s revenue recognition policies are in accordance with the FASB’s accounting standard. Revenues from solar cells, solar modules, and PV systems are recognized upon shipment of the products only if no significant Company obligations remain, the fee is fixed or determinable, and collection is received or the resulting receivable is deemed probable. Revenue is recognized, net of discount and allowances, at the time of product shipment. 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. In general, the Company does not accept product returns; only under special situations, when both the Company and customers agree, is a product exchange allowed. Historically, the Company has not experienced any product returns. For solar cells, solar modules, and PV systems, the Company is covered by product quality insurance and product liability insurance. The product quality insurance retroactively covers the period from July 1, 2007 to the end of the insurance period on June 30, 2011. As such, the Company does not maintain a provision for potential warranty cost.
Fair Value 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:
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Level 1 inputs to the valuation methodology, which are quoted prices (unadjusted) for identical assets or liabilities in active markets.
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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 analyzes all financial instruments with features of both liabilities and equity, pursuant to which the Company’s warrants were required to be recorded as a liability at fair value and marked to market each reporting period.
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.
Recently Issued Accounting Standards
In October 2009, the FASB issued an Accounting Standards Update (“ASU”) regarding accounting for own-share lending arrangements in contemplation of convertible debt issuance or other financing. This ASU requires that at the date of issuance of the shares in a share-lending arrangement entered into in contemplation of a convertible debt offering or other financing, the shares issued shall be measured at fair value and be recognized as an issuance cost, with an offset to additional paid-in capital. Further, loaned shares are excluded from basic and diluted earnings per share unless default of the share-lending arrangement occurs, at which time the loaned shares would be included in the basic and diluted earnings-per-share calculation. This ASU is effective for fiscal years beginning on or after December 15, 2009, and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued ASU No. 2010-02 regarding accounting and reporting for decreases in ownership of a subsidiary. Under this guidance, an entity is required to deconsolidate a subsidiary when the entity ceases to have a controlling financial interest in the subsidiary. Upon deconsolidation of a subsidiary, an entity recognizes a gain or loss on the transaction and measures any retained investment in the subsidiary at fair value. In contrast, an entity is required to account for a decrease in its ownership interest of a subsidiary that does not result in a change of control of the subsidiary as an equity transaction. This ASU clarifies the scope of the decrease in ownership provisions, and expands the disclosures about the deconsolidation of a subsidiary or de-recognition of a group of assets. This ASU is effective beginning in the first interim or annual reporting period ending on or after December 31, 2009. The adoption of this ASU did not have a material impact on its consolidated financial statements.
In January 2010, FASB issued ASU No. 2010-06 - “Improving Disclosures about Fair Value Measurements.” This update provides amendments to Subtopic 820-10 that requires new disclosure to include transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements. Further, this update clarifies existing disclosures on level of disaggregation and disclosures about inputs and valuation techniques. A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities and should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this ASU did not have a material impact on its consolidated financial statements.
In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements”. ASU 2010-09 primarily rescinds the requirement that, for listed companies, financial statements clearly disclose the date through which subsequent events have been evaluated. Subsequent events must still be evaluated through the date of financial statement issuance; however, the disclosure requirement has been removed to avoid conflicts with other Securities and Exchange Commission (“SEC”) guidelines. ASU 2010-09 was effective immediately upon issuance and was adopted in February 2010.
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.
RESULTS OF OPERATIONS
The following table sets forth the results of our operations for the fiscal years ended October 31, 2010 and 2009.
REVENUES. During the fiscal year ended October 31, 2010, we had revenues of $74.6 million as compared to revenues of $31.5 million during the fiscal year ended October 31, 2009, an increase of approximately137%. The increase in revenues is attributable to increased shipment of PV modules to the European market, which are backed by strong orders from both existing and new customers due to a lower sales price in Europe and continued support of clean energy from European governments.
COST OF REVENUES. Cost of revenues for the fiscal year ended October 31, 2010 was $67.2 million as compared to $30.3 million for the fiscal year ended October 31, 2009, an increase of approximately 122%. The increase is due to incremental sales of our solar modules as well as a reduction by more than 50% in the cost of silicon wafers/cells compared to the same period last year due to an increased supply of silicon wafers in the market.
GROSS PROFIT. Our gross profit for the fiscal year ended October 31, 2010 was $7.4 million as compared to a gross profit of $1.1 million for the fiscal year ended October 31, 2009, representing gross margins of approximately 9.9% and 3.5%, respectively. The increase in gross profit was primarily due to a decrease in our raw material costs, which was offset by reduced average module sales prices. The cost of silicon wafers/cells fell by 55% while the sales price of modules was reduced by 50% compared to the same period last year. In addition, the increase in gross margin is also attributed to continuous focuses on cost control measures on manufacturing process.
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES. Selling, general, and administrative expenses totaled $9.6 million for the fiscal year ended October 31, 2010 as compared to $7.7 million for the fiscal year ended October 31, 2009, an increase of approximately 25%. The increase is attributable to increased export sales-related expenses, including shipping and transportation costs and freight, and expenses related to increased travel by our sales team in Europe.
OTHER EXPENSES (INCOME). Other income for the fiscal year ended October 31, 2010 consisted of non-operating income, interest income, and change in fair value of derivative instruments. We had other income of $79,480 for the fiscal year ended October 31, 2010 as compared to $0.6 million for the fiscal year ended October 31, 2009. The source of other income for both periods was the positive impact from changes in the value of our issued and outstanding warrants.
NET INCOME (LOSS). We had net loss of $2.7 million for the fiscal year ended October 31, 2010 as compared to net loss of $5.7 million for the fiscal year ended October 31, 2009. The decrease in net loss is primarily attributable to significantly improved gross margins from sales revenue and offset by incremental sales-related costs.
LIQUIDITY
Cash Flows
Net cash used in operating activities was $1.1 million for the fiscal year ended October 31, 2010, while net cash provided by operating activities was $1.8 million for the fiscal year ended October 31, 2009. The decrease in net cash flow from operating activities was mainly due to decrease in customer deposits and accounts payable balances. With strong demands of silicon wafers in the market, we increased the portion of cash settlement for silicon wafer/cells purchases during the fourth quarter of our last fiscal year.
Net cash used in investing activities was $0.5 million for the fiscal year ended October 31, 2010, while net cash used in investing activities was $0.4 million for the fiscal year ended October 31, 2009. Similar to the prior fiscal year, we continued to control spending on equipment-related costs.
There were no financing activities during our fiscal years ended October 31, 2010 and 2009.
CAPITAL RESOURCES
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.
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.
CONTRACTUAL OBLIGATIONS
We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We present in the table below a summary of the most significant assumptions used in our determination of amounts in order to assist in the review of this information within the context of our consolidated financial position, results of operations, and cash flows.
The following table summarizes our contractual obligations as of October 31, 2010, and the effect such obligations are expected to have on our liquidity and cash flows in future periods.
