UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2008March 31, 2009

o¨ TRANSITION REPORT UNDER SECTION 13 OR 15 (D) OF THE EXCHANGE ACT

For the transition period from __________ to __________

COMMISSION FILE NUMBER:  33-16335

CHINA WIND SYSTEMS, INC.
(Name (Name of Registrant as specified in its charter)

DELAWARE
74-2235008
(State or other jurisdiction of(I.R.S. Employer
incorporation of organization)
Identification No.)

No. 9 Yanyu Middle Road
Qianzhou Township, Huishan District, Wuxi City
Jiangsu Province, China 150090
(Address (Address of principal executive office)

(86) 51083397559
(86) 51083397559
(Registrant’s (Registrant’s telephone number)

Not applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ¨ No ¨

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

Large accelerated filer¨Accelerated filer¨
Non-accelerated filer
(Do not check if smaller reporting company)
¨Smaller reporting companyþ

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.  44,679,496 shares of common stock are issued and outstanding as of November 10, 2008.May 5, 2009.


CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-Q
September 30, 2008March 31, 2009
 
TABLE OF CONTENTS
 
  
Page
No.
PART I. - FINANCIAL INFORMATION
Item 1.Financial Statements3
Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations.2827
Item 3Quantitative and Qualitative Disclosures About Market Risk.4140
Item 4Controls and Procedures.4241
   
PART II - OTHER INFORMATION
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds.43
Item 6.Exhibits.43
 
1
 
FORWARD LOOKING STATEMENTS
 
This report contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this report. Additionally, statements concerning future matters are forward-looking statements.
 
Although forward-looking statements in this report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the headings “Risks Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report on Form 10-KSB,10-K, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q and in other reports that we file with the SEC.   You are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We file reports with the SEC. The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
 
We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report, except as required by law. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Quarterly Report, which are designed to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

2

PART 1 - FINANCIAL INFORMATION

Item 1.Financial Statements.
Item 1. Financial Statements.

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

  September 30, December 31, 
  2008 2007 
  (Unaudited)   
ASSETS       
        
CURRENT ASSETS:       
Cash and cash equivalents $744,885 $5,025,434 
Accounts receivable, net of allowance for doubtful accounts  3,942,594  2,158,412 
Inventories, net of reserve for obsolete inventory  2,185,721  1,929,796 
Advances to suppliers  259,190  938,331 
Prepaid expenses and other  78,847  378,429 
        
Total Current Assets  7,211,237  10,430,402 
        
PROPERTY AND EQUIPMENT - Net  18,343,726  6,525,986 
        
OTHER ASSETS:       
Deposit on long-term assets - related party  5,603,128  10,863,706 
Land use rights, net  3,827,481  502,634 
Investment in cost method investee  -  34,181 
Due from related parties  -  139,524 
        
Total Assets $34,985,572 $28,496,433 
        
LIABILITIES AND STOCKHOLDERS' EQUITY       
        
CURRENT LIABILITIES:       
Loans payable $1,021,138 $820,333 
Convertible debt, net of discount on debt  -  3,261,339 
Accounts payable  3,202,606  1,845,769 
Accrued expenses  190,882  198,542 
VAT and service taxes payable  65,831  434,839 
Advances from customers  65,850  77,357 
Due to related party  -  98,541 
Income taxes payable  591,745  508,407 
        
Total Current Liabilities  5,138,052  7,245,127 
        
STOCKHOLDERS' EQUITY:       
Series A convertible preferred ($0.001 par value; 60,000,000 shares authorized; 14,028,189 and 0 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively)  14,028  - 
Common stock ($0.001 par value; 150,000,000 shares authorized; 40,976,062 and 37,384,295 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively)  40,976  37,385 
Additional paid-in capital  13,966,914  3,488,896 
Retained earnings  12,274,138  16,074,270 
Statutory reserve  526,628  305,472 
Other comprehensive gain - cumulative foreign currency translation adjustment  3,024,836  1,345,283 
        
Total Stockholders' Equity  29,847,520  21,251,306 
        
Total Liabilities and Stockholders' Equity $34,985,572 $28,496,433 
  March 31,  December 31, 
  2009  2008 
  (Unaudited)    
ASSETS      
       
CURRENT ASSETS:      
Cash and cash equivalents $107,910  $328,614 
Notes receivable  199,836   269,549 
Accounts receivable, net of allowance for doubtful accounts (Note 2)  4,900,064   4,518,259 
Inventories, net of reserve for obsolete inventory (Note 3)  2,409,723   1,892,090 
Advances to suppliers  101,916   117,795 
Due from related party (Note 8)  -   437,688 
Prepaid expenses and other  79,240   21,744 
         
Total Current Assets  7,798,689   7,585,739 
         
PROPERTY AND EQUIPMENT - net (Note 4)  26,748,919   25,939,596 
         
OTHER ASSETS:        
Land use rights, net (Note 5)  3,789,616   3,806,422 
         
Total Assets $38,337,224  $37,331,757 
         
LIABILITIES AND STOCKHOLDERS' EQUITY        
         
CURRENT LIABILITIES:        
Loans payable (Note 7) $1,314,713  $1,021,272 
Accounts payable  2,445,776   2,485,137 
Accrued expenses  233,517   187,605 
VAT and service taxes payable  -   97,341 
Advances from customers  100,096   45,748 
Income taxes payable  336,710   569,371 
         
Total Current Liabilities  4,430,812   4,406,474 
         
LONG-TERM LIABILITIES:        
Loan payable - net of current portion and debt discount (Note 7)  158,515   - 
         
Total Liabilities  4,589,327   4,406,474 
         
RELATED PARY TRANSACTIONS (Note 8)        
COMMITMENTS (Note 11)        
         
STOCKHOLDERS' EQUITY: (Note 6)        
Preferred stock $0.001 par value;        
(March 31, 2009 and December 31, 2008 - 60,000,000 shares authorized, all of which        
were designated as series A convertible preferred, 14,028,189 shares issued and outstanding; at March 31, 2009 and December 31, 2008, respectively)
  14,028   14,028 
Common stock ($0.001 par value; 150,000,000 shares authorized;        
44,979,667 and 44,895,546 shares issued and outstanding        
at March 31, 2009 and December 31, 2008, respectively)  44,980   44,896 
Additional paid-in capital  15,706,220   15,571,288 
Retained earnings  14,231,262   13,639,641 
Statutory reserve  675,640   621,203 
Other comprehensive gain - cumulative foreign currency translation adjustment  3,075,767   3,034,227 
         
Total Stockholders' Equity  33,747,897   32,925,283 
         
Total Liabilities and Stockholders' Equity $38,337,224  $37,331,757 

See notes to unaudited consolidated financial statements

3

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)INCOME

  For the Three Months Ended For the Nine Months Ended 
  September 30, September 30, 
  2008 2007 2008 2007 
          
NET REVENUES $11,770,162 $8,000,293 $31,400,186 $16,589,475 
             
COST OF SALES  8,816,389  5,633,977  23,508,720  11,831,546 
             
GROSS PROFIT  2,953,773  2,366,316  7,891,466  4,757,929 
             
OPERATING EXPENSES:            
Depreciation  69,712  68,607  228,189  207,875 
Selling, general and administrative  414,078  223,164  1,681,177  566,106 
             
Total Operating Expenses  483,790  291,771  1,909,366  773,981 
             
INCOME FROM OPERATIONS  2,469,983  2,074,545  5,982,100  3,983,948 
             
OTHER INCOME (EXPENSE):            
Interest income  2,075  91  11,719  372 
Interest expense  (20,427) (9,946) (2,298,874) (31,360)
Other income from foregiveness of income and VAT taxes  -  6,771,442  -  6,771,442 
Debt issuance costs  -  -  (21,429) - 
             
Total Other Income (Expense)  (18,352) 6,761,587  (2,308,584) 6,740,454 
             
INCOME BEFORE INCOME TAXES  2,451,631  8,836,132  3,673,516  10,724,402 
             
INCOME TAXES  590,769  714,840  1,651,331  1,315,094 
             
NET INCOME  1,860,862  8,121,292  2,022,185  9,409,308 
             
DEEMED PREFERRED DIVIDEND  -  -  (2,884,062) - 
             
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS $1,860,862 $8,121,292 $(861,877)$9,409,308 
             
COMPREHENSIVE INCOME:            
NET INCOME $1,860,862 $8,121,292 $2,022,185 $9,409,308 
             
OTHER COMPREHENSIVE INCOME:            
Unrealized foreign currency translation gain  67,269  299,690  1,679,553  523,986 
             
COMPREHENSIVE INCOME $1,928,131 $8,420,982 $3,701,738 $9,933,294 
             
NET INCOME (LOSS) PER COMMON SHARE:            
Basic $0.05 $0.22 $(0.02)$0.26 
Diluted $0.03 $0.22 $(0.02)$0.26 
             
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:            
Basic  40,363,220  36,577,704  38,634,312  36,577,704 
Diluted  67,189,108  36,577,704  38,634,312  36,577,704 
  For the Three Months Ended 
  March 31, 
  2009  2008 
  (Unaudited)  (Unaudited) 
       
NET REVENUES $7,860,867  $8,447,074 
         
COST OF SALES  6,264,218   6,272,826 
         
GROSS PROFIT  1,596,649   2,174,248 
         
OPERATING EXPENSES:        
Depreciation  77,530   78,020 
Selling, general and administrative  500,948   616,568 
         
Total Operating Expenses  578,478   694,588 
         
INCOME FROM OPERATIONS  1,018,171   1,479,660 
         
OTHER INCOME (EXPENSE):        
Interest income  230   5,633 
Interest expense  (23,671)  (2,259,694)
Foreign currency loss  (11)  - 
Debt issuance costs  (12,000)  (21,429)
         
Total Other Income (Expense)  (35,452)  (2,275,490)
         
INCOME (LOSS) BEFORE INCOME TAXES  982,719   (795,830)
         
INCOME TAXES  336,661   454,031 
         
NET INCOME (LOSS)  646,058   (1,249,861)
         
DEEMED PREFERRED STOCK DIVIDEND  -   (2,884,062)
         
NET INCOME (LOSS) ALLOCABLE TO COMMON SHAREHOLDERS $646,058  $(4,133,923)
         
COMPREHENSIVE INCOME (LOSS):        
NET INCOME (LOSS) $646,058  $(1,249,861)
         
OTHER COMPREHENSIVE INCOME:        
Unrealized foreign currency translation gain  41,540   1,007,245 
         
COMPREHENSIVE INCOME (LOSS) $687,598  $(242,616)
         
NET INCOME (LOSS) PER COMMON SHARE:        
Basic $0.01  $(0.11)
Diluted $0.01  $(0.11)
         
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:        
Basic  44,964,840   37,484,504 
Diluted  58,993,029   37,484,504 

See notes to unaudited consolidated financial statements

4

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

  For the Nine Months Ended 
  September 30, 
  2008 2007 
CASH FLOWS FROM OPERATING ACTIVITIES:      
Net income $2,022,185 $9,409,308 
Adjustments to reconcile net income from operations to net cash      
provided by operating activities:      
Depreciation  482,376  450,881 
Amortization of debt discount to interest expense  2,263,661  - 
Amortization of debt offering costs  21,429  - 
Rent expense associated with prepaid land use rights  63,346  7,805 
Increase in allowance for doubtful accounts  171,816  182,882 
Increase in reserve for inventory obsolescence  -  106,942 
Stock based compensation expense  75,000  - 
Other income from forgiveness of income and VAT taxes  -  (6,771,442)
Changes in assets and liabilities:      
Accounts receivable  (1,777,797) (2,538,272)
Inventories  (124,107) 426,386 
Prepaid and other current assets  280,762  46,630 
Advances to suppliers  726,728  (127,886)
Accounts payable  1,189,915  1,153,705 
Accrued expenses  2,343  22,058 
VAT and service taxes payable  (389,946) 1,011,064 
Income taxes payable  48,284  957,899 
Advances from customers  (16,345) 1,830,260 
       
