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TMCNet:  SUNSI ENERGIES INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[November 14, 2012]

SUNSI ENERGIES INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives, and expected operating results, and the assumptions upon which those statements are based, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). These forward-looking statements generally are identified by the words "believes," "project," "expects," "anticipates," "estimates," "intends," "strategy," "plan," "may," "will," "would," "will be," "will continue," "will likely result," and similar expressions. We intend such forward-looking statements to be covered by the safe-harbor provisions for forward-looking statements contained in the PSLRA, and are included in this statement for purposes of complying with those safe-harbor provisions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Some of the factors that could cause results or events to differ materially from current expectations include, but are not limited to: general economic, market or business conditions; general stock market performance; the performance of the solar energy industry in general; increasingly competitive environment; changing regulatory conditions or requirements; changing government incentive programs for solar energy projects; changing alternative energy technologies; the price of trichlorosilane ("TCS") sold within China and outside of China; the price of, and demand for, polysilicon; the price of, and demand for, solar PV panels; the level of production by the Wendeng factory; Baokai's success in attaining new clients under its TCS distribution agreement; the decision by the NASDAQ Capital Market to reject the Company's application for listing; our ability to successfully manage a business in China; that Wendeng is one of the lowest cost producers of TCS and that we will emerge as one of the strongest TCS manufacturers in 2013; that Wendeng is one of the few remaining stand-alone TCS makers that can still produce TCS at current market pricing levels; generating positive cash flow in 2013; generating significant revenue and profits in 2013 from ORC units and LED lighting sales; and obtaining financing to purchase ORC units. These risks and uncertainties should also be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.


Further information concerning our business, including additional factors that could materially affect our financial results, is included herein and in our other filings with the Securities and Exchange Commission.

Overview We are an international manufacturer, distributor and licensee of alternative energy products and solutions. Prior to August 2012, our only operating activity involved the manufacturing, selling and distribution of TCS through our Baokai and Wendeng subsidiaries in China. We generated 100% of our revenue from the sale of TCS, substantially all of which was sold in China. TCS is a specialty chemical primarily used in the production of polysilicon, which is an essential raw material in the production of solar cells for PV panels that convert sunlight to electricity.

In August 2012, we entered into two transactions that were intended to diversify our future revenue streams and change our geographic presence to include businesses operating in the United States, Canada and Mexico. We acquired majority interest in TransPacific Energy, Inc. ("TPE"), a renewable energy technology corporation located in California and Nevada that designs and installs proprietary modular Organic Rankine Cycle ("ORC") units utilizing up to nine different proprietary refrigerant mixtures to maximize heat recovery and convert waste heat directly from any process that generates waste heat or flue gas (such as industrial , solar, geothermal and biomass processes) converting it into electrical energy. Additionally, we entered into a five year distribution agreement with Shanghai Lightsky Optoelectronics Technology Co., Ltd.

("Lightsky"), an unaffiliated entity located in Shanghai, China, whereby SunSi became the exclusive distributor of Lightsky LED lighting products in the United States, Canada and Mexico.

Our Acquisition of Zibo Baokai Commerce and Trade Co. Ltd.

On December 8, 2010, SunSi Energies Hong Kong Limited ("SunSi HK") acquired 90% of Zibo Baokai Commerce and Trade Co. Ltd. ("Baokai") for $263,647, an acquisition which gave us the exclusive domestic and international distribution rights to 100% of the production of trichlorosilane from Zibo Baoyun Chemical Plant ("ZBC"); however, we did not acquire any interest or ownership position in the ZBC factory. ZBC has an annual production capacity of 25,000 metric tons ("MT").

As part of the Baokai distribution rights, ZBC agreed to sell Baokai all of its TCS production at a price of cost, plus a 10% to 15% mark-up depending on the nature of the sale. By mutual agreement with ZBC, Baokai will earn a profit margin of 2% on these sales because the sales came from existing customers of ZBC and from the efforts of the ZBC sales force.

4 --------------------------------------------------------------------------------Our Acquisition of Wendeng He Xie Silicon Co. Ltd On March 18, 2011, we acquired a 60% equity interest in Wendeng He Xie Silicon Co., Ltd. ("Wendeng"), a trichlorosilane manufacturing company, from Liu Dongqiang, a Chinese individual. Wendeng is located in the Shandong province of China close to strategic ports, including Weihai and Qingdao. The state-of-the-art Wendeng facility was built in 2008 and currently has an annual capacity of 30,000 MT of TCS.

On June 13, 2011, we amended the terms of the Wendeng Acquisition, whereby Mr.

Liu canceled our obligation to buy back the 674,814 shares of our stock and confirmed that the purchase price for the 60% equity interest in Wendeng is fully paid. Such shares had been classified as "Redeemable Common Stock" on the Registrant's balance sheet and excluded from Stockholders' Equity and are now included in the Company's Stockholders' Equity section of the balance sheet at a value of approximately $2.7 million.