(1)
Operating lease amounts include the lease for our main office and manufacturing facility. All leases are on a fixed repayment basis. None of the leases includes contingent rentals.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Our consolidated financial statements for the fiscal years ended October 31, 2010 and 2009 begin on the following page, starting with page.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Perfectenergy International Ltd. and subsidiaries
We have audited the accompanying consolidated balance sheets of Perfectenergy International Ltd. and subsidiaries as of October 31, 2010 and 2009 and the related consolidated statements of operations and other comprehensive loss, shareholders’ equity, and cash flows for each of the years in the two-year period ended October 31, 2010. Perfectenergy International Ltd’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Perfectenergy International Ltd. and subsidiaries as of October 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the two-year period ended October 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
/s/ Frazer Frost, LLP
Brea, California
January 31, 2011
The accompanying notes are an integral part of these consolidated financial statements.
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
See report of independent registered public accounting firm.
The accompanying notes are an integral part of these consolidated financial statements.
See report of independent registered public accounting firm.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
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.
In October 2007, the Company entered into an Investment Agreement with Shanghai Zizhu Science Park Development Co., Ltd. (“Science Park”), under which the Company planned to construct a new solar cell production facility on certain land in the Shanghai Zizhu Science-Based Industrial District of Shanghai, China, which would have expanded lamination and cell production capacity. As required by the Investment Agreement, on February 28, 2008, the Company formed Perfectenergy Solar-Tech (Shanghai) Ltd. (“Perfectenergy Solar-Tech”) under the laws of the People’s Republic of China (“PRC” or “China”) as a wholly owned subsidiary of Perfectenergy International Limited (“Perfectenergy BVI”). Perfectenergy BVI was required to contribute $20,000,000 to the registered capital of Perfectenergy Solar-Tech, of which $4,000,000 has been contributed with the remaining $16,000,000 which should have been contributed by February 28, 2010. Due to supplementary land use restrictions, 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.
(b) Basis of Presentation and Principles of Consolidation
The consolidated financial statements reflect the activities of the Company and its wholly owned subsidiaries, Perfectenergy BVI, Perfectenergy (Shanghai) Limited (“Perfectenergy Shanghai”), Perfectenergy GmbH (“Perfectenergy GmbH”), and Perfectenergy Solar-Tech.
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 consolidated financial statements are in U.S. dollars 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. 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.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
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.
(d) Fair Value 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.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
The Company analyzes all financial instruments with features of both liabilities and equity, pursuant to which the Company’s warrants were required to be recorded as a liability at fair value and marked to market each reporting period. Except for the warrant liability, 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.
(e) 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 October 31, 2010 were translated at 6.67 RMB to $1.00 as compared to 6.82 RMB to $1.00 at October 31, 2009. The assets and liabilities of the Company’s German subsidiary at October 31, 2010 were translated at €0.72 to $1.00 as compared to €0.68 to $1.00 at October 31, 2009. 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 years ended October 31, 2010 and 2009 were 6.79 RMB and 6.82 RMB, respectively. The average translation rates applied to statement of operations accounts of the Company’s German subsidiary for the years ended October 31, 2010 and 2009 were €0.74 and €0.73 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.
(f) Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
(g) 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. An estimate for doubtful accounts is recorded when collection of the full amount is no longer probable.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
(h) 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. The Company took an additional charge of approximately $1,868,000 during the year ended October 31, 2010 and fully reserved the advanced inventory payment. The Company continues to seek reimbursement from the supplier, but made a full provision against the prepaid amount based on current situations. If the Company receives reimbursement in the future, it will recognize income of approximately $3,803,000. At October 31, 2010 and 2009, allowance for doubtful accounts amounted to $ 3,803,337 and $1,861,097, respectively.
(i) 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. As of October 31, 2010 and 2009, the Company had $561,796 and $637,335, respectively, in inventory reserve. The Company believes that the reserve is adequate to provide for expected losses.
(j) 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.
(k) Equipment and Leasehold Improvements
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.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
Estimated useful lives of the Company’s assets are as follows:
Useful Life
Leasehold improvements
Lease term (expires on May 31, 2011)
Transportation equipment
years
Machinery
5 - 10 years
Office equipment
years
(l) 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 October 31, 2010, the Company expects these assets to be fully recoverable.
(m) 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.
(n) Value Added Tax
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.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
(o) 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 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.
(p) Revenue Recognition
The Company’s revenue recognition policies are in accordance with the FASB’s accounting standard. Revenues from solar cells, solar modules, and PV systems are recognized upon shipment of the products only if no significant Company obligations remain, the fee is fixed or determinable, and collection is received or the resulting receivable is deemed probable. Revenue is recognized, net of discount and allowances, at the time of product shipment. 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. In general, the Company does not accept product returns; only under special situations, when both the Company and customers agree, is a product exchange allowed. For solar cells, solar modules, and PV systems, the Company is covered by product quality insurance and product liability insurance. The product quality insurance retroactively covers the period from July 1, 2007 to the end of the insurance period on June 30, 2011. As such, the Company does not maintain a provision for potential warranty cost.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
(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 costs amounted to $2,166,191 and $435,230 for the years ended October 31, 2010 and 2009, respectively.
(r) Advertising
Advertising and promotion expenses are expensed as incurred, and the expense was immaterial for the years ended October 31, 2010 and 2009.
(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 income (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:
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
For the years ended October 31, 2010 and 2009, 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 October 2009, the FASB issued an Accounting Standards Update (“ASU”) regarding accounting for own-share lending arrangements in contemplation of convertible debt issuance or other financing. This ASU requires that at the date of issuance of the shares in a share-lending arrangement entered into in contemplation of a convertible debt offering or other financing, the shares issued shall be measured at fair value and be recognized as an issuance cost, with an offset to additional paid-in capital. Further, loaned shares are excluded from basic and diluted earnings per share unless default of the share-lending arrangement occurs, at which time the loaned shares would be included in the basic and diluted earnings-per-share calculation. This ASU is effective for fiscal years beginning on or after December 15, 2009, and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued ASU No. 2010-02 regarding accounting and reporting for decreases in ownership of a subsidiary. Under this guidance, an entity is required to deconsolidate a subsidiary when the entity ceases to have a controlling financial interest in the subsidiary. Upon deconsolidation of a subsidiary, an entity recognizes a gain or loss on the transaction and measures any retained investment in the subsidiary at fair value. In contrast, an entity is required to account for a decrease in its ownership interest of a subsidiary that does not result in a change of control of the subsidiary as an equity transaction. This ASU clarifies the scope of the decrease in ownership provisions, and expands the disclosures about the deconsolidation of a subsidiary or de-recognition of a group of assets. This ASU is effective beginning in the first interim or annual reporting period ending on or after December 31, 2009. The adoption of this ASU did not have a material impact on its consolidated financial statements.
In January 2010, FASB issued ASU No. 2010-06 - “Improving Disclosures about Fair Value Measurements.” This update provides amendments to Subtopic 820-10 that requires new disclosure to include transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements. Further, this update clarifies existing disclosures on level of disaggregation and disclosures about inputs and valuation techniques. A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities and should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of this ASU did not have a material impact on its consolidated financial statements.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements”. ASU 2010-09 primarily rescinds the requirement that, for listed companies, financial statements clearly disclose the date through which subsequent events have been evaluated. Subsequent events must still be evaluated through the date of financial statement issuance; however, the disclosure requirement has been removed to avoid conflicts with other Securities and Exchange Commission (“SEC”) guidelines. ASU 2010-09 was effective immediately upon issuance and was adopted in February 2010.