NET CASH PROVIDED BY OPERATING ACTIVITIES  5,039,650  6,168,220 
       
CASH FLOWS FROM INVESTING ACTIVITIES:      
Proceeds (payments) for due from related parties  145,808  (486,032)
Proceeds from sale of cost-method investee  35,720  26,056 
Deposit on long-term assets - related party  (89,721) (5,792,030)
Purchase of property and equipment  (11,629,385) (17,581)
       
NET CASH USED IN INVESTING ACTIVITIES  (11,537,578) (6,269,587)
       
CASH FLOWS FROM FINANCING ACTIVITIES:      
Proceeds from loans payable  142,880  260,561 
Proceeds from exercise of warrants  2,011,575  - 
Payments on related party advances  (102,979) - 
       
NET CASH PROVIDED BY FINANCING ACTIVITIES  2,051,476  260,561 
       
EFFECT OF EXCHANGE RATE ON CASH  165,903  20,161 
       
NET (DECREASE) INCREASE IN CASH  (4,280,549) 179,355 
       
CASH - beginning of year  5,025,434  421,390 
       
CASH - end of period $744,885 $600,745 
       
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:      
Cash paid for:      
 Interest $55,932 $31,360 
 Income taxes $1,603,047 $- 
      
NON-CASH INVESTING AND FINANCING ACTIVITIES:     
Deemed preferred dividend reflected in paid-in capital $2,884,062 $- 
Reclassification of long-term deposit - related party to distribution $2,717,099 $- 
Convertible debt converted to series A preferred stock $5,525,000 $- 
Deposit on long-term assets -related party reclassified to land use rights $3,286,935 $- 
Series A preferred converted to common shares $759 $- 
  For the Three Months Ended 
  Match 31, 
  2009  2008 
  (Unaudited)  (Unaudited) 
CASH FLOWS FROM OPERATING ACTIVITIES:      
Net income (loss) $646,058  $(1,249,861)
Adjustments to reconcile net income (loss) from operations to net cash        
provided by (used in) operating activities:        
Depreciation  175,113   159,062 
Amortization of debt discount to interest expense  1,500   2,263,661 
Amortization of debt offering costs  -   21,429 
Amortization of land use rights  21,585   2,784 
Increase in allowance for doubtful accounts  1,109   - 
Stock-based compensation expense  42,031   45,000 
Changes in assets and liabilities:        
Notes receivable  70,041   - 
Accounts receivable  (377,183)  (1,263,740)
Inventories  (515,182)  (1,136,507)
Prepaid and other current assets  (57,485)  (49,696)
Advances to suppliers  16,025   320,583 
Due from related party  438,174   - 
Accounts payable  (42,397)  (1,225,962)
Accrued expenses  45,669   7,150 
VAT and service taxes payable  (97,450)  62,655 
Income taxes payable  (233,343)  (64,183)
Advances from customers  54,282   10,804 
         
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES  188,547   (2,096,821)
         
CASH FLOWS FROM INVESTING ACTIVITIES:        
Decrease in due from related parties  -   96,650 
Proceeds from sale of cost-method investee  -   34,840 
Deposit on long-term assets - related party  -   (822,212)
Purchase of property and equipment  (951,736)  (3,907)
         
NET CASH USED IN INVESTING ACTIVITIES  (951,736)  (694,629)
         
CASH FLOWS FROM FINANCING ACTIVITIES:        
Proceeds from loans  542,116   139,360 
Proceeds from exercise of warrants  -   187,340 
Payments on related party advances  -   (100,441)
         
NET CASH PROVIDED BY FINANCING ACTIVITIES  542,116   226,259 
         
EFFECT OF EXCHANGE RATE ON CASH  369   120,480 
         
NET DECREASE IN CASH  (220,704)  (2,444,711)
         
CASH  - beginning of year  328,614   5,025,434 
         
CASH - end of period $107,910  $2,580,723 
         
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:        
Cash paid for:        
Interest $21,264  $16,752 
Income taxes $580,004  $518,214 
         
NON-CASH INVESTING AND FINANCING ACTIVITIES:        
Debt discount for grant of warrants $92,985  $- 
Deemed preferred stock dividend reflected in paid-in capital $-  $2,884,062 
Convertible notes converted to series A preferred stock $-  $5,525,000 

See notes to unaudited consolidated financial statements.

5

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008March 31, 2009

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

China Winds Systems, Inc. (the “Company”) was incorporated in Delaware on June 24, 1987 under the name of Malex, Inc.  On December 18, 2007, the Company’s corporate name was changed to China Wind Systems, Inc.

On November 13, 2007, the Company entered into a Share Exchange Agreement (the “Exchange Agreement”) among Fulland Limited, a Cayman Islands corporation (“Fulland”), the stockholders of Fulland, and Synergy Business Consulting, LLC (“Synergy”), the then principal stockholder of the Company, pursuant to which, simultaneously with the financing described in Note 6, the Company (i) issued 36,577,704 shares of common stock to the former stockholders of Fulland, (ii) purchased 8,006,490 shares of common stock from Synergy for $625,000 and cancelled such shares, (iii) issued Synergy 291,529 shares of common stock for professional services, and (iv) paid cash fees of $415,000 in connection with the Exchange Agreement. The Company paid $1,040,000 frommanufactures and sells textile dyeing and finishing machines and manufactures and sells high precision forged rolled rings for the proceedswind power industry and other industries specialty equipment used in the production of the financing for closing costs, including the $625,000 paid for purchase of shares from Synergy. At the time of the closing, under the Exchange Agreementcoal generated electricity through its affiliates, Wuxi Huayang Dyeing Machinery Co., Ltd. (“Dyeing”) and the financing, the Company, then known as Malex, Inc. was not engaged in any business activityWuxi Huayang Electrical Power Equipment Co., Ltd. (“Electrical”), and was considered a blank check shell.through its wholly-owned subsidiary, Wuxi Fulland Wind Energy Equipment Co., Ltd. (“Fulland Wind Energy”).

The Company is the sole stockholder of Fulland.  Fulland owns 100% of Green Power Environment Technology (Shanghai) Co., Ltd. (“Green Power”), which is a wholly foreign-owned enterprise (“WFOE”) organized under the laws of the People’s Republic of China (“PRC” or “China”). Green Power is a party to a series of contractual arrangements, as fully described below, dated October 12, 2007 with Wuxi Huayang Dyeing Machinery Co., Ltd. (“Dyeing”) and Wuxi Huayang Electrical, Power Equipment Co., Ltd. (“Electrical”), and together with Dyeing, sometimes collectively referred to as the “Huayang Companies”), both of which are limited liability companies headquartered in, and organized under the laws of, the PRC.

Fulland is a limited liability company incorporated under the laws of the Cayman Islands on May 9, 2007 which was formed by the owners of the Huayang Companies as a special purpose vehicle for purposes of raising capital, in accordance with requirements of the PRC State Administration of Foreign Exchange (“SAFE”). On May 31, 2007, SAFE issued an official notice known as Hui Zong Fa [2007] No. 106 (“Circular 106”), which requires the owners of any Chinese company to obtain SAFE’s approval before establishing any offshore holding company structure for foreign financing as well as subsequent acquisition matters in China. Accordingly, the owners of the Huayang Companies, Mr. Jianhua Wu and Ms. Lihua Tang, submitted their application to SAFE in early September 2007. On October 11, 2007, SAFE approved their application, permitting these Chinese citizens to establish an offshore company, Fulland, as a special purpose vehicle for any foreign ownership and capital raising activities by the Huayang Companies.

Additionally, on August 27, 2008, the Company incorporated Wuxi Fulland Wind Energy Equipment Co. , Ltd. (“Fulland Wind Energy”). Fulland owns 100% of Fulland Wind Energy, which is a wholly foreign-owned enterprise (“WFOE”) organized under the laws of the PRC.

In 2007, the Company recapitalized the Company to give effect to the Exchange Agreement discussed above. Under generally accepted accounting principles, the acquisition by the Company of Fulland is considered to be capital transactions in substance, rather than a business combination. That is, the acquisition is equivalent, to the acquisition by Fulland of the Company, then known as Malex, Inc., with the issuance of stock by Fulland for the net monetary assets of the Company. This transaction is reflected as a recapitalization, and is accounted for as a change in capital structure. Accordingly, the accounting for the acquisition is identical to that resulting from a reverse acquisition. Under reverse acquisition accounting, the comparative historical financial statements of the Company, as the legal acquirer, are those of the accounting acquirer, Fulland. Since Fulland and Greenpower did not have any business activities, the Company’s financial statements prior to the closing on the reverse acquisition, reflect only business of the Huayang Companies. The accompanying financial statements reflect the recapitalization of the stockholders’ equity as if the transactions occurred as of the beginning of the first period presented. Thus, the 36,577,704 shares of common stock issued to the former Fulland stockholders are deemed to be outstanding for all periods reported prior to the date of the reverse acquisition.

6

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Wuxi Huayang Dyeing Machinery Co., Ltd.

Wuxi Huayang Dyeing Machinery Co., Ltd. (“Dyeing”) is a Chinese limited liability company and was formed under laws of the People’s Republic of China on August 17, 1995.  Dyeing produces and sells a variety of high and low temperature dyeing and finishing machinery.

Wuxi Huayang Electrical Power Equipment Co., Ltd.

Wuxi Huayang Electrical Power Equipment Co., Ltd. (“Electric”)and Wuxi Fulland Wind Energy Equipment Co., Ltd.

Electric a Chinese limited liability company and was formed under laws of the People’s Republic of China on May 21, 2004.  On August 27, 2008, the Company incorporated Fulland Wind Energy.  Fulland owns 100% of Fulland Wind Energy, which is a WFOE organized under the laws of the PRC. Beginning in April 2007, Electric began to produce large-scaled forged rolled rings for the wind-power and other industries that are up to three meters in diameter.  Commencing in 2008, the sale of rolled rings accounted for more than 85% or88% of Electric’s revenue.   As a result, we are referringIn 2009, the Company began to this segment of our business as theproduce and sell forged products through Fulland Wind Energy. Fulland Wind Energy manufactures forged rolled rings and electric power equipment division.in the Company’s new facilities.  In addition to forged rolled rings, Electric continues to manufacture electric power auxiliary apparatuses (including coking equipment) and provide of related engineering services.. Electric equipment products mainly include various auxiliary equipment of power stations, chemical equipment, dust removal and environmental protection equipment, and metallurgy non- standard equipment. The Company refers to this segment of its business as the forged rolled rings and electric power equipment division

As a result of the transaction effected by the Exchange Agreement, the Company’s business has become the business of the Huayang Companies.