The TCS Market During calendar year 2011, the world polysilicon prices decreased approximately 60% as the top five producers more than doubled output, according to data compiled by Bloomberg News. Polysilicon sold for as much as $400 per kilogram ("kg") approximately four years ago and as recently as August 2011 was selling for $55 per kg. For the week ended November 6, 2012, the polysilicon spot price averaged approximately $17.00 per kg. As a result of historically low prices for polysilicon in November and December of 2011, about 90 percent of China's polysilicon plants, comprising half of the country's production suspended output in November and December according to the China Nonferrous Metals Industrial Association, which acts as a conduit between industry and government. This oversupply situation has continued throughout 2012 with an estimated 50-80% of China's polysilicon capacity currently idle.

Since November 2011, the low price of polysilicon coupled with the significant oversupply of polysilicon has had a material adverse impact on the price that we could sell TCS for and the level of plant utilization at Wendeng and our exclusive supplier to Baokai (ZBC). This has negatively impacted our revenues and results of operations. Due to the current polysilicon oversupply situation we believe that an industry consolidation is occurring where we will emerge as one of the strongest entities and lowest cost producers. The ZBC facility which supplies TCS for Baokai and our Wendeng facility have operated at very minimal capacity during 2012. The ongoing low pricing of polysilicon and the liquidation of polysilicon inventories below cost by many polysilicon companies and our competitors in order to generate cash flow has resulted in low price bids from our customers to supply them TCS at levels which would not enable us to operate profitably. Currently during the shutdown period, the Baokai distribution segment is at a breakeven level because we are not incurring any significant marketing or business development expenses directly associated with Baokai operations.

During 2012, our cash operating losses at Wendeng have been approximately $20,000 per month. Despite the continued depressed price of polysilicon, we believe that Wendeng is one of the few remaining TCS producers in China that can produce TCS near current price levels and make a cash profit (excluding depreciation expense on equipment) on TCS production. There can be no assurances that Wendeng can produce TCS profitably on a cash basis at these price levels, or that the price of polysilicon will not continue to fall.

Our Acquisition of TransPacific Energy, Inc.

On May 10 and May 17, 2012, we entered into two share exchange agreements (the "Agreements") with shareholders of TPE to acquire an aggregate controlling equity interest of its common stock. TPE is a renewable energy technology corporation located in California and Nevada that designs and installs proprietary modular ORC units utilizing up to nine different proprietary refrigerant mixtures (which it has patented) to maximize heat recovery and convert that waste heat directly into electrical energy. Furthermore, the ORC units help to address greenhouse emissions and have qualified for various government and state subsidies available in the United States.

5 -------------------------------------------------------------------------------- TPE's technology converts waste heat into clean electricity using multi-component fluids that are environmentally sound, non-toxic and non-flammable. In contrast, the typical Organic Rankine Cycle uses binary cycles and organic fluids such as pentane, isobutene, butane, propane and ammonia instead of water-based fluids. Potential applications for this technology include any process that generates waste heat or flue gas (such as industrial smokestacks, landfills, geothermal, solar and garbage incinerators) or utilize warm ocean waters. Additionally, TPE's technology can be utilized as an alternative to cooling towers and steam condensers, and use heat released to efficiently generate electricity with air cooled or water cooled condensers.

From June 14, 2012 through August 20, 2012, we paid $520,000 in cash and issued 255,351 shares of our common stock, valued at approximately $965,226 or $3.78 per share, in exchange for 24,753,768 shares of TPE's common stock in accordance with the terms of the Agreements. These investments represent approximately a 50.3% equity interest in the common stock of TPE.

TPE's technology is relatively new and generated revenue of $59,609 in our quarter recently ended September 30, 2012. TPE contracts with a United States based independent third party to manufacture the major components of the ORC units. Additionally, TPE's proprietary refrigerants are manufactured by another independent third party using TPE's formulation.

Currently, TPE has commissioned work to these contractors for the manufacture of four ORC units that will operate using TPE's proprietary refrigerants.

Furthermore, TPE is seeking financing for three additional ORC units that it has been awarded in a contract to a consortium of companies for a geothermal installation by the government of Morocco. We believe that we will be successful in obtaining financing on favorable terms in order to build our ORC units; however we can provide no assurances.

A typical ORC application takes approximately six months from the date of the initial order until final deployment. We believe that we can reduce this time frame from six months to three months through operating efficiencies; however, there can be no assurances that we will be successful in doing so.

Our strategy to generate revenue and operating profits from our ORC segment is as follows: Purchase and own our ORC equipment using TPE's technology to generate ongoing, incremental electricity which can be sold back to a customer at a discount via a purchase power agreement ("PPA") or sold back to the utility grid in the jurisdiction where the ORC unit is installed; Sell our ORC equipment to a customer and receive an ongoing royalty payment from the incremental energy generated by the ORC unit; and License TPE's technology out to various markets and jurisdictions.