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.
Note 3 - Accounts Receivable
Accounts receivable consisted of the following:
At October 31, 2010 and 2009, there was no allowance for doubtful accounts as management believes all accounts balances were considered to be uncollectible.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
Note 4 - Other Receivables
Other receivables consisted of the following:
In June and July 2008, Perfectenergy Shanghai entered into three purchase contracts for purchasing original MEMC granular polysilicon from Sun Materials. In accordance with the terms of the purchase contracts, Perfectenergy Shanghai paid 100% of the advance payments to Sun Materials totaling approximately $3.7 million. However, as of October 31, 2010, 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 BVI, its original supplier for the MEMC granular polysilicon, Regus BVI was obligated to repay the prepayments in five installments. Regus BVI’s repayment was not in accordance with the terms established in the repayment agreement. 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.
Note 5 - Inventories
Inventories consisted of the following:
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 $1,197,636 and $491,913 as of October 31, 2010 and October 31, 2009, respectively.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
Note 7 - Equipment and Leasehold Improvements
Equipment and leasehold improvements consisted of the following:
Construction in progress represents the costs incurred in connection with the construction of machinery and equipments.
Depreciation expense for the years ended October 31, 2010 and 2009 amounted to $1,838,838 and $1,330,194, respectively.
Note 8 - Advances on Equipment Purchases
Advances on equipment purchases represent partial payments for deposits on equipment purchases and amounted to $0 and $470,108 as of October 31, 2010 and October 31, 2009, respectively.
Note 9 - 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.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
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 October 31, 2010, 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.
Note 10 - 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 years ended October 31, 2010 and 2009, the Company made pension contributions in the amount of $227,504 and $165,365, respectively.
Note 11 - Derivative Instruments
In order for the Investor Warrants to be accounted for as equity, such warrants must comply with FASB’s accounting standard related to derivative instruments and hedging activities. The Investor Warrants contain a provision permitting the holder to redeem the warrants for cash, based on a Black-Scholes valuation, in the event of a change in control deemed not to be within the Company’s control resulting in a classification of the Investor Warrants as derivative instrument liabilities rather than as equity instruments. The Company allocated the proceeds received between the common stock and Investor Warrants first to the Investor Warrants based on the fair value on the date the proceeds were received with the balance to common stock. Net proceeds were allocated as follows:
The change in the fair value of the Investor Warrants, determined under the Cox-Ross-Rubinstein binomial model, at each reporting date will result in either an increase or decrease the amount recorded as liability, based on the fluctuation of the Company’s stock price with a corresponding adjustment to other income (or expense). For the years ended October 31, 2010 and 2009, a gain of $29,564 and $700,125, respectively, was recognized in the accompanying statement of operations based on the decrease in fair value since the last reporting date. At October 31, 2010 and October 31, 2009, the fair value of the derivative instrument totaled $0 and 29,563, respectively.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
All warrants expired on August 8, 2010. The value of the Investor Warrants at October 31, 2009 was determined using the Cox-Ross-Rubinstein binomial model using the following assumptions: volatility 170%; risk free interest rate 0.05% for the Investor warrants and 0.27% for the Placement and Advisory warrants; dividend yield of 0%; and expected term of 0.27 years of the Investor Warrants and 0.77 years of the Placement and Advisory Warrants. The volatility of the Company’s common stock was estimated by management based on the historical volatility of our common stock, the risk free interest rate was based on Treasury Constant Maturity Rates published by the U.S. Federal Reserve for periods applicable to the expected life of the warrants, the expected dividend yield was based on the Company’s current and expected dividend policy, and the expected term is equal to the contractual life of the warrants.
As of October 31, 2010, the Company had warrants as follows:
Note 12 - 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. Options are generally vested on an annual basis over the three years following the date of grant and expire after 10 years.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
On April 7, 2010, the Company granted a total of 200,000 stock options to three executives and four directors at $0.20 per share. 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. The fair value of the options was estimated on the date of grant using a Black-Scholes Option Pricing model using the following assumptions:
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 was 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 was based on the current and expected dividend policy. The value of the options was based on the Company’s common stock price on the date each option was granted. 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:
As of October 31, 2010, approximately $59,146 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 1.5 years. As of October 31, 2010, 1,127,720 of the outstanding options are exercisable. Compensation expenses for the years ended October 31, 2010 and 2009 were $1,270,721 and $1,627,868, respectively.
Stock-based award as of October 31, 2010 is as follows:
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
Note 13 - 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.
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 years ended October 31, 2010 and 2009, 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 years ended October 31, 2010 and 2009.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
Note 14 - Income Taxes
Under the income tax laws of the PRC, Chinese companies were generally subject to an income tax at an effective rate of 33% (30% state income taxes plus 3% local income taxes) on income reported in the statutory financial statements after appropriate tax adjustments, unless the enterprise is located in a specially designated region where enterprises are granted a three-year income tax exemption and a 50% income tax reduction for the next three years or the enterprise is a manufacturing related joint venture with a foreign enterprise or a wholly owned subsidiary of a foreign enterprise, which are granted a two-year income tax exemption and a 50% income tax reduction for the next three years.
Beginning January 1, 2008, the new Enterprise Income Tax (“EIT”) law will replace the existing laws for Domestic Enterprises (“DES’”) and Foreign Invested Enterprises (“FIEs”). The key changes are as follows:
a.
The new standard EIT rate of 25% will replace the 33% rate currently applicable to both DES’ and FIEs, except for high tech companies that pay a reduced rate of 15%; and
b.
Companies established before March 16, 2007 will continue to enjoy tax holiday treatment approved by local government for a grace period of 5 years or until the end of the tax holiday term, whichever is sooner.
Perfectenergy Shanghai was established on July 8, 2005 as a wholly owned subsidiary of the Company, a foreign enterprise in the PRC. Thus, Perfectenergy Shanghai was granted an income tax exemption for the years ended December 31, 2006 and 2005, was entitled to a 50% reduction of the income tax rate of 33% for 2007 (or a rate of 16.5%), and was entitled to a 50% reduction of the income tax rate of 25% for 2008 and 2009 (or a rate of 12.5%).
On January 1, 2008, Perfectenergy Shanghai received the high technology certification from the tax authority. The certification allows the Company to receive the 15% preferential income tax rate for a period of three years from January 1, 2008 to December 31, 2010. Because of the lower tax rate, the Company continued to follow the status of a foreign enterprise in 2009 and 2008. In 2010, the Company exercised and applied the 15% preferential income tax rate.
The following table reconciles the U.S. statutory tax rates to the Company’s effective tax rate for the years ended October 31, 2010 and 2009:
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
(a)
These rates differ from the stated effective tax rate in China mainly due to losses incurred by the non-Chinese entities or other non-deductible expenses that are not deductible in the PRC. In addition, Perfectenergy Shanghai took a charge of approximately $1,868,000 to fully reserve the advanced inventory payment and recorded intercompany commission expenses of approximately $798,000. These charges, attributed to 18% of the rate change, are non-deductible expenses for tax purposes under the PRC tax law.