Contemporaneously with the closing under the Exchange Agreement, the Company sold 3% convertible notes in the principal amount of $5,525,000 to an investor group. Pursuant to the securities purchase agreement relating to the issuance of the convertible notes, on March 28, 2008, the Company amended and restated its certificate of incorporation to provide for the authorization of a class of preferred stock with the directors having the right to designate one or more series of preferred stock and set the rights, preferences, privileges and limitations of each such series and set forth the rights, preferences, privileges and limitations of a series of preferred stock designated as the series A convertible preferred stock (“series A preferred stock”). The notes were, by their terms, automatically converted into 14,787,135 shares of series A preferred stock and warrants to purchase a total of 18,829,756 shares of common stock upon the filing the restated certificate of incorporation (See Note 6).

Basis of presentationpresentation; management’s responsibility for preparation of financial statements

Management acknowledges its responsibility for the preparation of the accompanying interim consolidated financial statements which reflect all adjustments, consisting of normal recurring adjustments, considered necessary in its opinion for a fair statement of its consolidated financial position and the results of its operations for the interim period presented.
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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

These consolidated financial statements should be read in conjunction with the summary of significant accounting policies and notes to consolidated financial statements included in the Company’s Form 10-KSB10-K annual report for the year ended December 31, 2007.2008.

The accompanying unaudited condensed consolidated financial statements for China Wind Systems, Inc., its subsidiaries and variable interest entities, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole.

The Company’s consolidated financial statements include the financial statements of its wholly-owned subsidiaries, Fulland, Greenpower and Greenpower,Fulland Wind Energy, as well as the financial statements of Huayang Companies, Dyeing and Electric.  All significant intercompany accounts and transactions have been eliminated in consolidation.

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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

The Huayang Companies are considered variable interest entities (“VIE”), and the Company is the primary beneficiary.  The Company’s relationships with the Huayang Companies and their shareholders are governed by a series of contractual arrangements between Green Power, the Company’s wholly foreign-owned enterprise in the PRC, and each of the Huayang Companies, which are the operating companies of the Company in the PRC. Under PRC laws, each of Green Power, Huayang Dye Machine and Huayang Electrical Power Equipment is an independent legal personentity and none of them is exposed to liabilities incurred by the other parties. The contractual arrangements constitute valid and binding obligations of the parties of such agreements. Each of the contractual arrangements and the rights and obligations of the parties thereto are enforceable and valid in accordance with the laws of the PRC. On October 12, 2007, the Company entered into the following contractual arrangements with each of Huayang Dye Machine and Huayang Electrical Power Equipment:

Consulting Services Agreement. Pursuant to the exclusive consulting services agreements between Green Power and the Huayang Companies, Green Power has the exclusive right to provide to the Huayang Companies general business operation services, including advice and strategic planning, as well as consulting services related to the technological research and development of dye and finishing machines, electrical equipments and related products (the “ServicesServices”). Under this agreement, Green Power owns the intellectual property rights developed or discovered through research and development, in the course of providing the Services, or derived from the provision of the Services. The Huayang Companies shall pay a quarterly consulting service fees in Renminbi (“RMB”) to Fulland that is equal to all of the Huayang Companies’ profits for such quarter.

Operating Agreement. Pursuant to the operating agreement among Green Power, the Huayang Companies and all shareholders of the Huayang Companies (collectively the “Huayang Companies Shareholders”), Green Power provides guidance and instructions on the Huayang Companies’ daily operations, financial management and employment issues. The Huayang Companies Shareholders must designate the candidates recommended by Green Power as their representatives on the boards of directors of each of the Huayang Companies. Green Power has the right to appoint senior executives of the Huayang Companies. In addition, Green Power agrees to guarantee the Huayang Companies’ performance under any agreements or arrangements relating to the Huayang Companies’ business arrangements with any third party. The Huayang Companies, in return, agrees to pledge their accounts receivable and all of their assets to Green Power. Moreover, the Huayang Companies agrees that without the prior consent of Green Power, the Huayang Companies will not engage in any transactions that could materially affect their respective assets, liabilities, rights or operations, including, without limitation, incurrence or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of their assets or intellectual property rights in favor of a third party or transfer of any agreements relating to their business operation to any third party. The term of this agreement, as amended on November 1, 2008, is ten (10)20 years from October 12, 2007 and may be extended only upon Green Power’s written confirmation prior to the expiration of the this agreement, with the extended term to be mutually agreed upon by the parties.

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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Equity Pledge Agreement. Under the equity pledge agreement between the Huayang Companies ShareholdersCompanies’ shareholders and Green Power, the Huayang Companies Shareholders pledged all of their equity interests in the Huayang CompaniesCompanies’ to Green Power to guarantee the Huayang Companies’ performance of their obligations under the consulting services agreement. If the Huayang Companies or the Huayang CompaniesCompanies’ Shareholders breaches their respective contractual obligations, Green Power, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. theThe Huayang CompaniesCompanies’ Shareholders also agreed that upon occurrence of any event of default, Green Power shall be granted an exclusive, irrevocable power of attorney to take actions in the place and stead of the Huayang CompaniesCompanies’ Shareholders to carry out the security provisions of the equity pledge agreement and take any action and execute any instrument that Green Power may deem necessary or advisable to accomplish the purposes of the equity pledge agreement. The Huayang CompaniesCompanies’ Shareholders agreed not to dispose of the pledged equity interests or take any actions that would prejudice Green Power’s interest. The equity pledge agreement will expire two (2) years after the Huayang Companies’ obligations under the consulting services agreements have been fulfilled.

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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

 NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Option Agreement.Under the option agreement between the Huayang CompaniesCompanies’ Shareholders and Green Power, the Huayang CompaniesCompanies’ Shareholders irrevocably granted Green Power or its designated person an exclusive option to purchase, to the extent permitted under PRC law, all or part of the equity interests in the Huayang Companies for the cost of the initial contributions to the registered capital or the minimum amount of consideration permitted by applicable PRC law. Green Power or its designated person has sole discretion to decide when to exercise the option, whether in part or in full. The term of this agreement, as amended on November 1, 2008, is ten (10)20 years from October 12, 2007 and may be extended prior to its expiration by written agreement of the parties.

The accounts of the Huayang Companies are consolidated in the accompanying financial statements pursuant to Financial Accounting Standards Board Interpretation No. 46 (Revised), “Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51”.51.” As a VIE, the Huayang CompaniesCompanies’ sales are included in the Company’s total sales, its income from operations is consolidated with the Company’s, and the Company’s net income includes all of the Huayang Companies net income. The Company does not have any non-controlling interest and accordingly, did not subtract any net income in calculating the net income attributable to the Company. Because of the contractual arrangements, the Company had a pecuniary interest in the Huayang Companies that require consolidation of the Company’s and the Huayang Companies financial statements.

Use of estimates

The preparation of the financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Actual results could materially differ from these estimates. Significant estimates in 20082009 and 20072008 include the allowance for doubtful accounts, the allowance for obsolete inventory, the useful life of property and equipment and intangible assets, assumptions used in assessing impairment of long-term assets and valuation of deferred tax assets, accruals for taxes due, and the calculation of the value of any beneficial conversion feature related to convertible debt, and warrants granted upon the conversion of debt to preferred stock.

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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Fair value of financial instruments

Effective January 1, 2008, theThe Company adopted SFAS 157, Fair Value Measurements (SFAS 157). SFAS 157 clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
 
Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other then quoted prices that are observable, and inputs derived from or corroborated by observable market data.
 
Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

The adoption of SFAS No. 157 did not have a material impact on the Company’s fair value measurements. The carrying amounts reported in the balance sheetsheets for cash, accounts receivable, loans payable, accounts payable and accrued expenses, customer advances, and amounts due from related parties approximate their fair market value based on the short-term maturity of these instruments.
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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008 The Company did not identify any assets or liabilities that are required to be presented on the consolidated balance sheets at fair value in accordance with SFAS 157.

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Cash and cash equivalents

For purposes of the consolidated statements of cash flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less and money market accounts to be cash equivalents. The Company maintains cash and cash equivalents with various financial institutions mainly in the PRC and the United States. Balances in the United States are insured up to $250,000 at each bank.  Balances in banks in the PRC are uninsured.

Concentrations of credit risk

The Company's 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 environment 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. 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.

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. Substantially all of the Company’s cash is maintained with state-owned banks within the People’s Republic of China of which no deposits are covered by insurance. 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. A significant portion of the Company's sales are credit sales which are primarily to customers whose ability to pay is dependent upon the industry economics prevailing in these areas; however, concentrations of credit risk with respect to trade accounts receivables is limited due to generally short payment terms.  The Company also performs ongoing credit evaluations of its customers to help further reduce credit risk.
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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

At September 30 2008March 31, 2009 and December 31, 2007,2008, the Company’s bank deposits by geographic area were as follows:


 
September 30, 2008
 
December 31, 2007
  March 31, 2009  December 31, 2008 
Country:                         
United States $29,308  3.9%$171,121  3.4% $11,619   10.8% $832   0.3%
China  715,577  96.1% 4,854,313  96.6%  96,291   89.2%  327,782   99.7%
Total cash and cash equivalents $744,885  100.0%$5,025,434  100.0% $107,910   100.0% $328,614   100.0%

Notes receivable

Notes receivable represents trade accounts receivable due from various customers where the customers’ bank has guaranteed the payment of the receivable. This amount is non-interest bearing and is normally paid within three to six months.   Historically, the Company has experienced no losses on notes receivable. The Company‘s notes receivable totaled $199,836 at March 31, 2009 and $269,549 at December 31, 2008.

Accounts receivable

Accounts receivable are presented net of an allowance for doubtful accounts. The Company maintains allowances for doubtful accounts for estimated losses. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, the Company considers many factors, including the age of the balance, customer’s historical payment history, its current credit-worthiness and current economic trends. Accounts are written off after exhaustive efforts at collection. At September 30, 2008March 31, 2009 and December 31, 2007,2008, the Company has established, based on a review of its outstanding balances, an allowance for doubtful accounts in the amount of $843,568$877,064 and $626,218,$874,856, respectively.

Inventories

Inventories, consisting of raw materials, work in process and finished goods related to the Company’s products are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, the Company will record reserves for the difference between the cost and the market value. These reserves are recorded based on estimates.  The Company recorded an inventory reserve of $79,159$79,269 and $74,192$79,170 at September 30, 2008March 31, 2009 and December 31, 2007,2008, respectively.
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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Property and equipment

Property and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized.  When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. The Company examines the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.

InvestmentIncluded in non-marketable equity securitiesproperty and equipment is construction-in-progress which consists of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use. Property purchased from a related party is recorded at the cost to the related party and any payment to or on behalf of the related party in excess of the cost is reflected as a distribution to related party.
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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Certain securities that the Company may invest in can be determined to be non-marketable. Non-marketable securities where the Company owns less than 20% of the investee are accounted for at cost pursuant to APB No. 18, “The Equity Method of Accounting for Investments in Common Stock” (“APB 18”). At December 31, 2007, the Company had a 5% membership interest in Wuxi Huayang Yingran Machinery Co. Ltd. (“Yingran”) amounting to $34,181, which at December 31, 2007, is reflected on the accompanying consolidated balance sheet as investments in cost method investee. In March 2008, the Company sold its 5% investment in Yingran to an individual related to the Company’s chief executive officer for a price which approximated its carrying value.

Impairment of long-lived assets

In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, TheAssets,” the Company periodically reviews, its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable.recoverable, or at least annually. The Company recognizes an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value. The Company did not consider it necessary to record any impairment charges duringfor the ninethree months ended September 30, 2008March 31, 2009 and 2007.2008.