We believe that we will be successful in executing our strategy for generating significant revenues and profits beginning in 2013. Additionally, we believe that TPE's proprietary refrigerants will produce high levels of incremental energy when used in ORC applications; however there can be can be no assurance.

6 --------------------------------------------------------------------------------Our Purchase of the Exclusive Rights to Distribute Shanghai Lightsky Optoelectronics Technology Co., Ltd.'s LED Lighting Products On August 27, 2012, we entered into a five year distribution agreement with Shanghai Lightsky Optoelectronics Technology Co., Ltd. ("Lightsky") located in Shanghai, China whereby we became the exclusive distributor of Lightsky LED lighting products in the United States, Canada and Mexico.

Lightsky is a leading, high-tech enterprise which was established by the Shanghai Academy of Science and Technology and Shanghai Zhongbo Capital Co., Ltd. Lightsky researches, designs and manufactures LED lighting products to meet the world's ever evolving lighting needs. Lightsky's products range from illumination LED lighting, LED video display systems and architectural LED lighting. Lightsky has completed major lighting installation at the Shanghai International Airport, the 2010 Shanghai World Expo and Hong Kong University.

Lightsky's sales of its products are concentrated in China and throughout Asia.

Lightsky holds a series of design and utility patents and is ISO9001 certified.

We issued 150,000 shares of our restricted common stock valued at $780,000, which represents fair market value, as consideration for the exclusive rights.

The shares are restricted for an eighteen month period from their date of issuance. In order to maintain its exclusivity and qualify for any automatic renewal periods beyond the five year period, we must achieve certain performance milestones.

We are marketing Lightsky's products through our wholly-owned subsidiary SunSi USA, which was incorporated in 2012.

Our strategy to generate revenues and operating profits from our LED segment is as follows: Concentrate on the sale and installation of high return on investment ("ROI") products with widest applications in the commercial, industrial and institutional sectors; Focus on customers with whom economics "carry the day", where utility costs and incentives may be at their highest (such as corporations, hospitals and institutions) and where lighting and "green image" are largely important; Identify and target larger customers who can undertake multi-year LED product roll-out of high and continuous volumes; and Offer complete or "turnkey" retro-fit LED project installation services to prospective customers by partnering with energy savings firms that will perform the installation of our Lightsky products, help to quantify potential future energy savings, and prepare the appropriate documentation necessary for our customers to qualify for various tax subsidies and credits.

During 2012, we do not expect to generate any significant revenues from the sale of LED products. We believe that the favorable pricing levels that we are receiving from Lightsky to distribute their products, combined with our marketing strategy will enable us to generate significant revenues and operating profits from our LED segment in 2013; although we can offer no assurances.

7 --------------------------------------------------------------------------------Results of Operations for the Three and Nine Months Ended September 30, 2012 and 2011 The following table sets forth operations by segment for the three months ended September 30, 2012 and 2011: TCS Baokai Wendeng ORC LED Corporate Consolidated Sales: 2012 $ 32,250 $ 133,838 $ 59,609 $ - $ - $ 225,697 2011 $ 3,830,636 $ 6,434,811 $ - $ - $ - $ 10,265,447 Cost of goods sold: 2012 $ 31,599 $ 126,323 $ 59,609 $ - $ - $ 217,531 2011 $ 3,753,885 $ 4,633,336 $ - $ - $ - $ 8,387,221 Gross margin: 2012 $ 651 $ 7,515 $ - $ - $ - $ 8,166 2011 $ 76,751 $ 1,801,475 $ - $ - $ - $ 1,878,226 Operating expenses: 2012 $ 43,260 $ 371,117 $ 3,532 $ 34,119 $ 403,036 $ 855,064 2011 $ 19,085 $ 1,353,540 $ - $ - $ 252,454 $ 1,625,079 Other income (expense): 2012 $ - $ - $ - $ - $ (9,074 ) $ (9,074 ) 2011 $ - $ - $ - $ - $ - $ - Provision for income taxes: 2012 $ (10,652 ) $ (90,901 ) $ - $ - $ - $ (101,553 ) 2011 $ 14,417 $ 39,010 $ - $ - $ - $ 53,427 Net income (loss): 2012 $ (31,957 ) $ (272,701 ) $ (3,532 ) $ (34,119 ) $ (412,110 ) $ (754,419 ) 2011 $ 43,249 $ 408,925 $ - $ - $ (252,454 ) $ 199,720 8--------------------------------------------------------------------------------The following table sets forth operations by segment for the nine months ended September 30, 2012 and 2011: TCS Baokai Wendeng ORC LED Corporate Consolidated Sales: 2012 $ 794,261 $ 406,044 $ 59,609 $ - $ - $ 1,259,914 2011 $ 13,592,881 $ 12,302,953 $ - $ - $ - $ 25,895,834 Cost of goods sold: 2012 $ 778,370 $ 368,096 $ 59,609 $ - $ - $ 1,206,075 2011 $ 13,299,264 $ 8,379,350 $ - $ - $ - $ 21,678,614 Gross margin: 2012 $ 15,891 $ 37,948 $ - $ - $ - $ 53,839 2011 $ 293,617 $ 3,923,603 $ - $ - $ - $ 4,217,220 Operating expenses: 2012 $ 154,096 $ 1,432,026 $ 3,532 $ 34,119 $ 949,416 $ 2,573,189 2011 $ 56,233 $ 2,553,877 $ - $ - $ 812,701 $ 3,422,811 Other income (expense): 2012 $ - $ - $ - $ - $ (15,053 ) $ (15,053 ) 2011 $ - $ - $ - $ - $ - $ - Provision for income taxes: 2012 $ (34,551 ) $ (348,520 ) $ - $ - $ - $ (383,071 ) 2011 $ 59,346 $ 342,431 $ - $ - $ - $ 401,777 Net income (loss): 2012 $ (103,654 ) $ (1,045,558 ) $ (3,532 ) $ (34,119 ) $ (964,469 ) $ (2,151,332 ) 2011 $ 178,038 $ 1,027,295 $ - $ - $ (812,701 ) $ 392,632 Operating segments do not sell products to each other, and accordingly, there is no inter-segment revenue to be reported.