Since Perfectenergy Shanghai had an operating loss for the year ended October 31, 2009, the loss can be carried forward to offset income for the next five years. The Company recorded non-current deferred tax assets of $0 and $95,105 as of October 31, 2010 and 2009, respectively. The Company believes that a valuation allowance is not deemed necessary for the deferred assets for the following reasons: (i) there will be sufficient operating income generated in future years based on the fact that the Company’s wholly owned subsidiary, Perfectenergy Shanghai, is expected to generate profits based on sales orders received for future periods, and (ii) the current operating loss of Perfectenergy Shanghai can be carried forward for five years to offset future operating income under PRC tax regulations.
The estimated tax savings due to the reduced tax rate for the years ended October 31, 2010 and 2009 amounted to $195,381 and $126,519, respectively. There was no material effect to loss per share if the statutory income tax had been applied.
Perfectenergy GmbH’s aggregated tax burden, including corporate income tax plus solidarity surcharge and trade tax is 31.5%. The Company recorded non-current deferred tax assets of $10,184 and $281,000 as of October 31, 2010 and 2009, respectively. The Company believes that a valuation allowance is not deemed necessary for the deferred assets as there will be sufficient operating income generated in future years based on the fact that Perfectenergy GmbH is expected to generate profits based on sales orders received for future periods. German corporations will now be subject to limitation on the utilization of loss carryforwards for corporation tax. This so-called minimum tax is computed by allowing the first €1 million of net operating loss carryforwards to offset taxable income. Any utilization above that threshold will generally be limited to 60% of taxable income. There is no expiration date for the net operating loss carryforwards. Under the prior law, German corporations were able to offset 100% of their income with loss carryforwards.
PFGY was incorporated in the United States and has incurred net operating losses for income tax purposes for the year 2010 and 2009. The estimated accumulated net operating loss carryforwards for the U.S. income taxes amounted to $397,000 and $397,000 as of October 31,2010 and 2009, respectively, which may be available to reduce future years’ taxable income. These carryforwards will expire, if not utilized, between 2027 and 2030. Management believes that the realization of the benefits from these losses appears uncertain due to the Company’s limited operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero. The valuation allowance at October 31, 2010 was $135,000. Management will review this valuation allowance periodically and make adjustments as warranted.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
The Company did not have cumulative undistributed earnings of foreign subsidiaries as of October 31, 2010. Should the Company have any undistributed earnings, such earnings will be included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations. No provision will be made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if the Company concludes that such earnings will be remitted in the future.
Taxes Payables
Taxes payables consisted of the following:
Note 15 - Concentration of Risk
Cash
Cash 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 $1,170,245 and $1,347,547 at October 31, 2010 and 2009, 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.
Major Customers
For the years ended October 31, 2010 and 2009, five customers accounted for approximately 64% and 74%, respectively, of the Company’s sales. These customers accounted for approximately 47% and 59% of the Company’s accounts receivable as of October 31, 2010 and 2009, respectively.
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
Major Vendors
For the years ended October 31, 2010 and 2009, the Company purchased approximately 46% and 61%, respectively, of their raw materials from three major suppliers. These suppliers represented 64% and 45% of the Company’s total accounts payable as of October 31, 2010 and 2009, 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. Perfectenergy GmbH remains a sales branch and does not maintain its own supply channel. The following table summarizes the financial information for the Company’s revenues based on geographic area:
Note 16 - 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). The Company entered into a three-year office lease for Perfectenergy GmbH expiring November 30, 2010 with a monthly rent of approximately $2,176 (approximately EUR 1,452). The Company entered into a two-year lease for Perfectenergy Solar-Tech expiring March 14, 2010 with a monthly rent of $5,900 (approximately RMB 40,000), the lease is extended up to the end of 2010 based on oral agreement with the landlord. At October 31, 2010, total future minimum lease payments under an operating lease were as follows:
PERFECTENERGY INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
October 31, 2010
Total rent expense for the years ended October 31, 2010 and 2009 amounted to $304,569 and $316,636, respectively.
Long-Term Silicon Supply Agreements
On January 8, 2010, Perfectenergy Shanghai entered into a long-term supply contract with Chengdu Jiayang Silicon Materials Technology Co., Ltd. (“Chengdu”) under which Perfectenergy Shanghai must purchase from Chengdu $1 million silicon wafers in 2010, $1.2 million silicon wafers in 2011, and $1.5 million silicon wafers in 2012. Due to fluctuations in the silicon supply market, the purchasing price of these silicon wafers will be based on market conditions.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
There are no reportable disagreements with our independent auditors independent auditors, Frazer Frost, LLP (successor entity of Moore Stephens Wurth Frazer and Torbet, LLP).
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures
Regulations under the Securities Exchange Act of 1934, as amended, require public companies to maintain “disclosure controls and procedures,” which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financing officer) carried out an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on those evaluations, as of October 31, 2010, our Chief Executive Officer and Chief Financial Officer believe that:
(i)
our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports we file under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure; and
(ii)
our disclosure controls and procedures are ineffective due to the material weaknesses described below under “Management’s annual report on internal control over financial reporting.”
Notwithstanding management’s assessment that our internal control over financial reporting was ineffective as of October 31, 2010 due to the material weaknesses described below under “Management’s annual report on internal control over financial reporting, ” we believe that the consolidated financial statements included in this annual report on Form 10-K correctly present our financial condition, results of operations, and cash flows for the fiscal years covered by such statements in all material respects.
Internal Control over Financial Reporting
(a) Management’s annual report on internal control over financial reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the Company’s principal executive officer and principal financial officer and effected by the Company’s board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
·
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, the Company’s internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of October 31, 2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on that evaluation, our management concluded that our internal control over financial reporting is not effective, as of October 31, 2010, as management identified the following material weaknesses 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 for the accurate accounting of different business issues.
Our management believes that the material weaknesses identified above were the direct result of a continued significant increase in operating activities during the 2010 fiscal year. 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 reviewing 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 existing personnel, including in the areas of new and emerging accounting standards.
We plan on continuing to identify and implement remedial measures.
(b) Changes in internal control over financial reporting
During our last fourth fiscal quarter, we implemented the measures described in (i) through (iii) above in our internal control over financial reporting in connection with the evaluation required by Rule 13a-15(d) or Rule15d-15(d) promulgated under the Exchange Act , which have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE.
Current Management
Set forth below is a summary of our executive officers’ and directors’ business experience for the past 5 years. The experience and background of each of the directors, as summarized below, were significant factors in their previously being nominated as directors of the Company.
Wennan Li, 44, has been our Chairman, Chief Executive Officer and President since August 8, 2007. His current term as CEO and President ends on September 1, 2012. Mr. Li is up for re-election to the Board at our 2011 annual stockholder meeting. Mr. Li has extensive experience with technological development, production management, and international marketing in the PV industry. Mr. Li is the founder, director, and general manager of our subsidiary, Perfectenergy Shanghai, since August 2005. From November 2002 to August 2005, Mr. Li was the Vice President of Topsolar Shanghai Limited, a leading PV company in China. He has also served as a PV industry expert advising the Shanghai government in matters relating to the PV industry. Mr. Li received a master’s degree in 1991 from the Management School of Shanghai Jiaotong University and a bachelor’s degree in 1988 from Xi’an Jiaotong University in Electrical Automation.