Advances from customers

Advances from customers at September 30, 2008 and December 31, 2007 amounted to $65,850 and $77,357, respectively, and consist of prepayments from third party customers to the Company for merchandise that had not yet been shipped. The Company will recognize the deposits as revenue as customers take delivery of the goods, in compliance with its revenue recognition policy.

Income taxes

The Company is governed by the Income Tax Law of the People’s Republic of China and the United States.  Income taxes are accounted for under Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”, which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns.

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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

NOTEThe Company adopted FIN 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statements No. 109,” as of January 1, – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)2007.  Under FIN 48, the evaluation of a tax position is a two-step process. The first step is to determine whether it is more likely than not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements. A tax position is measured at the largest amount of benefit that is greater than 50% likelihood of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.  The adoption had no effect on the Company’s consolidated financial statements.  

Revenue recognition

The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectability is reasonably assured. The Company accounts for the product sale as a multiple element arrangement. Revenue from multiple element arrangements is allocated among the separate accounting units based on the residual method. Under the residual method, the revenue is allocated to undelivered elements based on fair value of such undelivered elements and the residual amounts of revenue allocated to delivered elements. The Company recognizes revenues from the sale of dyeing equipment, forged rolled rings, and electric equipment upon shipment and transfer of title. The other elements may include installation and generally a one-year warranty. Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally within a couple days of the delivery of the equipment. Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, amounts allocated to warranty revenues were not material. Based on historical experience, warranty service calls and any related labor costs have been minimal.
 
All other product sales with customer specific acceptance provisions, including the forged rolled rings, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.

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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
Stock-based compensationNOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Advances from customers

Advances from customers at March 31, 2009 and December 31, 2008 amounted to $100,096 and $45,748, respectively, and consist of prepayments from customers for merchandise that had not yet been shipped. The Company accounts for stock options issued to employeeswill recognize the deposits as revenue as customers take delivery of the goods, in accordance with its revenue recognition policy.

Stock-based compensation

Stock based compensation is accounted for under SFAS No. 123R, “Share-Based Payment,Payment.” SFAS No. 123R requires recognition in the financial statements of the cost of employee and director services received in exchange for an Amendmentaward of FASB Statement No. 123” (“SFAS 123R”)equity instruments over the period the employee or director is required to perform the services in exchange for the award (presumptively the vesting period). SFAS No. 123R also requires companies to recognizemeasurement of the cost of employee and director services received in the statement of operationsexchange for an award based on the grant-date fair value of stock options and other equity based compensation issuedthe award. The Company accounts for non-employee share-based awards in accordance with EITF No. 96-18, “Accounting for Equity Instruments That Are Issued to employees.Other Than Employees for Acquisition, or in Conjunction with Selling, Goods or Services.”

Shipping costs

Shipping costs are included in selling expenses and totaled $113,367$66,432 and $664$57,463 for the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, respectively.

AdvertisingEmployee benefits

The Company’s operations and employees are all located in the PRC.  The Company makes mandatory contributions to the PRC government’s health, retirement benefit and unemployment funds in accordance with the relevant Chinese social security laws, which is approximately 25% of salaries. The costs of these payments are charged to income in the same period as the related salary costs and are not material.

Advertising

Advertising is expensed as incurred and is included in selling, general and administrative expenses on the accompanying consolidated statement of operations and was not material.

Research and development

Research and development costs are expensed as incurred. For the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, research and development costs were not material.

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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Foreign currency translation

The reporting currency of the Company is the U.S. dollar. The functional currency of the Company is the local currency, the Chinese Renminbi (“RMB”). Results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income.  The cumulative translation adjustment and effect of exchange rate changes on cash for the nine monthsquarter ended September 30,March 31, 2009 and 2008 was $369 and 2007 was $165,903$120,480, respectively. Transactions denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing on the transaction dates. Assets and $20,161, respectively. Transactionliabilities denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing at the balance sheet date with any 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.
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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

All of the Company’s revenue transactions are transacted in the functional currency. The Company does not enter any material transaction in foreign currencies and accordingly, transaction gains or losses have not had, and are not expected to have, a material effect on the results of operations of the Company.

Asset and liability accounts at September 30, 2008March 31, 2009 and December 31, 20072008 were translated at 6.85516.8456 RMB to $1.00 USD and at 6.87186.8542 RMB to $1.00, USD, respectively.respectively, which were the exchange rates on the balance sheet dates. Equity accounts were stated at their historical rate. The average translation rates applied to the statements of income statements for the ninethree months ended September 30,March 31, 2009 and 2008 and 2007 were 6.998866.84659 RMB and 7.675767.17568 RMB to $1.00, USD, respectively.  In accordance with Statement of Financial Accounting Standards No. 95, "StatementStatement of Cash Flows" cash flows from the Company'sCompany’s operations areis calculated based upon the local currencies using the average translation rate. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.sheets.

Earnings (loss)Income per share of common stock
 
Basic earningsnet income per share is computed by dividing net earningsincome available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted income per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. Potentially dilutive common shares consist of common shares issuable upon the conversion of Seriesseries A convertiblepreferred stock (using the if-converted method) and common stock warrants.warrants (using the treasury stock method).  The following table presents a reconciliation of basic and diluted earningsnet income per share:

  
For the Three Months Ended
September 30,
 
For the Nine Months Ended
September 30,
 
  2008 2007 2008 2007 
Net income (loss) available to common shareholders for basic and diluted earnings per share $1,860,862 $8,121,292 $(861,877)$9,409,308 
              
Weighted average shares outstanding – basic  40,363,220  36,577,704  38,634,312  36,577,704 
Effect of dilutive securities:             
Series A convertible preferred stock  14,028,189  -  -  - 
Unexercised warrants  12,797,699  -  -  - 
Weighted average shares outstanding– diluted  
67,189,108
  
36,577,704
  
38,634,312
  
36,577,704
 
Earnings (loss) per share - basic $0.05 $0.22 $(0.02)$0.26 
Earnings (loss) per share - diluted $0.03 $0.22 $(0.02)$0.26 
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Three Months ended
March 31,
 
  2009  2008 
Net income (loss) allocable to common shareholders for basic and diluted net income (loss) per common share $646,058  $(4,133,923)
         
Weighted average common shares outstanding – basic  44,964,840   37,484,504 
Effect of dilutive securities:        
Series A convertible preferred stock  14,028,189   - 
Weighted average common shares outstanding– diluted  58,993,029   37,484,504 
Net income (loss) per common share  - basic $0.01  $(0.11)
Net income (loss) per common share  - diluted $0.01  $(0.11)

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

In calculating earnings (loss) per common share for the nine months ended September 30, 2008, the Company’s common stock equivalents were anti-dilutive and are not reflected in diluted earnings per shares, At September 30, 2007, the Company did not have any dilutive securities. The Company's aggregate common stock equivalents at September 30,March 31, 2009 and 2008 include the following:

Warrants16,436,935
Series A convertible preferred stock14,028,189
Total30,465,124
  2009  2008 
Warrants  16,571,001   18,906,756 
Series A preferred stock  14,028,189   14,787,135 
Total  30,599,190   33,693,891 

The warrants and series A convertible preferred
Using the treasury stock were issued on March 28, 2008 upon conversion ofmethod, there was no dilution resulting from the notes. The shares of series A preferred stock held in escrow pursuant to an escrow agreement (see Note 6) are not treated as outstanding at September 30, 2008 because the delivery of shares is contingent upon certain events, and any shares not delivered will be returned to the Company for cancellation.warrants.

Accumulated other comprehensive income
 
The Company follows Statement of Financial Accounting Standards No. 130 (SFAS 130) "“Reporting Comprehensive Income"” to recognize the elements of comprehensive income. Comprehensive income is comprised of net income and all changes to the statements of stockholders' equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. For the Company, comprehensive income for the ninethree months ended September 30,March 31, 2009 and 2008 and 2007 included net income and unrealized gains from foreign currency translation adjustments.
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CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Related parties

Parties are considered to be related to the Company if the parties that, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests.

Recent Accounting Pronouncements

In June 2007, the Emerging Issues Task Force The Company discloses all related party transactions. All transactions shall be recorded at fair value of the FASB issued EITF Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goodsgoods or Servicesservices exchanged. Property purchased from a related party is recorded at the cost to be Used in Future Research and Development Activities, (“EITF 07-3”) which is effective for fiscal years beginning after December 15, 2007. EITF 07-3 requires that nonrefundable advance payments for future research and development activities be deferred and capitalized. Such amounts will be recognized as an expense as the goods are delivered or the related services are performed. The adoptionparty and any payment to or on behalf of EITF 07-3 did not havethe related party in excess of the cost is reflected as a material impact on the Company’s results of operations, financial position or liquidity.distribution to related party.

Recent accounting pronouncements

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008.2008, and applies to any business combinations which occur after March 31, 2009. The adoption of SFAS 141(R), effective January 1, 2009, may have an impact on accounting for future business combinations once adopted.combinations.
14
 CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements – an amendment of Accounting Research Bulletin No. 51” (“SFAS 160”), which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the non-controlling interest, changes in a parent’s ownership interest and the valuation of retained non-controlling equity investments when a subsidiary is deconsolidated. The Statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008. The Company has not determined the effect that the applicationadoption of SFAS No. 160 willdid not have any material impact on the preparation of its consolidated financial statements.

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities””.. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently evaluatingadoption of SFAS No. 161 did not have a material impact on the impactpreparation of adopting SFAS 161 on its consolidated financial statements.

In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon either mandatory or optional conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s non-convertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company will adopthas adopted FSP APB 14-1 beginning in the first quarter of fiscalJanuary 1, 2009, and this standard must be applied on a retrospectiveretroactive basis. The Company is evaluating the impact the adoption of FSP APB 14-1 willdid not have any impact on its consolidated financial position and results of operations.

14
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

In May 2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 162, The Hierarchy of Generally Accepted Accounting Principles. This standard is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with generally accepted accounting principles in the United States for non-governmental entities. SFAS No. 162 is effective 60 days following approval by the U.S. Securities and Exchange Commission (“SEC”) of the Public Company Accounting Oversight Board’s amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company does not expectadoption of SFAS No. 162 todid not have a material impact on the preparation of its consolidated financial statements.

On June 16, 2008, the FASB issued final Staff Position (FSP) No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” to address the question of whether instruments granted in share-based payment transactions are participating securities prior to vesting. The FSP determines that unvested share-based payment awards that contain rights to dividend payments should be included in earnings per share calculations. The guidance will be effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the requirements of (FSP) No. EITF 03-6-1 as well as the impact of its adoption did not have any impact on the Company’s consolidated financial statements.

In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP FAS 140-4 and FIN 46(R)-8”). FSP FAS 140-4 and FIN 46(R)-8 amends FAS 140 and FIN 46(R) to require additional disclosures regarding transfers of financial assets and interest in variable interest entities. FSP FAS 140-4 and FIN 46(R)-8 is effective for interim or annual reporting periods ending after December 15, 2008. The adoption of FSP FAS 140-4 and FIN 46(R)-8 did not have an impact on its consolidated financial statements.
15
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008position and results of operations.