Revenue Sales for the three months ended September 30, 2012 totaled $225,697, compared to $10,265,447 for the three months ended September 30, 2011. Sales for the three months ended September 30, 2012 and 2011 were comprised of $32,250 and $3,830,636, respectively, from our Baokai segment; $133,838 and $6,434,811, respectively, from our Wendeng segment; and $59,609 and nil, respectively, from our ORC segment. All sales for Baokai and Wendeng segments during these periods were recorded within China; with the exception of one sale made by Wendeng to Russia valued at approximately $188,000. All revenue recognized by our ORC segment was recorded within the United States; no prior year period comparable results exist as our ORC segment was acquired on August 20, 2012.

9 -------------------------------------------------------------------------------- Sales for the nine months ended September 30, 2012 totaled $1,259,914, compared to $25,895,834 for the nine months ended September 30, 2011. Sales for the nine months ended September 30, 2012 and 2011 were comprised of $794,261 and $13,592,881, respectively, from our Baokai segment; $406,044 and $12,302,953, respectively, from our Wendeng segment; and $59,609 and nil, respectively, from our ORC segment. All sales for Baokai and Wendeng segments during these periods were recorded within China; with the exception of one sale made by Wendeng to Russia valued at approximately $188,000. All revenue recognized by our ORC segment was recorded within the United States; no prior year period comparable results exist as our ORC segment was acquired on August 20, 2012.

The price of TCS in China is typically based on short-term contracts and spot prices; enabling both the buyer and the seller to adapt to changing market conditions. During 2011, the price of TCS ranged from a high of approximately $1,600 per metric ton to a low of approximately $635 per metric ton. This decline in TCS pricing was consistent with the decrease in the price of polysilicon, which has fallen approximately 60%-70% from January 2011.

Furthermore, a global oversupply of polysilicon has continued to materially reduce both the price and demand for TCS since the fourth quarter 2011. These factors have adversely impacted our Chinese subsidiaries' operating results.

The pricing of TCS is expected to remain depressed for the remainder of 2012.

Both Baokai and Wendeng have received minimal orders in the fourth quarter of 2012 and are currently operating at limited capacity. We expect the TCS and polysilicon markets will improve during the first half of 2013; however, we can provide no assurances.

Gross Margin We calculate gross margin by subtracting cost of goods sold from sales. Gross margin percentage is calculated by dividing gross margin by sales.

Gross margin for the three months ended September 30, 2012 was $8,166, compared to $1,878,226 for the three months ended September 30, 2011. Gross margin percentage for the three months ended September 30, 2012 was 3.6%, compared to 18.3% for the three months ended September 30, 2011.

Gross margin for the nine months ended September 30, 2012 was $53,839, compared to $4,217,220 for the nine months ended September 30, 2011. Gross margin percentage for the nine months ended September 30, 2012 was 4.3%, compared to 16.3% for the nine months ended September 30, 2011.

The decrease in gross margin is primarily attributable to the decreased level of sales and sales prices realized compared to the prior year periods. Our gross margin and gross margin percentage continue to be adversely impacted by the low price levels and demand for polysilicon.

For the three months ended September 30, 2012, we realized a gross margin percentage of 2.0% at our Baokai segment, compared to a gross margin percentage of 2.2% in the prior year period. For the nine months ended September 30, 2012, we realized a gross margin percentage of 2.0% at our Baokai segment, compared to a gross margin percentage of 2.2% in the prior year period. Our margins are currently fixed at 2% on sales recorded at our Baokai segment. We are a distributor of TCS produced by Zibo Baoyun Chemical Factory. Our purchase price is fixed to the percentage of the selling price; therefore, our gross margin percentage is not affected by market price fluctuations. We have the opportunity to realize greater margin percentages, potentially up to 10-15%, at our Baokai segment if we introduce new customers to ZBC. There can be no assurances that we will be successful in generating new customers or realizing these higher margin opportunities.