Xiaolin Zhuang, 39, has been our Chief Financial Officer and Secretary since February 1, 2008. His term of office with the Company ends on January 31, 2011. Concurrent to these positions, Mr. Zhuang serves as the Chief Financial Officer of our subsidiary, Perfectenergy Shanghai, since February 2008. Prior to joining the Company, Mr. Zhuang served as the China Financial Controller of Synthesis Energy Systems, Inc. from April 2007 to January 2008. From November 2003 to May 2007, Mr. Zhuang served as the Finance Manager and Group Internal Auditor Head for Jebsen & Co. (China) Ltd. & Jebsen & Co. Ltd. Since September 1995, Mr. Zhuang has served as a member of the China Institute of Certified Public Accountants (CICPA). Mr. Zhuang earned a bachelor’s degree in Economics in 1994 from the Shanghai University of Finance and Economics.
Diping Zhou, 43, has been our Vice President of Operations since September 1, 2008. Her current term ends on September 1, 2012. Ms. Zhou has extensive accounting experience, and prior to her current position, she served as our Chief Accounting Officer, Treasurer, and Secretary since August 8, 2007. Concurrent to her position with the Company, she also serves as Vice President and an accountant for Perfectenergy Shanghai. From 2002 through 2005, Ms. Zhou was the manager of budget and financial department in Topsolar Shanghai Limited, a leading Chinese solar energy products manufacturer. Ms. Zhou received a bachelor’s degree in Accounting from Shanghai Lixin University of Commerce in 1988. Ms. Zhou has extensive accounting experience.
Min Fan, 45, has been a director since August 25, 2007, and he is up for re-election to the Board at our 2011 annual stockholder meeting. Mr. Fan is one of the co-founders of Ctrip.com International Ltd. (Nasdaq: CTRP), a Chinese-based travel services business. He has served as CTRP’s Chief Executive Officer since January 2006 and as a director since October 2006. He also served as CTRP’s Chief Operating Officer from November 2004 to January 2006, and as CTRP’s Executive Vice President from 2000 to November 2004. Mr. Fan is also a founding stockholder of Home Inns & Hotels Management, Inc. (Nasdaq: HMIN), an economy hotel developer, operator, and franchisor. Mr. Fan obtained a master’s and bachelor’s degree from Shanghai Jiao Tong University, and studied at the Lausanne Hotel Management School of Switzerland in 1995.
Yunxia Yang, 53, has been a director since August 25, 2007, and she is up for re-election to the Board at our 2011 annual stockholder meeting. Ms. Yang is one China’s leading solar energy researchers with extensive experience in solar products development and has been a professor in the School of Materials Science and Engineering at the East China University of Science & Technology since 1987. Ms. Yang received her bachelor’s degree in 1982 and a master’s degree in 1987 in the study of Materials, both from East China University of Science & Technology.
Adam Roseman, 32, has been a director since August 25, 2007, and he is up for re-election to the Board at our 2011 annual stockholder meeting. Mr. Roseman has extensive experience in finance and management. He is the founder and Chief Executive Officer of ARC Investment Partners, LLC and ARC China, Inc. Previously, Mr. Roseman was an investment banker in various sectors at Lehman Brothers, Piper Jaffray, and Goldman Sachs. During the past five years, Mr. Roseman has also sat on the Boards of Directors of Big Brothers Big Sisters Los Angeles and Big Brothers Big Sisters Orange County.
Yajun Wu, 51, has been a director since November 20, 2007, and he is up for re-election to the Board at our 2011 annual stockholder meeting. Mr. Wu serves as the Executive Vice President and Deputy Chief Financial Officer of Alcatel Shanghai Bell Co., Ltd. in Shanghai, a position that he has held since February 2003. From July 2002 to February 2003, he was Alcatel’s Director of Credit Management. From March 1999 to July 2002, Mr. Wu served as Vice President and Deputy Chief Financial Officer of Shanghai Bell Alcatel Mobile Communication System Co., Ltd.
Family Relationships
There are no family relationships between or among any of the current directors, executive officers, or persons nominated or charged by the Company to become directors or executive officers.
Involvement in Certain Legal Proceedings
None of our directors or executive officers has, during the past ten years:
·
Had any petition under the federal bankruptcy laws or any state insolvency law filed by or against, or had a receiver, fiscal agent, or similar officer appointed by a court for the business or property of such person, or any partnership in which he was a general partner at or within two years before the time of such filing, or any corporation or business association of which he was an executive officer at or within two years before the time of such filing;
·
Been convicted in a criminal proceeding or a named subject of a pending criminal proceeding (excluding traffic violations and other minor offenses);
·
Been the subject of any order, judgment, or decree, not subsequently reversed, suspended, or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining him from, or otherwise limiting, the following activities:
(i)
Acting as a futures commission merchant, introducing broker, commodity trading advisor, commodity pool operator, floor broker, leverage transaction merchant, any other person regulated by the Commodity Futures Trading Commission, or an associated person of any of the foregoing, or as an investment adviser, underwriter, broker or dealer in securities, or as an affiliated person, director or employee of any investment company, bank, savings and loan association or insurance company, or engaging in or continuing any conduct or practice in connection with such activity;
(ii)
Engaging in any type of business practice; or
(iii)
Engaging in any activity in connection with the purchase or sale of any security or commodity or in connection with any violation of federal or state securities laws or federal commodities laws;
·
Been the subject of any order, judgment, or decree, not subsequently reversed, suspended, or vacated, of any federal or state authority barring, suspending, or otherwise limiting for more than 60 days the right of such person to engage in any activity described in (i) above, or to be associated with persons engaged in any such activity;
·
Been found by a court of competent jurisdiction in a civil action or by the SEC to have violated any federal or state securities law, where the judgment in such civil action or finding by the SEC has not been subsequently reversed, suspended, or vacated; or
·
Been found by a court of competent jurisdiction in a civil action or by the Commodity Futures Trading Commission to have violated any federal commodities law, where the judgment in such civil action or finding by the Commodity Futures Trading Commission has not been subsequently reversed, suspended, or vacated;
·
Been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated, relating to an alleged violation of:
(i)
Any federal or state securities or commodities law or regulation; or
(ii)
Any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order; or
(iii)
Any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or
·
Been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Securities Exchange Act of 1934), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Exchange Act requires our executive officers, directors, and persons who beneficially own more than 10% of a registered class of our equity securities to file with the SEC initial statements of beneficial ownership, reports of changes in ownership, and annual reports concerning their ownership of our common shares and other equity securities on Forms 3, 4, and 5, respectively. Executive officers, directors, and greater than 10% stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) reports they file. Based on a review of the copies of such forms received by us, and to the best of our knowledge, no required reports during the fiscal year ended October 31, 2010 were untimely filed by any executive officer, director, or greater than 10% stockholder.
Code of Ethics
We have adopted a Code of Business Conduct and Ethics that applies to our executive officers, directors, and employees, which code is attached to our annual report on Form 10-K filed with the SEC on January 26, 2009. A copy of our code of ethics will also be provided to any person without charge upon written request sent to us at our offices.