At its June 25, 2008 meeting, the Financial Accounting Standards Board ratified the consensus reached by the Emerging Issues Task Force Issue 07-5 Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock  (EITF 07-5).  The adoption of EITF 07-5’s requirements will affect accounting for convertible instruments and warrants with down-round provisions.  Down-round provisions are designed to protect an investor in the event the issuer issues securities at a lower price or with a lower exercise or conversion price.  Convertible instruments and warrants which are derivatives and have such provisions will no longer be recorded in equity.  EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years.  Earlier application by an entity that has previously adopted an alternative accounting policy is not permitted.  After reviewing FAS 133 and EITF 07-5, the Company does not believe that EITF 07-5 has a material effect on the Company’s financial condition, results of operations or cash flows.

NOTE 2 – ACCOUNTS RECEIVABLE

At September 30, 2008March 31, 2009 and December 31, 2007,2008, accounts receivable consisted of the following:

  September 30, 2008 December 31, 2007 
Accounts receivable $4,786,162 $2,784,630 
Less: allowance for doubtful accounts  (843,568) (626,218)
  $3,942,594 $2,158,412 
  March 31, 2009  December 31, 2008 
Accounts receivable $5,777,128  $5,393,115 
Less: allowance for doubtful accounts  (877,064)  (874,856)
  $4,900,064  $4,518,259 

15
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 3 - INVENTORIESINVENTORIES

At September 30, 2008March 31, 2009 and December 31, 2007,2008, inventories consisted of the following:

  September 30, 2008 December 31, 2007 
Raw materials $1,473,589 $1,135,697 
Work in process  294,500  454,788 
Finished goods  496,791  413,503 
   2,264,880  2,003,988 
Less: Reserve for obsolete inventory  (79,159) (74,192)
  $2,185,721 $1,929,796 
  March 31, 2009  December 31, 2008 
Raw materials $1,073,316  $1,054,182 
Work in process  407,241   254,960 
Finished goods  1,008,435   662,118 
   2,488,992   1,971,260 
Less: Reserve for obsolete inventory  (79,269)  (79,170)
  $2,409,723  $1,892,090 

NOTE 4 - PROPERTY AND EQUIPMENT

At September 30, 2008March 31, 2009 and December 31, 2007,2008, property and equipment consist of the following:

  Useful Life 2008 2007 
Office equipment and furniture  5 Years $96,049 $78,430 
Manufacturing equipment  5 – 10 Years  10,369,583  3,516,584 
Vehicles  5 Years  67,147  62,933 
Construction in progress  -  5,243,364  - 
Building and building improvements  20 Years  6,006,117  5,629,201 
      21,782,260  9,287,148 
Less: accumulated depreciation     (3,438,534) (2,761,162)
           
     $18,343,726 $6,525,986 
  Useful Life  2009  2008 
Office equipment and furniture 5 Years  $99,686  $99,561 
Manufacturing equipment 5 – 10 Years   15,355,800   14,754,250 
Vehicles 5 Years   79,472   79,372 
Construction in progress  -   286,612   207,605 
Building and building improvements 20 Years   14,712,628   14,404,419 
       30,534,198   29,545,207 
Less: accumulated depreciation      (3,785,279)  (3,605,611)
             
      $26,748,919  $25,939,596 

For the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, depreciation expense amounted to $482,376$175,113 and $450,881,$159,062, respectively, of which $254,187$97,583 and $243,006$83,826, respectively, is included in cost of sales, respectively.sales.  Upon completion of the construction in progress, the assets will be classified to its respective property and equipment category.
 
NOTE 5 – LAND USE RIGHTS

There is no private ownership of land in China. Land is owned by the government and the government grants land use rights for specified terms. The Company’s land use rights are valued at a fixed amount, which is RMB 27,000,795 at September 30, 2008March 31, 2009 and the dollar value of the land use right fluctuates based on the exchange rate.  In 2008, in connection with the acquisition of land use rights from a related party, (See Note 8), the Company was grantedreceived the transferredcertificate of land use rights from the government and accordingly,government. At the time the Company received the land use rights, $5,617,000 was carried as a deposit on long-term assets.  As a result of the grant of the land use rights, the Company reclassified this amount as follows: (i) approximately $3,300,000 from deposits on long-term assets$3,304,000 to prepaid land use rights and (ii) approximately $2,300,000 has been reclassified$2,313,000 to distributions to related parties which(see Note 8).  The distribution to relate parties represents the excess paidamount by which the Company’s purchase price for the land uses right exceeds the cost of the land use rights to related parties over the related parties original costs.parties. The Company’s land use rights have terms of 45 and 50 years and expire on January 1, 2053 and October 30, 2053, respectively.2053.  The Company amortizes thesethe land use rights over the term of the respective land use right. For the ninethree months ended September 30,March 31, 2009 and 2008, and 2007, amortization expenseof land use rights amounted to $63,346$21,585 and $7,805,$2,784, respectively.

16

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008March 31, 2009
 NOTE 5 – LAND USE RIGHTS (continued)

At September 30, 2008March 31, 2009 and December 31, 2007,2008, land use rights consist of the following:
        
 Useful Life 2008 2007  Useful Life 2009  2008 
Land Use Rights  45 - 50 years $3,938,790 $546,341  45 - 50 years $3,944,256  $3,939,307 
Less: Accumulated Amortization     (111,309) (43,707)    (154,640)  (132,885)
    $3,827,481 $502,634    $3,789,616  $3,806,422 
 
Rent expenseAmortization of land use rights attributable to future periods is as follows:

Period ending September 30:   
2009 $84,448 
2010  84,448 
2011  84,448 
2012  84,448 
Thereafter  3,489,689 
  $3,827,481 

Period ending March 31:   
2010 $86,352 
2011  86,352 
2012  86,352 
2013  86,352 
Thereafter  3,444,208 
  $3,789,616 
NOTE 6 – STOCKHOLDERS’ EQUITY

(a)           Common stock

In February 2008,On January 1, 2009, the Company issued 323,00070,000 shares of its common stock pursuant to an exercisefor investor relation services. The Company valued these shares at the fair value of warrants for proceedsthe common shares on date of $187,340.grant of $35,000, or $0.50 per share, and recorded professional fees of $35,000.

On March 28, 2008,3, 2009, the Company issued 25,000232 shares of its common stock to a director in connection with election as a director.for services rendered. The shares were valued at fair value on the date of grant at $1.80 per share. Accordingly,and the Company recorded stock-based compensation of $45,000.$87.

On April 28, 2008,March 31, 2009, the Company issued 15,00013,889 shares of its common stock to a director in connection with his election as a director.its chief financial officer for services rendered pursuant to an employment agreement.  The shares were valued at fair value on the date of grant, at $2.00 per share. Accordingly,and the Company recorded stock-based compensation of $30,000.

On June 12, 2008, the Company issued 758,946 shares of its common stock upon the conversion of 758,946 shares of Series A preferred stock.

During the three months ended June 30, 2008, the Company issued 1,150,000 shares of its common stock pursuant to an exercise of warrants for proceeds of $667,000.

During the three months ended September 30, 2008, the Company issued 1,319,821 shares of its common stock upon the exercise of warrants for which it received $1,157,235.$6,944.

17
 
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008March 31, 2009
NOTE 6 – STOCKHOLDERS’ EQUITY (continued)

(b)  Conversion of Convertible Notes; Restatement of Certificate of Incorporation

On November 13, 2007, concurrently with the closing pursuant to the Exchange Agreement, the Company entered into a securities purchase agreement with three accredited investors including Barron Partners LP (the “Investors”).investors.  Pursuant to the agreement, the Company issued and sold to the Investors,investors, for $5,525,000, the Company’s 3% convertible subordinated notes in the principal amount of $5,525,000.  At the time of the financing, the Company did not have any authorized shares of preferred stock.  On March 28, 2008, upon the filing of both a restated certificate of incorporation, which created a series of preferred stock and gave the board of directors broad authority to create one or more series of preferred stock, as well asand  a statement of designation that set forth the rights, preferences, privileges and limitations of the holders of the series A convertible preferred stock, these notes were automatically converted into an aggregate of (i) 14,787,135 shares of series A preferred stock and (ii) warrants to purchase 11,176,504 shares of common stock at $0.58 per share, 5,588,252 shares of common stock at $0.83 per share, and 2,065,000 shares at $0.92 per share.

share, subject to adjustment.  The restated certificate of incorporation increased the number of authorized shares of capital stock from 75,000,000 to 210,000,000 shares, of which (i) 150,000,000 shares are designated as common stock, par value of $.001 per share, and (ii) 60,000,000 shares are designated as preferred stock, par value of $.001 per share.

(c)           Series A Preferred Stock

The series A preferred stock has the following rights, preferences and limitations:

·
●  		There are 60,000,000 authorized shares of series A preferred stock.   
 
·
●  		No dividends shall be payable with respect to the series A preferred stock. No dividends shall be declared or payable with respect to the common stock while the series A preferred stock is outstanding. The Company shall not redeem or purchase any shares of Common Stock or any other class or series of capital stock which is junior to or on parity with the Seriesseries A Preferred Stockpreferred stock while the Seriesseries A Preferred Stockpreferred stock is outstanding.
 
·
●  		The holders of the series A preferred stock have no voting rights except as required by law. However, so long as any shares of series A preferred stock are outstanding, the Company shall not, without the affirmative approval of the holders of 75% of the shares of the series A preferred stock then outstanding, (a) alter or change adversely the powers, preferences or rights given to the series A preferred stock or alter or amend the statement of designations relating to the series A preferred stock, (b) authorize or create any class of stock ranking as to dividends or distribution of assets upon a liquidation senior to or otherwise pari passu with the series A preferred stock, or any of preferred stock possessing greater voting rights or the right to convert at a more favorable price than the series A preferred stock, (c) amend its certificate of incorporation or other charter documents in breach of any of the provisions hereof,of the certificate of designation, (d) increase the authorized number of shares of series A preferred stock or the number of authorized shares of preferred stock, or (e) enter into any agreement with respect to the foregoing.
 
·
●  
Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary, the holders of the series A preferred stock have a liquidated preference of $.374 per share. 
 
·
●  		Each share of series A preferred stock shall be initiallyis convertible (subject to the 4.9% limitations described below) into such number of shares of common stock based on the conversion ratio of one share of series A preferred stock for one share of common stock, subject to adjustment, at the option of the holders, at any time after the original issue date.time. 
 
·
●  		All of the outstanding shares of series A preferred stock shall be automatically converted into common stock upon the close of business on the business day immediately preceding the date fixed for consummation of any transaction resulting in a change of control of the Company, as defined in the statement of designation.
 
18
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

·●  The holders may not convert the series A preferred stock to the extent that such conversion would result in the holder and its affiliates beneficially owning more than 4.9% of the Company’s common stock.  This provision may not be waived or amended.
 
18
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 6 – STOCKHOLDERS’ EQUITY (continued)

(d)           Securities Purchase Agreement

Pursuant to the securities purchase agreement in additionrelating to the issuance of the convertible notes:Company’s November 2007 private placement, as amended:
 
·●  The Company agreed to have appointed such number of independent directors that would result in a majority of its directors being independent directors, that the audit committee would be composed solely of not less than three independent directors and the compensation committee would have at least three directors, a majority of which shall be independent directors within 90 days after the closing, which was February 11, 2008. Failure to meetdirectors.  The Company is presently in compliance with this date will result in liquidated damages commencing February 12, 2008, until the date on which the requirement is satisfied. Thereafter, ifcovenant.  If the Company does not meet these requirements for a period of 60 days for an excused reason, as defined in the Purchase Agreement,securities purchase agreement, or 75 days for a reason which is not an excused reason, thisthe Company would result in the imposition ofbe required to pay liquidated damages. The investors have agreed to waive any liquidated damages related to the initial appointment of independent directors and the establishment of the committees which occurred in March 2008.
 