10-------------------------------------------------------------------------------- For the three months ended September 30, 2012, we realized a gross margin percentage of 5.6% at our Wendeng segment, compared to a gross margin percentage of 28.0% in the prior year period. For the nine months ended September 30, 2012, we realized a gross margin percentage of 9.3% at our Wendeng segment, compared to a gross margin percentage of 31.9% in the prior year period. The decrease in gross margin and gross margin percentage at our Wendeng segment is directly attributable to the decline in the segment's product sales and sale prices as described above.

For the three and nine months ended September 30, 2012, we realized an effective gross margin percentage of 0.0% at our ORC segment. This ORC project was in process prior to our acquisition of TPE. It was contracted with the intention of demonstrating the viability of the TPE's technology. We do not expect this project to generate any positive gross margin. However, we do expect to generate significant revenues and gross margins from TPE's future projects; though we can offer no assurances.

Professional Fees Professional fees totaled $151,424 for the three months ended September 30, 2012, compared to $280,963 for the three months ended September 30, 2011.

Professional fees totaled $441,148 for the nine months ended September 30, 2012, compared to $690,560 for the nine months ended September 30, 2011.

Professional fees consist of legal, accounting and other consulting or service provider fees. Most of our professional services are attributable to our status as a publicly traded company. The decrease in our professional fees when compared to the prior year periods are largely attributable to the increased audit accounting review and compliance services related to the acquisitions of our Chinese subsidiaries in late 2010 and early 2011, which were paid during 2011.

General and Administrative Expenses General and administrative ("G&A") expenses totaled $703,640 for the three months ended September 30, 2012, compared to $1,344,116 for the three months ended September 30, 2011. G&A expenses totaled $2,132,041 for the nine months ended September 30, 2012, compared to $2,732,251 for the nine months ended September 30, 2011.

The primary components of our G&A expenses include salaries and benefits not directly associated with our manufacturing processes, depreciation on non-production capital assets, amortization, facility costs and maintenance, investor relations activities and various administrative and office expenses.

The decrease in our G&A expenses for the three and nine months ended September 30, 2012 when compared to the prior year period is largely attributable to the temporary closure of our Wendeng facility.

Provision for Income Taxes (Benefit) We recorded an income tax benefit of ($101,553) for the three months ended September 30, 2012, compared to a provision for income taxes of $53,427 for the three months ended September 30, 2011. We recorded an income tax benefit of ($383,071) for the nine months ended September 30, 2012, compared to a provision for income taxes of $401,777 for the nine months ended September 30, 2011.

11 -------------------------------------------------------------------------------- These provisions for income taxes or income tax benefits are recorded as a result of the operations realized at our Chinese subsidiaries for each of the periods ended September 30, 2012 and 2011.They are recorded at a 25% tax rate, which is the statutory rate in China for all earnings. Any profits generated in China are not available to be offset against net operating losses in the United States.

Potential benefits of income tax losses are not recognized in the accounts until realization is more likely than not. The Company has generated a net operating loss from its U.S.-based operations of approximately $2,571,500 which expires in 2031. Pursuant to ASC 740, the Company is required to compute tax asset benefits for net operating losses carried forward. The potential benefits of net operating losses have not been recognized in these financial statements because the Company cannot be assured it is more likely than not it will utilize the net operating losses in the United States carried forward in future years.

Net loss For the three months ended September 30, 2012, we incurred a net loss of ($754,419), compared to net income of $199,720 for the three months ended September 30, 2011. For the nine months ended September 30, 2012, we incurred a net loss of ($2,151,332), compared to net income of $392,632 for the nine months ended September 30, 2011.

The weighted average number of basic and fully diluted shares outstanding for the three months ended September 30, 2012 was 15,572,388, compared to 14,916,428 for the three months ended September 30, 2011. The weighted average number of basic and fully diluted shares outstanding for the nine months ended September 30, 2012 was 15,194,903, compared to 14,632,164 for the nine months ended September 30, 2011.

There are no dilutive equivalents included in our calculation of fully diluted shares for the three and nine months ended September 30, 2012, since their inclusion would be anti-dilutive due to our net loss per share. Further, there are no dilutive equivalents included in our calculation of fully diluted shares for the three and nine months ended September 30, 2011, nor are there any fully diluted equivalents that would be required to have been included in any period in which we were profitable.