Material Changes to the Procedures by which Security Holders may Recommend Nominees to the Board
There have been no material changes to the procedures by which our security holders may recommend nominees to the Board of Directors.
Audit Committee; Audit Committee Financial Expert
We formed an Audit Committee of our board of directors and approved the charter for such committee on July 29, 2008. The members of our Audit Committee are Yajun Wu, Adam Roseman, and Yunxia Yang. Mr. Wu is the Audit Committee’s Chairman, and he is an independent member of the board, as defined by the SEC and the Nasdaq Listing Rules. The board of directors has determined that Mr. Wu is also an “audit committee financial expert” as defined by SEC rules.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The following summary compensation table indicates the cash and non-cash compensation earned during the fiscal years ended October 31, 2010, 2009, and 2008 by (i) our Chief Executive Officer (principal executive officer), (ii) our Chief Financial Officer (principal financial officer), (iii) the three most highly compensated executive officers other than our CEO and CFO who were serving as executive officers at the end of our last completed fiscal year whose total compensation exceeded $100,000 during such fiscal year ends, and (iv) up to two additional individuals for whom disclosure would have been provided but for the fact that the individual was not serving as an executive officer at the end of our last completed fiscal year whose total compensation exceeded $100,000 during such fiscal year ends. The compensation amounts reflected in the table below are expressed in U.S. Dollars based on the interbank exchange rate of RMB6.6 for each 1.00 U.S. Dollar, on October 31, 2010.
SUMMARY COMPENSATION TABLE
(1)
Reflects dollar amount expensed by the Company during the applicable fiscal year for financial statement reporting purposes pursuant to FAS 123R. FAS 123R requires the Company to determine the overall value of the options as of the date of grant based upon the Black-Scholes method of valuation, and to then expense that value over the service period over which the options become exercisable (vested). As a general rule, for time in service based options, the Company will immediately expense any option or portion thereof that is vested upon grant, while expensing the balance on a pro rata basis over the remaining vesting term of the option.
(2)
On April 7, 2010, Mr. Li was granted options to purchase an aggregate 50,000 shares of our common stock at $0.20 per share, vesting at 33.33% per year. These options expire on April 7, 2020. 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. We used the Cox-Ross-Rubinstein binomial model to value the options at the time they were issued, based on volatility of 170%, dividend yield of 0%, the stated exercise prices, and expiration dates of the instruments and using an average risk-free rate of 2.98%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
(3)
On August 8, 2007, Mr. Li was granted options to purchase an aggregate 407,274 shares of our common stock at $2.80 per share, vesting at 33.33% per year. These options expire on August 8, 2017. We 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%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
(4)
On April 7, 2010, Mr. Zhuang was granted options to purchase an aggregate 30,000 shares of our common stock at $0.20 per share, vesting at 33.33% per year. These options expire on April 7, 2020. 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. We used the Cox-Ross-Rubinstein binomial model to value the options at the time they were issued, based on volatility of 170%, dividend yield of 0%, the stated exercise prices, and expiration dates of the instruments and using an average risk-free rate of 2.98%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
(5)
On February 1, 2008, Mr. Zhuang was granted options to purchase an aggregate 125,000 shares of our common stock at $4.08 per share, vesting at 33.33% per year. These options expire on February 1, 2013. We 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 2.36%. Because we do 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 5 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
(6)
This amount includes statutory benefits under PRC laws, including pension, housing, medical, and unemployment insurance benefits.
(7)
On April 7, 2010, Ms. Zhou was granted options to purchase an aggregate 30,000 shares of our common stock at $0.20 per share, vesting at 33.33% per year. These options expire on April 7, 2020. 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. We used the Cox-Ross-Rubinstein binomial model to value the options at the time they were issued, based on volatility of 1.70%, dividend yield of 0%, the stated exercise prices, and expiration dates of the instruments and using an average risk-free rate of 2.98%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
(8)
On August 8, 2007, Ms. Zhou was granted options to purchase an aggregate 196,488 shares of our common stock at $2.80 per share, vesting at 33.33% per year. These options expire on August 8, 2017. We 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%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
Grants of Plan-Based Awards
There were no plan-based awards granted during the year ended October 31, 2010 to any named executive officer.
Employment Agreements
The Company entered into an Amended and Restated Employment Agreement with Xiaolin Zhuang on December 29, 2008 for his services as Chief Executive Officer, which agreement restated the Employment Agreement between Mr. Zhuang and Perfectenergy Shanghai dated February 1, 2008 and the compensation terms of which were amended on April 7, 2010. Mr. Zhuang’s base salary, beginning November 1, 2009, is RMB53,000 (approximately US$7,764) per month, and his bonus compensation arrangement for the fiscal year ended October 31, 2010 was a portion of an aggregate 10% of any net profits realized by the Company during the same fiscal year, with a minimum guaranteed aggregate bonus payment of US$75,000. The aggregate bonus was to be paid to Mr. Zhuang, Wennan Li, and Diping Zhou, and Mr. Zhuang’s portion of the aggregate bonus payment was $14,393. Pursuant to the employment agreement, Mr. Zhuang was issued options to purchase 125,000 shares of the Company’s common stock at $4.08 per share under the Company’s 2007 Stock Incentive Plan. The options were granted on February 1, 2008 and expire on February 1, 2013, and they vest according to the following schedule: one-third on each of the first, second, and third anniversary of the grant date. In the event of termination, all vested options must be exercised within six months of the termination date. If the Company terminates Mr. Zhuang’s employment due to (i) Mr. Zhuang’s inability to perform his duties after medical treatment for a non-work related illness, (ii) Mr. Zhuang’s inability or incompetence to perform his duties, (iii) a major change in circumstances that were relied on as a basis to entering into the employment agreement, including a merger, division, or acquisition of the Company, or (iv) the Company’s statutory reorganization or major financial difficulties, Mr. Zhuang is entitled to one months’ salary for each year of service. The employment agreement terminates on February 1, 2011, and it may be renewed upon mutual agreement by the parties.
The Company entered into an Employment Agreement with Wennan Li, which became effective on September 2, 2008, for his services as the Company’s Chief Executive Officer, the compensation terms of which were amended on April 7, 2010. Mr. Li’s base salary, beginning November 1, 2009, is RMB63,600 (approximately US$9,317) per month, and his bonus compensation arrangement for the fiscal year ended October 31, 2010 was a portion of an aggregate 10% of any net profits realized by the Company during the same fiscal year, with a minimum guaranteed aggregate bonus payment of US$75,000. The aggregate bonus was to be paid to Mr. Li, Xiaolin Zhuang, and Diping Zhou, and Mr. Li’s portion of the aggregate bonus payment was $25,757. The employment agreement expires on September 1, 2012.
The Company entered into an Employment Agreement with Diping Zhou, which became effective on September 2, 2008, for her services as the Company’s Vice President of Operations, the compensation terms of which were amended on April 7, 2010. Ms. Zhou’s base salary, beginning November 1, 2009, is RMB53,00 (approximately US$7,764) per month, and her bonus compensation arrangement for the fiscal year ended October 31, 2010 was a portion of an aggregate 10% of any net profits realized by the Company during the same fiscal year, with a minimum guaranteed aggregate bonus payment of US$75,000. The aggregate bonus was to be paid to Ms. Zhou, Wennan Li, and Xiaolin Zhuang, and Ms. Zhou’s portion of the aggregate bonus payment was $14,393. The employment agreement expires on September 1, 2012.