·●  The Company agreed to have a qualified chief financial officer who may be a part-time chief financial officer until February 13, 2008.officer.  If the Company cannot hire a qualified chief financial officer promptly upon the resignation or termination of employment of a former chief financial officer, the Company may engage an accountant or accounting firm to perform the duties of the chief financial officer.  In no event shall the Company either (i) fail to file an annual, quarterthree months or other report in a timely manner because of the absence of a qualified chief financial officer, or (ii) not have a person who can make the statements and sign the certifications required to be filed in an annual or quarterlythree monthly report under the Securities Exchange Act of 1934.
 
·●  Liquidated damages for failure to comply with the preceding two covenants are computed in an amount equal to 12% per annum of the purchase price, up to a maximum of 12% of the purchase price, which is $663,000, which is payable in cash or series A preferred stock, at the election of the investors.  If payment is made isin shares of series A preferred stock, each share is valued at $.374 per share.
 
●
·
The Company and the investors entered into a registration rights agreement pursuant to which the Company agreed to file, by January 12, 2008, a registration statement covering the common stock issuable upon conversion of the series A preferred stock and exercise of the warrants and to have the registration statement declared effective by June 11, 2008.  The failure of the Company to have the registration statement declared effective by June 11, 2008 and other timetables provided in the registration rights agreement would result in the imposition of liquidated damages, which are payable through the issuance of additional shares of series A preferred stock at the rate of 4,860 shares of series A preferred stock for each day, based on the proposed registration of all of the underlying shares of common stock, with a maximum of 1,770,000 shares. The number of shares issuable per day is subject to adjustment if the Company cannot register all of the required shares as a result of the Securities and Exchange Commission’s interpretation of Rule 415. The registration rights agreement also provides for additional demand registration rights in the event that the investors are not able to register all of the shares in the initial registration statement. The Company filed its registration on February 14, 2008 and it was declared effective on June 13, 2008. No liquidated damages were incurred and accordingly, pursuant to FASB Staff Position, or FSP, EITF 00-19-2, Accounting for Registration Payment Arrangements, no liability was recorded.

The Company filed its registration on February 14, 2008 and it was declared effective on June 13, 2008. No liquidated damages were incurred and accordingly, pursuant to FASB Staff Position, or FSP, EITF 00-19-2, Accounting for Registration Payment Arrangements, no liability was recorded.

·●  The Investors have a right of first refusal on future financings.
 
19
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

·●  Until the earlier of November 13, 2011 or such time as the Investors shall have sold all of the underlying shares of common stock, the Company is restricted from issuing convertible debt or preferred stock.
 
·●  Until the earlier of November 13, 2010 or such time as the Investors have sold 90% of the underlying shares of common stock, the Company’s debt cannot exceed twice the preceding four quarters earnings before interest, taxes, depreciation and amortization.
 
·●  The Company’s officers and directors agreed, with certain limited exceptions, not to publicly sell shares of common stock for 27 months or such earlier date as all of the convertible securities and warrants have been converted or exercised and the underlying shares of common stock have been sold.
 
·The Company entered into an escrow agreement pursuant to which the Company issued into escrow its 3% convertible promissory note due March 31, 2008 in the principal amount of $3,000,000. Upon the filing of the Restated Certificate this note automatically was converted into 24,787,135 shares of series A preferred stock. These shares of series A preferred stock are in addition to the 14,787,135 shares of series A preferred stock issued to the investors upon conversion of the convertible notes held by them. The series A preferred stock is to be held in escrow subject to the following.
19
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
 
NOTE 6 – STOCKHOLDERS’ EQUITY (continued)

oPrior to September 17, 2008, 14,787,135 shares were held pursuant to the following provisions. If, for the year ended December 31, 2008, the Company’s pre-tax earnings per share are less than the target numbers, all or a portion of such shares are to be delivered to the Investors. The agreement also had a target for 2007, which was met, and no shares were delivered with respect to 2007. If the pre-tax earnings are less than 50% of the target, all of the shares are to be delivered to the Investors. If the shortfall is less than 50%, the number of shares to be delivered to the Investors is determined on a formula basis. On September 12, 2008, the Investors agreed to eliminate the provisions of the securities purchase agreement that provided for the delivery of shares held in escrow and a reduction in the warrant exercise price if certain levels of pre-tax income were not reached. Pursuant to this agreement, 14,787,135 shares of Series A preferred stock of the 24,787,135 shares held in an escrow account were returned to the Company, with the remaining 10,000,000 reserved to cover potential tax liabilities for 2007 and 2008.
oThe target number for 2008 is $0.13131 per share. The per share numbers are based on all shares that are outstanding or are issuable upon exercise or conversion of all warrants or options, regardless of whether such shares would be used in computing diluted earnings per share under GAAP.
oIf the Company does not file its Form 10-K for 2008 within 30 days after the filing is required, after giving effect to any extension permitted by Rule 12b-25 under the Securities Exchange Act of 1934, any shares remaining in escrow shall be delivered to the Investors.
oThe remaining 10,000,000 shares of series A preferred stock are to be delivered to the Investors in the event that, based on the Company’s audited financial statements for 2007 and 2008 the Company or certain affiliated companies owes any taxes to the PRC government or any authority or taxing agency of the PRC for any period ended on or prior to September 30, 2007. For each $1.00 of such tax liability, four shares of series A preferred stock are to be delivered to the Investors. At December 31, 2007, the Company did not have any tax liabilities for the period ended on or prior to September 30, 2007.
·●  In connection with the Securities Purchase Agreement,securities purchase agreement, $30,000 was deducted from the gross proceeds and was paid to an investor as reimbursement for due diligence expenses, which was deferredis treated as a debt discount and was amortized over the life of the convertible notes. Other fees incurred in connection with the debt issuance include $25,000 of legal fees, which were treated as a deferred debt issue costs and are being amortized to debt issue cost expense over the life of the notes. The unamortized portion of this debt discount on March 28, 2008, the date on which the convertible notes were automatically converted, was recognized at that time.
20
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

·●  With certain exceptions, until the Investors have sold all of the underlying shares of Common Stock, if the Company sells common stock or issues convertible securities with a conversion or exercise price which is less than the conversion price of the preferred stock, the conversion price of the series A preferred stock and the exercise price of the warrants is reduced to the lower price.

(e)           Warrants
 
On March 23, 2009, in connection with the Company’s sale to two investors of its 18-month, 15% notes in the aggregate principal amount of $250,000, the Company issued five-year warrants to purchase 437,500 shares at an exercise price of $0.40 per share.  These warrants were treated as a discount on the secured notes and were valued at $92,985 to be amortized over the 18-month note term. The warrants issued upon conversionfair value of the notes have a term of five years fromthis warrant was estimated on the date of grant using the notes,Black-Scholes option-pricing model in accordance with SFAS 123R using the following weighted-average assumptions: expected dividend yield of 0%; expected volatility of 137.51%; risk-free interest rate of 1.69% and expire on November 13, 2012. The warrants provide a cashless exercise feature; however,an expected holding period of five years.

There was no warrant activity during the holders of the warrants may not make a cashless exercise prior to November 13, 2008 in the case of the $0.58 warrants, and prior to May 13, 2009 in the case of the $0.83 warrants and $0.92 warrants, and after these respective periods only if the underlying shares are not covered by an effective registration statement.
three months ended March 31, 2008.  Warrant activitiesactivity for the ninethree months ended September 30, 2008 areMarch 31, 2009 is summarized as follows:

  Number of Weighted average 
  shares exercise price 
Outstanding at December 31, 2007  400,000 $0.50 
Granted  18,829,756  0.65 
Exercised  (2,792,821) 0.72��
Cancelled  -  - 
        
Outstanding at Septemuer30, 2008  16,436,935 $0.68 
  
Number of
Warrants
  
Weighted
Average
Exercise Price
 
Balance at beginning of year  16,133,501  $0.50 
Granted  437,500   0.40 
Exercised  -   - 
Balance at end of period  16,571,001  $0.50 
         
Warrants exercisable at end of period  16,571,001  $0.50 

The following table summarizes the shares of the Company's common stock issuable upon exercise of warrants outstanding at September 30, 2008:March 31, 2009:
Warrants Outstanding  Warrants Exercisable 
Range of
Exercise
Price
 
Number
Outstanding at
March 31,
2009
  
Weighted
Average
Remaining
Contractual
Life (Years)
  
Weighted
Average
Exercise
Price
  
Number
Exercisable at
March 31,
2009
  
Weighted
Average
Exercise
Price
 
$ 0.50  400,000   3.62  $0.50   400,000  $0.50 
 0.567  9,232,424   3.62   0.567   9,232,424   0.567 
 0.40  6,938,577   3.71   0.40   6,938,577   0.40 
    16,571,001      $0.50   16,571,001  $0.50 

Warrants Outstanding Warrants Exercisable 
Range of
Exercise
Price
 
 Number
Outstanding at
September 30,
2008
 
Weighted
Average
Remaining
Contractual
Life (Years)
 
Weighted
Average
Exercise
Price
 
Number
Exercisable at
September 30,
2008
 
Weighted
Average
Exercise
Price
 
$       0.50  400,000  4.12 $0.50  400,000 $0.50 
         0.58
  9,535,858  4.12  0.58  9,535,858  0.58 
         0.83
  5,588,252  4.12  0.83  5,588,252  0.83 
         0.92
  912,825  4.12  0.92  912,825  0.92 
   16,436,935    $0.68  16,436,935 $0.68 
20
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
 
(f) NOTE 6 – STOCKHOLDERS’ EQUITY (continued)Beneficial Conversion Feature; Deemed Dividend

The(f)           Beneficial Conversion Feature and Deemed Dividend

In November 2007, the Company evaluated the application of EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios,” and EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments” and concluded that the convertible notes havehad a beneficial conversion option Pursuantoption. In fiscal 2007, pursuant to EITF 00-27, Issue 15, the Company computed the intrinsic value of the conversion option at $2,610,938 based on a comparison of (a) the proceeds of the convertible debt allocated to the common stock portion of the conversion option by first allocating the proceeds received from the convertible debt offering to the debt and the detachable warrants on a relative fair value basis, and (b) the fair value at the commitment date of the common stock to be received by the Company upon conversion. The excess of (b) over (a) is the intrinsic value of the embedded conversion option of $2,610,938 that has been recognized by the Company as a discount to the notes wereand amortized using the straight-line method over the shorter (1)stated term; with the term of Notes, (2)unamortized portion being recognized upon the conversion of the notes to common stock, or (3) upon filing by the Company of certificate of designation and immediate conversion of the notes to the series A preferred stock and warrants.notes.
21
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

The Company filed the Restated Certificaterestated certificate of incorporation on March 28, 20082008.   Upon filing of the restated certificate of incorporation, the note was automatically converted into 14,787,135 shares of series A preferred stock and accordingly,warrants to purchase 18,829,756 shares of the common stock. As a result of the automatic conversion of the note into shares of series A preferred stock and warrants, as described above, the Company recognized the value of the warrants and any remaining debt discount upon conversion of the debt.note.