Liquidity and Capital Resources At September 30, 2012, we had cash on hand of $698,117. Of this amount, $466,215 was on deposit with institutions located in the United States, $231,781 in China and $121 in Hong Kong. For the foreseeable future, we do not intend to repatriate any funds from China to support our operations within the United States. Prior to our acquisition of a controlling interest in TPE and the exclusive North American distribution rights to Lightsky products, our U.S.-based operations consisted solely of a holding company that incurred expenses and had no revenue generating activities. Proceeds generated from private placements of our common stock and loans have been the primary sources of funding for our U.S.-based operations. We believe our current cash position and ability to raise funds through the sale of new equity and convertible notes, coupled with the revenue potential of our newly acquired U.S.-based businesses, will be sufficient to fund our U.S. activities for the next twelve months.

Furthermore, we expect to generate positive cash flow over the next twelve months which will supplement our cash position.

At September 30, 2012, we had a working capital deficit of $5,020,072. The deficit is primarily attributable to the related party payable of $5,490,623 due to the minority shareholder of Wendeng. These funds were used to build and expand the Wendeng facility. Our Wendeng subsidiary minority shareholder is currently not requesting repayment of this amount; however, since this is an interest free demand loan to the Company, it has been categorized as a current liability.

Net cash used in operating activities was $1,184,394 for the nine months ended September 30, 2012, compared to net cash used in operating activities of $882,290 for the nine months ended September 30, 2011. The increase in net cash used during 2012 as compared to 2011 is attributable to an increase in our net loss to ($2,151,332) from net income of $392,632 in the prior year period; offset by a significant improvement in the net change in our operating assets and liabilities over the prior year period. Our current period operating loss includes non-cash depreciation and amortization expenses of $941,567 and aggregate reserves against our working capital assets (accounts receivable and inventory) of $397,681, as compared to $585,956 of depreciation and amortization and no reserves against working capital assets in the prior year period.

12 -------------------------------------------------------------------------------- Net cash used in investing activities was $286,744 for the nine months ended September 30, 2012, compared to net cash used in investing activities of $352,943 for the nine months ended September 30, 2011. The net cash used in the current period is attributable to the purchase of $209,373 in capital assets to support our ongoing efforts to expand the capacity of our Wendeng production facility and $520,000 to acquire a controlling interest in TPE (see "Our Acquisition of TransPacific Energy, Inc." above); offset by $442,629 in cash acquired in the transaction. During the nine months ended September 30, 2011, we realized a net cash increase of $533,594 from our acquisition of Wendeng, which was mostly funded with shares of our common stock. Capital expenditures in the prior year period totaled $535,077 for property, plant and equipment and $351,460 for intangible assets (land use rights).

Net cash provided by financing activities was $1,496,118 for the nine months ended September 30, 2012, compared to $1,420,498 for the nine months ended September 30, 2011. We received $1,477,500 in net proceeds from the issuance of new equity, compared to $1,579,500 in the prior year period. Additionally, we received $129,600 in short term loan proceeds and a $40,000 advance from an officer to help fund our corporate expenditures; of which all but $18,100 was repaid as of September 30, 2012. During the nine months ended September 30, 2011, we made payments totaling $159,002 on amounts due to related parties.

Critical Accounting Policies We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires the use of 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 and the reported amount of revenues and expenses during the reporting period. Our management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions.

Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

In preparing financial statements in conformity with US GAAP, management is required 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 and revenues and expenses during the reported periods. These accounts and estimates include, but are not limited to, the valuation of accounts receivable, inventories, deferred income taxes and the estimation on useful lives of property, plant and equipment. Actual results could differ from those estimates.

Financial Instruments The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are stated at cost and consist solely of bank deposits held in the United States, Hong Kong and China. The carrying amount of cash and cash equivalents approximates fair value.

At September 30, 2012, cash and cash equivalents totaling $231,902 were held in banks in China; a Wendeng branch of Industrial & Commercial Bank of China and a Central District, Hong Kong branch of HSBC Bank. The remittance of these funds out of China is subject to exchange control restrictions imposed by the Chinese government. Deposits in banks in China are not insured by any government entity or agency, and are consequently exposed to risk of loss. Management believes the probability of a bank failure, causing loss to the Company, is remote.

13 --------------------------------------------------------------------------------Concentration of Credit Risk Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. At September 30, 2012 and December 31, 2011, the Company's cash and cash equivalents and restricted cash were held by major financial institutions located in the United States, Hong Kong and China, which management believes are of high credit quality.

With respect to accounts receivable, the Company extends credit based on an evaluation of the customer's financial condition. The Company generally does not require collateral for trade receivables and maintains an allowance for doubtful accounts of accounts receivable.

Allowance for doubtful accounts The Company establishes an allowance for doubtful accounts based on management's assessment of the aging and collectability of its trade receivables. A considerable amount of judgment is required in assessing the amount of the allowance. The underlying assumptions, estimates and assessments we use to provide for losses are updated periodically to reflect our view of current conditions. Generally, the Company records a provision for bad debts equivalent to ten percent of the balance of its trade receivables outstanding for more than ninety days from their date of invoice. Trade receivables outstanding for more than one year from their date of invoice are reserved in full, unless the customer is actively making payments or has entered into a payment agreement with the Company. In such cases, the Company maintains its provision for bad debts at the ten percent level.