Outstanding Equity Awards as of October 31, 2010
(1)
33.33% of these options vested on August 8, 2008, August 8, 2009, and August 8, 2010.
(2)
33.33% of these options vest(ed) on February 1, 2009, February 1, 2010, and February 1, 2011.
(3)
33.33% of these options vest on April 7, 2011, April 7, 2012, and April 7, 2013.
Director Compensation
The following table provides compensation information for our directors during the fiscal year ended October 31, 2010:
(1)
Reflects dollar amount expensed by the Company during applicable fiscal year for financial statement reporting purposes pursuant to FAS 123R. FAS 123R requires the Company to determine the overall value of the options as of the date of grant based upon the Black-Scholes method of valuation, and to then expense that value over the service period over which the options become exercisable (vested). As a general rule, for time in service based options, the company will immediately expense any option or portion thereof which is vested upon grant, while expensing the balance on a pro rata basis over the remaining vesting term of the option.
(2)
Mr. Li’s compensation as a director is reflected in the table titled “Summary Compensation Table” above.
(3)
On August 8, 2007, we issued options to Mr. Fan for the purchase of an aggregate 50,000 shares of our common stock, which options have an exercise price of $2.80 per share, vested at 33.33% on each one-year anniversary following the grant date, and expire on August 8, 2017. We used the Cox-Ross-Rubinstein binomial model to value these options at the time they were issued, based on volatility of 70%, dividend yield of 0%, the stated exercise price, and expiration date of the instruments and using an average risk-free rate of 4.5%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
Additionally, on April 7, 2010, we issued options to Mr. Fan for the purchase of an aggregate 30,000 shares of our common stock, which options have an exercise price of $0.20 per share, vest at 33.33% on each one-year anniversary, and expire on April 7, 2020. The shares were valued at the market price on the date of grant. The estimated fair value of these options was $0.19 per share. We used the Cox-Ross-Rubinstein binomial model to value the options at the time they were issued, based on the volatility of 170%, dividend yield of 0%, the stated exercise price, and expiration date of the instrument and using an average risk-free rate of 2.98%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
(4)
On August 8, 2007, we issued options to Ms. Yang for the purchase of an aggregate 50,000 shares of our common stock, which options have an exercise price of $2.80 per share, vested at 33.33% on each one-year anniversary following the grant date, and expire on August 8, 2017. We used the Cox-Ross-Rubinstein binomial model to value these options at the time they were issued, based on volatility of 70%, dividend yield of 0%, the stated exercise price, and expiration date of the instruments and using an average risk-free rate of 4.5%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
Additionally, on April 7, 2010, we issued options to Ms. Yang for the purchase of an aggregate 30,000 shares of our common stock, which options have an exercise price of $0.20 per share, vest at 33.33% on each one-year anniversary, and expire on April 7, 2020. The shares were valued at the market price on the date of grant. The estimated fair value of these options was $0.19 per share. We used the Cox-Ross-Rubinstein binomial model to value the options at the time they were issued, based on the volatility of 170%, dividend yield of 0%, the stated exercise price, and expiration date of the instrument and using an average risk-free rate of 2.98%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
(5)
Mr. Roseman had options to purchase an aggregate 240,625 shares of our common stock outstanding as of October 31, 2010. We 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 price, and expiration date of the instruments and using an average risk-free rate of 4.5%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
(6)
On August 8, 2007, we issued options to Mr. Wu for the purchase of an aggregate 50,000 shares of our common stock, which options have an exercise price of $2.80 per share, vested at 33.33% on each one-year anniversary following the grant date, and expire on August 8, 2017. We used the Cox-Ross-Rubinstein binomial model to value these options at the time they were issued, based on volatility of 70%, dividend yield of 0%, the stated exercise price, and expiration date of the instruments and using an average risk-free rate of 4.5%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
Additionally, on April 7, 2010, we issued options to Mr. Wu for the purchase of an aggregate 30,000 shares of our common stock, which options have an exercise price of $0.20 per share, vest at 33.33% on each one-year anniversary, and expire on April 7, 2020. The shares were valued at the market price on the date of grant. The estimated fair value of these options was $0.19 per share. We used the Cox-Ross-Rubinstein binomial model to value the options at the time they were issued, based on the volatility of 170%, dividend yield of 0%, the stated exercise price, and expiration date of the instrument and using an average risk-free rate of 2.98%. Because we do 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 10 years of the option. This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
We compensate Min Fan, Yunxia Yang, and Yajun Wu with RMB100,000 (approximately $14,640) per annum each for their services as a director. On November 29, 2007, Mr. Fan, Ms. Yang, and Mr. Wu each received options to purchase 50,000 shares of our common stock at $2.80 per share, of which 33.33% vested on the first, second, and third year anniversary of the grant date of such options. On April 7, 2010, Mr. Fan, Ms. Yang, and Mr. Wu each received options to purchase 30,000 shares of our common stock at $0.20 per share, of which 33.33% vest on the first, second, and third year anniversary of the grant date of such options.
We are party to a written three-year agreement with Adam Roseman that expired on December 20, 2010 for his services as a director, under which he received $5,000 per month as compensation for his services. On November 29, 2007, Mr. Roseman received options to purchase 250,000 shares of our common stock at $2.80 per share, of which 30% vested on the grant date and 70% vests on a monthly basis over a period of two years from the grant date. Mr. Roseman is entitled to certain travel and administrative expenses in connection with his services as a director and is provided liability insurance. Although the written agreement expired, we orally agreed with Mr. Roseman that the terms would remain while w are negotiating a renewal of such agreement.
Compensation Committee Interlocks and Insider Participation
During the fiscal year ended October 31, 2010, our Compensation Committee was comprised of Min Fan, Wennan Li, and Yunxia Yang. Mr. Fan serves as the Chairman of the Compensation Committee. During the fiscal year ended October 31, 2010, Mr. Li also served as an executive officer of the Company.
During the fiscal year ended October 31, 2010:
(i)
none of our executive officers served as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served on our Compensation Committee;
(ii)
none of our executive officers served as a director of another entity, one of whose executive officers served on our Compensation Committee; and
(iii)
none of our executive officers served as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) of another entity, one of whose executive officers served as a member of our Board of Directors.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Securities Authorized for Issuance under Equity Compensation Plans
Please see the section titled “Securities Authorized for Issuance under Equity Compensation Plans” under Item 5 above.
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding the beneficial ownership of our common stock as of January 10, 2011 for each of our directors and officers; all directors and officers as a group; and each person known by us to beneficially own five percent or more of our common stock.
Beneficial ownership is determined in accordance with SEC rules. Unless otherwise indicated in the table, the persons and entities named in the table have sole voting and sole investment power with respect to the shares set forth opposite the shareholder’s name. Unless otherwise indicated, the address of each beneficial owner listed below is No. 479 You Dong Road, Xinzhuang Town, Shanghai 201100, People’s Republic of China.