The conversion features for the convertible notes have been evaluated under FAS 150, FAS 133, and EITF 00-19 and are deemed not to be an embedded derivative and any value attributable to these features would be classified as equity.

As discussed above, upon filing of the Company’s restated certificate of incorporation on March 28, 2008, the Company issued warrants to purchase 18,829,756 shares of the common stock. At November 13, 2007, the fair value of the warrants used to calculate the intrinsic value of the conversion option was estimated at $2,884,062 and was computed using the Black-Scholes option-pricing model based on the assumed issuance of the warrants on the date the notes were issued. Variables used in the option-pricing model include (1) risk-free interest rate at the date of grant (3.84%), (2) expected warrant life of 5 years, (3) expected volatility of 150%, and (4) 0% expected dividend.

As the series A preferred stock does not require redemption by the Company or have a finite life, upon issuance of the warrants on March 28, 2008, a one-time preferred stock deemed dividend of $2,884,062 was recognized immediately as a non-cash charge aton March 28, 2008. The non-cash, deemed dividend did not have an effect on net earnings or cash flows for the ninethree months ended September 30,March 31, 2008. The estimated fair market value of the warrants of $2,884,062 has been recorded as additional paid-in capital and a reduction to retained earnings.

DuringFor the ninethree months ended September 30,March 31, 2008, amortization of debt issue costs was $21,429 and included any remaining balance of debt issue costs that was expensed upon conversion of the convertible debtnotes to the series A preferred stock. At December 31, 2007, deferred debt costs of $21,429 were included in prepaid expensesstock and other on the consolidated balance sheets.warrants.  The amortization of debt discounts for the ninethree months ended September 30,March 31, 2009 and 2008 was $1,500 and $2,263,661, respectively, which has been included in interest expense on the accompanying statementstatements of operations andincome.   For the three months ended March 31, 2008, amortization of debt discounts included any remaining balance of the debt discount that was expenseexpensed upon conversion of the convertible debt to the series A preferred stock, which occurred on March 28, 2008.

In November 2007, the Company evaluated whether or not the convertible notes contain embedded conversion options, which meet the definition of derivatives under SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and related interpretations. The Company concluded that since the convertible notes had a fixed conversion rate of $0.374, the convertible notes were not derivative instruments. The Company analyzed this provision under EITF 05-04 and, although the debt is unconventional, the reset provision is deemed within the Company’s control and therefore it qualified as equity under EITF 00-19
The convertible notes payable is as follows at September 30, 2008 and December 31, 2007:
  September 30, December 31, 
  2008 2007 
Convertible notes payable $- $5,525,000 
Less: unamortized discount on notes payable
  -  (2,263,661)
Convertible notes payable, net $- $3,261,339 
2221
 
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008March 31, 2009
NOTE 6 – STOCKHOLDERS’ EQUITY (continued)

On March 28, 2008, the Company evaluated the application of Financial Accounting Standard No. 133, Accounting for Derivative Financial Instruments and Hedging Activities (FAS 133) and concluded that the preferred shares and warrants associated with the November 13, 2007 financing did not meet the definition of a derivate financial instrument.  Derivative financial instruments, as defined in FAS 133 consist of financial instruments or other contracts that contain all three of the following characteristics: i) the financial instrument has a notional amount and one or more underlying, e.g. interest rate, security price or other variable, ii) require no initial net investment and iii) permits net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Paragraph 9 of FAS 133 defines net settlement.  In order for the net settlement requirement to be met, the contract must meet one of the three tests listed in paragraph 9. 

Since there is no net settlement provision in the contract and no market mechanism that facilitates net settlement that would cause the contract to meet the criteria in paragraphs 9(a) and 9(b), we analyzed paragraph 9(c) of Statement 133 which provides that a contract that requires delivery of the assets associated with the underlying has the characteristic of net settlement if those assets are readily convertible to cash. Footnote 5 to that paragraph makes explicit reference to the use of the phrase readily convertible to cash in paragraph 83(a) of FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises.

An asset (whether financial or nonfinancial) can be considered to be readily convertible to cash, as that phrase is used in paragraph 9(c), only if the net amount of cash that would be received from a sale of the asset in an active market is either equal to or not significantly less than the amount an entity would typically have received under a net settlement provision

At the time of the November 2007 private placement, there was no market for the Company’s common stock.  Prior to the financing the Company was a blank check shell with no business.  At the time that the convertible notes were converted into preferred stock and warrants, there was still no active market in the Company’s common stock.

On March 28, 2008, in connection with the conversion of the convertible notes and warrants, the Company issued to the investors warrants to purchase a total of more than 18,800,000 shares of common stock.  On that date there were approximately 37,400,000 shares of common stock outstanding.  Thus, the warrants, at the time of issuance, represented more than 50% of the outstanding common stock.

Since the (i)the number of shares issuable upon exercise of the warrants, (ii) the relationship between the number of warrants and the outstanding common stock, (iii) the lack of an active market in the stock, (iii) the fact that the common stock is not listed on an exchange and was not so listed at the time the warrants were issued, (iv) the fact that the underlying common stock was not registered with the Securities and Exchange Commission, and (v) the fact that relatively modest sales would have a depressing effect on the market price of the common stock demonstrate that the net settlement test is not met and the warrants are not considered a derivative instrument..

22
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 7 – LOANS PAYABLE

At September 30, 2008March 31, 2009 and December 31, 2007,2008, loans payable consisted of the following:

  2008 2007 
Loan payable to Transportation Bank of China, due on January 29, 2009 with annual interest of 7.45% secured by assets of the Company. $291,754 $273,444 
        
Loan payable to Transportation Bank of China, due on June 10, 2008 with annual interest of 7.23% secured by assets of the Company.  -  410,167 
        
Loan payable to Transportation Bank of China, due on December 10, 2008 with annual interest of 7.78% secured by assets of the Company.  437,630  - 
        
Loan payable to Industrial and Commercial Bank of China, due on February 4, 2009 with annual interest of 7.56% secured by assets of the Company.  291,754  136,722 
        
Total Current Loans Payable $1,021,138 $820,333 
  2009  2008 
Loan payable to Bank of Communications, due on June 16, 2009 with annual interest at March 31, 2009 of 6.05% secured by assets of the Company. $292,158  $291,792 
         
Loan payable to Bank of Communications, due on June 10, 2009 with annual interest at March 31, 2009 of 6.05% secured by assets of the Company.  438,238   437,688 
         
Loan payable to Industrial and Commercial Bank of China, due on December 16, 2009 with annual interest at March 31, 2009 of 6.42% secured by assets of the Company.  292,159   291,792 
         
Loan payable to Industrial and Commercial Bank of China, due on November 18, 2009 with annual interest at March 31, 2009 of 6.1065% the rate being adjusted quarterly based on People’s Bank of China’s base rate plus 1.5% secured by assets of the Company.  146,079   - 
         
Loan payable to individual, due on January 9, 2010, with annual interest of 10% per annum.  146,079   - 
         
Principal amount of loan payable to investors, due on September 23, 2010, with annual interest of 15% per annum (see (a) below).  250,000   - 
Total loans payable  1,564,713   1,021,272 
         
Less: current portion of loans payable  (1,314,713)  (1,021,272)
Long-term loans payable  250,000   - 
         
Less: debt discount (a)  (91,485)  - 
         
Long-term loans payable – net $158,515  $- 

(a) In March 2009, the Company sold to two investors its 18-month, 15% notes in the aggregate principal amount of $250,000 and warrants to purchase 437,500 shares at an exercise price of $0.40 per share.  Pursuant to the related purchase agreements, our chief executive officer placed 1,531,250 shares of common stock into escrow.  The note holders have the right to take these shares, valued at $0.20 per share, if the Company does not pay the interest on or principal of the notes before such failure becomes an event of default.  Pursuant to the loan documents, in the event of that Leo Wang ceases to be employed by the Company as its chief financial officer, the holders of not less than $126,000 principal amount of the notes, shall have the right, on not less than 60 days’ notice, to declare the notes in default.  If Mr. Wang ceases to be employed by the Company as a result of his death, disability or a termination for cause, than the Company shall have 60 days to replace Mr. Wang with a chief financial officer acceptable to investors. The debt discount of $91,485 represents the value of the warrants issued in connection with this note.

23
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
NOTE 8 – RELATED PARTY TRANSACTIONS

Due from related partiesparty

From time to time, the Company advanced funds to companies partially owned by the Company for working capital purposes. These advances are non-interest bearing, unsecured and payable on demand. Through monthly payments, the affiliated companies intend to repay these advances.
At September 30, 2008March 31, 2009 and December 31, 2007,2008, due from related parties was due from the following:

Name Relationship 
September 30,
2008
 December 31, 2007 
Wuxi Huayang Yingran Machinery Co. Ltd.  5% cost method investee which was sold in March 2008 $- $139,524 
     $ - $139,524 
 
Name
 
 
Relationship
 
March 31,
2009
  
December 31,
2008
 
         
Wuxi Anyida Machinery Co. Ltd Company owned by sibling of CEO (1)  -   437,688 
           
    $-  $437,688 

Due to related parties
(1)  This loan was made in December 2008 and repaid in January 2009 without interest.  Although the Company does not believe that this loan violates the proscription against loans to directors or executive officers contained in Section 402 of the Sarbanes-Oxley Act of 2002, it is possible that a court might come to a different conclusion.

The chief executive officerPurchase of the Company and his spouse,assets from time to time, provided advances to the Company for operating expenses. At September 30, 2008 and December 31, 2007, the Company did not have any payable to the chief executive officer and his spouse. These advances were short-term in nature and non-interest bearing.
Wuxi Huayang Boiler, a company related through common ownership, from time to time, provided advances to the Company for working capital purposes. At September 30, 2008 and December 31, 2007, the Company had a payable to Boiler of $0 and $98,541, respectively. These advances were short-term in nature and non-interest bearing.
23
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

Deposits on long-term assets –related party and other

In July 2007, the Company agreed to acquire long-term assetsproperty from Boiler for an aggregate price of 89,282,500 RMB, or approximately $12,207,000. ThisThe Company had previously been a 33% owner of Boiler and, in 2007, the Company sold its interest in Boiler to a related party.  The original purchase price was reduced by 9,196,341RMB, or approximately $1,257,000, which represents the Company’s 33% ofinterest in the appreciation in the long-term assets attributable to Boilerproperty prior to the Company’s salessale of itsthe Company’s interest in Boiler.The long-term assets consistBoiler, resulting in a net purchase price of i)80,086,159 RMB, or approximately $10,950,000. The property consists of an approximately 100,000 square foot factory, which was substantially completed in 2005, ii) land use rights, iii) employee housing facilities and iv) other leasehold improvements. As of September 30, 2008 andThe purchase price was fully paid by December 31, 2007,2008.  Prior to payment of the purchase price, the Company treated its payments totaling 80,086,159 RMB and 79,458,230 RMB or approxmately $11,682,000 and $10,864,000, respectively, had been madeas deposits on long-term assets, which amounted to Boiler, adjusted by$11,538,000.  During 2008, the foreign exchange rate. In 2008, in connection withCompany received the acquisitioncertificate of land use rights from a related party,but as of December 31, 2008 had not received the Company was grantedcompleted title to the transferredbuildings until March 2009. During 2008, upon the receipt of the land use rights fromand the government and accordingly,full payment of the purchase price, the Company reclassified approximately $3,300,000 from deposits on long-term assets$3,304,000, representing Boiler’s cost of the land use rights to land use rights (See Note 5), reclassified approximately $5,517,000, which represents Boiler’s cost of constructing the factory and the remaining amount of $2,300,000,related leasehold improvements and employee housing facilities, to property and equipment, and reclassified approximately $2,717,000, which represents the excess of amountamounts paid by the Company for the land use rights and factory facilities over the original cost of the land use rights has been reflected asand factory facilities acquired, to a distribution to related parties. As of September 30, 2008,The difference between the Company has not received title to the facilitiestotal payments, $11,538,000, and the property has not been placed in service. The Company has initiated the transferpurchase price of the title to the facilities and the transfer$10,950,000 is expected to be completed in the fourth quarter of 2008 at which time the deposit on long-term assets will be reclassified to property and equipment. In connection with the remaining deposit on long-term assets, the Company reclassified approximately $404,000 fromtreated as a deposit on long-term assets to a distribution to related parties, which represents the excess of amount paid for the facilities including the factory and other buildings, over the original cost of the facilities.foreign currency translation adjustment.