Furthermore, the Company makes judgments about the creditworthiness of each customer based on ongoing credit evaluations and frequent communication, and monitors current economic trends that might impact the level of credit losses in the future. If the financial condition of the customers were to deteriorate, resulting in their inability to make payments, a specific allowance will be recorded.

Bad debts are written off when identified. The Company extends unsecured credit to substantially all of its customers in the normal course of business. In many cases, this is necessary to remain competitive in the marketplace in which the Company operates. Potential customers for the Company's products are finite in nature, and typically are larger, well capitalized companies. The Company does not accrue interest on aged trade accounts receivable as it is not a customary practice in the jurisdictions in which the Company operates. Historically, losses from uncollectible accounts have not significantly deviated from the specific allowance estimated by management. This specific provisioning policy has not changed since establishment and the management considers that the aforementioned specific provisioning policy is adequate and does not expect to change this established policy in the near future.

Inventory Inventories are stated at the lower of cost or market value. Cost is determined on weighted average basis and includes all expenditures incurred in bringing the goods in a saleable condition to the point of sale. The Company's inventory reserve requirements generally fluctuate based on projected demands and market conditions. In determining the adequate level of inventories to have on hand, management makes judgments as to the projected inventory demands as compared to the current or committed inventory levels. Inventory quantities and condition are reviewed regularly and provisions for excess or obsolete inventory are recorded based on the condition of inventory and the Company's forecast of future demand and market conditions.

Intangible assets - land use rights Land use rights are stated at cost less accumulated amortization. Amortization is provided using the straight-line method over the terms of 50 years. The lease term is obtained from the relevant Chinese land authority.

14 --------------------------------------------------------------------------------Property, plant and equipment Property, plant and equipment is stated at cost less accumulated depreciation. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use.

The property, plant and equipment of the Company will be depreciated using the straight-line method according to the following estimated residual value and service life.

Estimated Annual Service life residual rate depreciation rate (year) % % Building 20 5 2.05 Furniture and equipment 5 5 3.17 Machines and equipment 10 5 7.34 Automotive equipment 5 5 10.93 Office equipment 5 5 8.64 The residual value and service life of property, plant and equipment will be reviewed on each balance sheet date, and adjusted if necessary.

The Company capitalizes the interest expenses incurred before property, plant and equipment are built and installed to the usable state, and capitalizes other loan interest expenses.

Construction in progress The value of construction in progress comprises buildings and plants under construction, as well as machines and equipment being installed and commissioned, specifically comprises the costs of property, plant and equipment and other direct costs, relevant interest expenses accrued during the construction period and profits and losses from foreign exchange transactions.

Depreciation will not start until the construction in progress is completed and put into operation.

Impairment of Assets The Company reviews long-lived assets and certain identifiable intangibles held and used for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating the fair value and future benefits of its long-lived assets, management performs an analysis of the anticipated undiscounted future net cash flows of the individual assets over the remaining depreciation or amortization period. The Company recognizes an impairment loss if the carrying value of the asset exceeds the expected future cash flows.

15 -------------------------------------------------------------------------------- Each year, the Company performs a transitional test for impairment of goodwill and other indefinite-lived intangible assets. This test is performed by comparing, at the reporting unit level, the carrying value of goodwill to its fair value. The Company assesses fair value based upon its best estimate of the present value of future cash flows that it expects to generate by the reporting unit. In conjunction with its recent change in fiscal year-end, the Company's annual fair value assessment is performed each December 31 on subsidiaries with material goodwill on their respective balance sheets. However, changes in expectations as to the present value of the reporting unit's future cash flows might impact subsequent years' assessments of impairment.

Goodwill and Intangible Assets Under ASC 350, the Company is required to perform an annual impairment test of the Company's goodwill and indefinite-lived intangibles. On an annual basis, management assesses the composition of the Company's assets and liabilities, as well as the events that have occurred and the circumstances that have changed since the most recent fair value determination. If events occur or circumstances change that would more likely than not reduce the fair value of goodwill and indefinite-lived intangibles below their carrying amounts, they will be tested for impairment. The Company will recognize an impairment charge if the carrying value of the asset exceeds the fair value determination. The impairment test that the Company has selected historically consisted of a ten year discounted cash flow analysis including the determination of a terminal value, and requires management to make various assumptions and estimates including revenue growth, future profitability, peer group comparisons, and a discount rate which management believes are reasonable.