* Less than 1%
(1)
Under Rule 13d-3, a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares: (i) voting power, which includes the power to vote, or to direct the voting of shares; and (ii) investment power, which includes the power to dispose or direct the disposition of shares. Certain shares may be deemed to be beneficially owned by more than one person (if, for example, persons share the power to vote or the power to dispose of the shares). In addition, shares are deemed to be beneficially owned by a person if the person has the right to acquire the shares (for example, upon exercise of an option) within 60 days of the date as of which the information is provided. In computing the percentage ownership of any person, the amount of shares outstanding is deemed to include the amount of shares beneficially owned by such person (and only such person) by reason of these acquisition rights. As a result, the percentage of outstanding shares of any person as shown in this table does not necessarily reflect the person's actual ownership or voting power with respect to the number of shares of common stock actually outstanding.
(2)
The percentage of class beneficially owned is based on 29,626,916 shares of common stock outstanding on January 10, 2011.
(3)
407,274 of these shares represent the number of shares of common stock that Wennan Li has the right to acquire upon exercise of an option granted on August 8, 2007.
(4)
50,000 of these shares represent the number of shares of common stock that Min Fan has the right to acquire upon exercise of an option granted on August 8, 2007.
(5)
50,000 of these shares represent the number of shares of common stock that Yunxia Yang has the right to acquire upon exercise of an option granted on August 8, 2007.
(6)
196,488 of these shares represent the number of shares of common stock that Diping Zhou has the right to acquire upon exercise of an option granted on August 8, 2007.
(7)
All of these shares represent the number of shares of common stock Xiaolin Zhuang has the right to acquire upon exercise of an option granted on February 1, 2008.
(8)
240,625 of these shares represent the number of shares of common stock that Adam Roseman has the right to acquire upon exercise of an option granted on August 8, 2007. 25,000 of these shares are held in the name of Tapirdo Enterprises, LLC, of which Mr. Roseman is the manager and sole member. Mr. Roseman’s address is 9440 Little Santa Monica Blvd., Suite 401, Beverly Hills, CA 90210.
(9)
All of these shares represent the number of shares of common stock that Yajun Wu has the right to acquire upon exercise of an option granted on August 8, 2007.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Related Party Transactions
There are no related party transactions to report.
Director Independence
Our board of directors has determined that it currently has 4 members who qualify as “independent” as the term is used in Item 407 of Regulation S-K as promulgated by the SEC and Nasdaq’s Marketplace Rule 5605(a)(2). The independent directors are Min Fan, Yunxia Yang, Adam Roseman, and Yajun Wu. All of the members of our Audit Committee qualify as independent. All of the members of each of our Nominating and Compensation Committees qualify as independent, except for Wennan Li.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The following tables show the fees that were billed for audit and other services provided by Frazer Frost, LLP (the successor entity of Moore Stephens Wurth Frazer and Torbet, LLP) during the fiscal years indicated:
(1)
Audit Fees - This category includes the audit of our annual financial statements, review of financial statements included in our Quarterly Reports on Form 10-Q, and services that are normally provided by independent auditors in connection with the engagement for fiscal years. This category also includes advice on audit and accounting matters that arose during, or as a result of, the audit or the review of interim financial statements.
(2)
Audit-Related Fees - This category consists of assurance and related services by our independent auditors that are reasonably related to the performance of the audit or review of our financial statements and are not reported above under "Audit Fees." The services for the fees disclosed under this category include consultation regarding our correspondence with the SEC.
(3)
Tax Fees - This category consists of professional services rendered by our independent auditors for tax compliance and tax advice. The services for the fees disclosed under this category include tax return preparation and technical tax advice.
Pre-Approval Policies and Procedures of the Audit Committee
Our Audit Committee approves the engagement of our independent auditors and is also required to pre-approve all audit and non-audit expenses. In the fiscal year ended October 31, 2010, 100%, 100%, and 100% of our Audit-Related Fees, Tax Fees, and All Other Fees, respectively, were pre-approved by the Audit Committee.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
Financial Statements; Schedules
Our consolidated financial statements for the fiscal years ended October 31, 2010 and 2009 begin on page of this annual report. We are not required to file any financial statement schedules.
Exhibit Table
Exhibit
No.
Description
3.1
Articles of Incorporation (7)
3.2
Bylaws (1)
10.1
Premises Lease Agreement (English translation) (2)
10.2
Letter of Agreement from the Company to Adam Roseman, dated December 20, 2007 (3)
10.3
Amended and Restated Employment Agreement between Xiaolin Zhuang and Perfectenergy International Limited, dated December 29, 2008 (4)
10.4
Lease Agreement between Shanghai Changlong Industry Co. and Perfectenergy Solar-Tech (Shanghai) Ltd., dated March 11, 2008 (English translation) (4)
10.5
Leasing Contract between Tannenweg 10 Vermögensverwaltung GbR and Perfectenergy GmbH, dated October 3, 2007 (English translation) (4)
10.6
Addendum of the Tenancy Contract between Tannenweg 10 Vermögensverwaltung GbR and Perfectenergy GmbH, dated January 25, 2008 (English translation) (4)
10.7
Employment Agreement between the Company and Wennan Li, dated January 16, 2009 and effective September 2, 2008 (4)
10.8
Employment Agreement between the Company and Diping Zhou, dated January 16, 2009 and effective September 2, 2008 (4)
10.9
Long Term Supply Contract between Perfectenergy (Shanghai) Co., Ltd. and Chengdu Jiayang Silicon Materials Technology Co., Ltd., dated January 8, 2010 (English translation) (5)
10.10
Salary Adjustment Letter for Wennan (Jack) Li, dated April 7, 2010 (6)
10.11
Salary Adjustment Letter for Xiaolin (Edward) Zhuang, dated April 7, 2010 (6)
10.12
Salary Adjustment Letter for Diping Zhou, dated April 7, 2010 (6)
14.1
Code of Business Conduct and Ethics (4)
21.1
List of Subsidiaries (4)
31.1
Section 302 Certificate of Chief Executive Officer *
31.2
Section 302 Certificate of Chief Financial Officer *
32.1
Section 906 Certificate of Chief Executive Officer *
32.2
Section 906 Certificate of Chief Financial Officer *
* Filed herewith.
(1)
Filed on December 8, 2005 as an exhibit to the Company’s Registration Statement on Form SB-2 and incorporated herein by reference.
(2)
Filed on November 23, 2007 as an exhibit to the Company’s Amendment No. 1 to Registration Statement on Form SB-2 and incorporated herein by reference.
(3)
Filed on January 22, 2008 as an exhibit to the Company’s Amendment No. 2 to Registration Statement on Form SB-2 and incorporated herein by reference.
(4)
Filed on January 26, 2009 as an exhibit to our Annual Report on Form 10-K and incorporated herein by reference.
(5)
Filed on January 29, 2010 as an exhibit to our Annual Report on Form 10-K and incorporated herein by reference.
(6)
Filed on April 13, 2010 as an exhibit to our Current Report on Form 8-K and incorporated herein by reference.
(7)
Filed on June 14, 2010 as an exhibit to our Quarterly Report on Form 10-Q and incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PERFECTENERGY INTERNATIONAL LIMITED
Date: January 31, 2011
/s/ Wennan Li
Wennan Li, Chief Executive Officer and President
In accordance with the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.