The impairment test involves a two-step approach. Under the first step, the Company determines the fair value of each reporting subsidiary to which goodwill has been assigned. The Company then compares the fair value of each reporting subsidiary to its carrying value, including goodwill. The Company estimates the fair value of each reporting subsidiary by estimating the present value of the reporting subsidiaries' future cash flows. If the fair value exceeds the carrying value, no impairment loss is recognized. If the carrying value exceeds the fair value, the goodwill of the reporting unit is considered potentially impaired and the second step is completed in order to measure the impairment loss.

Under the second step, the Company calculates the implied fair value of goodwill by deducting the fair value of all tangible and intangible net assets, including any unrecognized intangible assets, of the reporting unit from the fair value of the reporting unit, as determined in the first step. The Company then compares the implied fair value of goodwill to the carrying value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, the Company recognizes an impairment loss equal to the difference.

Stock Purchase Warrants The Company has issued warrants to purchase shares of its common stock. Warrants have been accounted for as equity in accordance with FASB ASC 480, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, Distinguishing Liabilities from Equity.

Income Taxes The Company accounts for income taxes under FASB ASC 740, "Accounting for Income Taxes". Under FASB ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under FASB ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. FASB ASC 740-10-05, "Accounting for Uncertainty in Income Taxes" prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities.

16 -------------------------------------------------------------------------------- The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. We assess the validity of our conclusions regarding uncertain tax positions on a quarterly basis to determine if facts or circumstances have arisen that might cause us to change our judgment regarding the likelihood of a tax position's sustainability under audit. We have determined that there were no uncertain tax positions for the periods ended September 30, 2012 and December 31, 2011.

Basic and Diluted Net Income (Loss) Per Share The Company computes net income (loss) per share in accordance with ASC 260, "Earnings per Share". ASC 260 requires presentation of both basic and diluted earnings per share (EPS) on the face of the income statement. Basic EPS is computed by dividing net income (loss) available to common stockholders (numerator) by the weighted average number of shares outstanding (denominator) during the period. Diluted EPS gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants.

Diluted EPS excludes all dilutive potential shares if their effect is anti-dilutive.

Fair value of financial instruments The Company adopted FASB ASC 820 on June 1, 2010. The adoption of FASB ASC 820 did not materially impact the Company's financial position, results of operations or cash flows. FASB ASC 820 requires the disclosure of the estimated fair value of financial instruments including those financial instruments for which the fair value option was not elected. The carrying amounts of both the financial assets and liabilities approximate to their fair values due to short maturities or the applicable interest rates approximate the current market rates.

Revenue Recognition Revenue from the sales of the Company's products is recognized upon customer acceptance. This occurs at the time of delivery to the customer, provided persuasive evidence of an arrangement exists, such as a signed sales contract.

The significant risks and rewards of ownership are transferred to the customers at the time when the products are delivered and there is no significant post-delivery obligation to the Company. In addition, the sales price is fixed or determinable and collection is reasonably assured. The Company does not provide customers with contractual rights of return for products. When there are significant post-delivery performance obligations, revenue is recognized only after such obligations are fulfilled. The Company evaluates the terms of the sales agreement with its customer in order to determine whether any significant post-delivery performance obligations exist. Currently, the sales do not include any terms which may impose any significant post-delivery performance obligations on the Company.

17 -------------------------------------------------------------------------------- Revenue from the sales of the Company's products represents the invoiced value of goods, net of the value-added tax ("VAT"). All of the Company's products that are sold in China are subject to a Chinese VAT at a rate of 17% of the gross sales price. This VAT may be offset by the VAT paid by the Company on raw and other materials that are included in the cost of producing the Company's finished products.

Advertising expenses Advertising costs are expensed as incurred.

Shipping and handling costs All shipping and handling costs are included in cost of goods sold.

Foreign Currency Translation The Company's functional and reporting currency is the United States dollar.

Transactions may occur in Renminbi ("RMB") and management has adopted ASC 830, "Foreign Currency Matters". The RMB is not freely convertible into foreign currencies. Monetary assets denominated in foreign currencies are translated using the exchange rate prevailing at the balance sheet date. Average monthly rates are used to translate revenues and expenses. The Company has not, to the date of these financial statements, entered into derivative instruments to offset the impact of foreign currency fluctuations.

Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transaction. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.

Assets and liabilities of the Company's operations are translated into the reporting currency, United States dollars, at the exchange rate in effect at the balance sheet dates. Revenue and expenses are translated at average rates in effect during the reporting periods. Equity transactions are recorded at the historical rate when the transaction occurred. The resulting translation adjustment is reflected as accumulated other comprehensive income, a separate component of stockholders' equity in the statement of stockholders' equity.

Comprehensive Gain or Loss ASC 220, "Comprehensive Income", establishes standards for the reporting and display of comprehensive income and its components in the financial statements.

As of September 30, 2012, the Company has items that represent comprehensive income and, therefore, has included a schedule of comprehensive income (loss) in the financial statements.

18--------------------------------------------------------------------------------Off Balance Sheet Arrangements As of September 30, 2012, there were no off balance sheet arrangements.

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