At September 30, 2008 and December 31, 2007, deposits on long-term assets are as follows:
  2008 2007 
Factory building and related leasehold improvements – related party $5,603,128 $10,863,706 
  $5,603,128 $10,863,706 
NOTE 9 – INCOME TAXES
 
The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, ‘‘Accounting for Income Taxes’’ (‘‘SFAS 109’’). SFAS 109 requires the recognition of deferred tax assets and liabilities for both the expected impact of differences between the financial statements and the tax basis of assets and liabilities, and for the expected future tax benefit to be derived from tax losses and tax credit carryforwards.  SFAS 109 additionally requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Realization of deferred tax assets, including those related to the U.S. net operating loss carryforwards, are dependent upon future earnings, if any, of which the timing and amount are uncertain. Accordingly, the net deferred tax asset related to the U.S. net operating loss carryforward has been fully offset by a valuation allowance. The Company is governed by the Income Tax Law of the People’s Republic of China and the United States.

In 20082009 and 2007,2008, under the Income Tax Laws of PRC, Chinese companies are generally subject to an income tax at an effective rate of 25% and 33%, respectively, on income reported in the statutory financial statements after appropriate tax adjustments. The Company’s VIE, Dyeing isand Electric are subject to these statutory rates. In 2007, pursuant to local taxing regulations, the Company’s VIE, Electric, paid tax under a simplified method of recording under the following formula: (Net revenues x 5% x 33%). China Wind Systems, Inc. was incorporated in the United States and has incurred net operating losses of approximately $100,000 for income tax purposes for the year ended December 31, 2007 subject to the Internal Revenue Code Section 382, which places a limitation on the amount of taxable income that can be offset by net operating losses after a change in ownership. The net operating loss carries forward for United States income taxes, which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, through 2027. 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 United States income tax purposes. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero. Management will review this valuation allowance periodically and make adjustments as warranted.

24
 
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

The table below summarizes the differences between the U.S. statutory federal rate and the Company’s effective tax rate and as follows for the nine months ended September 30, 2008 and 2007:

  2008 2007 
U.S statutory rates  34.0% 34.0%
US effective rate in excess of China tax rate  (16.1)% (0.4)%
China income tax exemptions  0.0% (21.3)%
Non-deductible interest  20.9% 0.0%
US valuation allowance  6.2% 0.0%
        
Total provision for income taxes  45.0% 12.3%

Income tax expense for the nine months ended September 30, 2008 and 2007 was $1,651,331 and $1,315,094, respectively.March 31, 2009
 
NOTE 10 - SEGMENT INFORMATION

The following information is presented in accordance with SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information.  For the three and nine months ended September 30,March 31, 2009 and 2008, and 2007, the Company operated in two reportable business segments - (1) the manufacture of dyeing and finishing equipment and (2) the manufacture of forged rolled rings and other components for the wind power and other industries and electric power auxiliary apparatuses (including coking equipment). The Company's reportable segments are strategic business units that offer different products. They are managed separately based on the fundamental differences in their operations.  All of the Company’s operations are conducted in the PRC.

Information with respect to these reportable business segments for the three month ended March 31, 2009 and nine months ended September 30, 2008 and 2007 is as follows:
 
  
For the Three Months Ended
September 30,
 
For the Nine Months Ended
September 30,
 
  2008 2007 2008 2007 
Revenues:         
Dyeing and finishing equipment $5,958,627 $6,287,788 $17,125,918 $14,487,221 
Forged rolled rings and electric power equipment  
5,811,535
  
1,622,505
  
14,274,268
  
2,102,254
 
   11,770,162  8,000,293  31,400,186  16,589,475 
Depreciation and amortization:             
Dyeing and finishing equipment  94,967  87,198  293,662  273,011 
Forged rolled rings and electric power equipment  
64,487
  
64,232
  
188,714
  
177,870
 
   159,454  151,430  482,376  450,881 
Interest expense:             
Dyeing and finishing equipment  -  -  -  - 
Forged rolled rings and electric power equipment  
20,427
  
9,946
  
55,932
  
31,360
 
Other (a)  -  -  2,242,942  - 
   20,427  9,946  2,298,874  31,360 
Net income (loss):             
Dyeing and finishing equipment  988,906  7,007,814  2,780,281  8,337,148 
Forged rolled rings and electric power equipment  
1,039,993
  
1,113,478
  
2,169,855
  
1,072,160
 
Other (a)  (168,037) -  (2,927,950) - 
   1,860,862  8,121,292  2,022,186  9,409,308 
Identifiable assets at September 30, 2008 and
December 31, 2007:
             
Dyeing and finishing equipment $17,660,956 $17,914,593       
Forged rolled rings and electric power equipment  
17,222,834
  
7,455,095
       
Other (a)  101,782  3,126,745       
  $34,985,572 $28,496,433       
  2009  2008 
Revenues:      
Dyeing and finishing equipment $3,529,441  $4,653,138 
Forged rolled rings and electric power equipment  4,331,426   3,793,936 
   7,860,867   8,447,074 
Depreciation:        
Dyeing and finishing equipment  100,107   97,838 
Forged rolled rings and electric power equipment  75,006   61,224 
       175,113   159,062 
Interest expense:        
Dyeing and finishing equipment  -   - 
Forged rolled rings and electric power equipment  21,264   16,752 
Other (a)  2,407   2,242,942 
   23,671   2,259,694 
Net income (loss):        
Dyeing and finishing equipment  464,503   704,386 
Forged rolled rings and electric power equipment  424,036   640,949 
Other (a)  (242,481)  (2,595,196)
   646,058   (1,249,861)
Identifiable assets at March 31, 2009 and December 31, 2008 by segment:        
Dyeing and finishing equipment $17,595,919  $17,884,877 
Forged rolled rings and electric power equipment  20,709,971   19,415,748 
Other (a)  31,334   31,132 
  $38,337,224  $37,331,757 
         
Identifiable assets at March 31, 2009 and December 31, 2008 by geographical location:        
China $38,306,030  $37,321,465 
United States  31,194   10,292 
  $38,337,224  $37,331,757 
 
(a)The Company does not allocate any general and administrative expenses of its US activities to its reportable segments, because these activities are managed at a corporate level. Additionally, other identifiable assets represents assets located in the United States and Hong Kong and are not allocated to reportable segmentssegments.
 
25
 
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008March 31, 2009
 
NOTE 11 – STATUTORY RESERVES

The Company is required to make appropriations to reserve funds, comprising the statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the People’s Republic of ChinaPRC (the “PRC GAAP”). Appropriation to the statutory surplus reserve should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of the entities’ registered capital or members’ equity. Appropriations to the statutory public welfare fund are at a minimum of 5% of the after tax net income determined in accordance with PRC GAAP. Commencing on January 1, 2006, the new PRC regulations waived the requirement for appropriating retained earnings to a welfare fund. As of DecemberMarch 31, 2006,2009, the Company appropriated the required maximum 50% of its registered capital to statutory reserves for Dyeing.

For the ninethree months ended September 30, 2008,March 31, 2009, statutory reserve activity is as follows:

  Dyeing Rolled Rings Total 
Balance – December 31, 2007  72,407 $233,065 $305,472 
Additional to statutory reserves  -  221,156  221,156 
Balance - September 30, 2008 $72,407 $454,221 $526,628 

NOTE 12 – SUBSEQUENT EVENTS

From October 1, 2008 to November 10, 2008, the Company issued 303,434 shares of its common stock pursuant to an exercise of warrants for proceeds of $175,992.

On October 17, 2008, the Company entered into a purchase agreement with Eos Holdings LLC for the sale of a 17.4% subordinated note, due six months from the date of issuance (the “Note”) in the principal amount of $575,000, for a purchase price of $575,000. Under the terms of the purchase agreement and the Note, the Company may prepay the Note, in whole or in part, at any time prior to the maturity date of the Note upon five days’ oral or written notice to Eos Holdings. On November 14, 2008, the Company repaid the principal balance of this note in full.
  Dyeing  Electric  Total 
Balance – December 31, 2008  72,407   548,796   621,203 
Additional to statutory reserves  -   54,437   54,437 
Balance – March 31, 2009 $72,407  $603,233  $675,640 
 
As a condition to the sale of the Note, the purchase agreement requires that Eos Holdings exercise certain common stock purchase warrants having a total exercise price of not less than $175,000, at a per share exercise price of $.58. On October 17, 2008, Eos Holdings purchased the Note and exercised the warrants.
Payment of the Company’s obligations of the Note were initially secured by a pledge of and conversion right with respect to 959,000 shares (the “Pledged Shares”) of the Company’s common stock owned by Jianhua Wu, the Company’s chief executive officer and principal beneficial owner of common stock. The pledge and conversion right enables Eos Holdings to convert any or all of the principal amount of the Note into Pledged Shares at any time or from time to time until the Note is paid in full or until Eos Holdings exercises the conversion right in full, at an initial conversion price of $.60 per share (the “Conversion Price”). The number of Pledged Shares to be delivered shall be determined by dividing the principal amount of the Note being converted by the Conversion Price, with any fractional shares to be rounded to the nearest whole share. The Pledged Shares shall be held in escrow.
On October 23, 2008, pursuant to a restated pledge and conversion right agreement, the number of Pledged Shares was increased to 1,437,500 shares of common stock and the Conversion Price was reduced to $0.40 per share.

26
 
CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2008

In connection with the issuance of the Note, on October 17, 2008, the Company entered into a consulting agreement with Eos Asia Investments Ltd., an affiliate of Eos Holdings, for the provision of consulting services. Pursuant to the consulting agreement, the Company shall pay consulting fees at a rate of $31,662.50 per month until the Company repays the Note in full or until Eos Holdings LLC exercises its right to receive the Pledged Shares. Assuming the Note is paid on the maturity date of April 20, 2009, the total payments made by the Company as interest on the Note and as consulting fees under the consulting agreement would total $240,000.

During the period from October 23, 2008 through the November 7, 2008, the Company sold to investors an aggregate of 3,400,000 shares of the Company’s common stock, at a purchase price of $0.40 per share, for an aggregate purchase price of $1,360,000. The sale of these securities was exempt from registration under Section 4(2) of the Securities Act. Each of the investors is either (a) an “accredited investor” as defined in Rule 501 of Securities and Exchange Commission under the Securities Act, or (b) not a “U.S. person” as that term is defined in Rule 902(k) of Regulation S under the Act, and that such investor was acquiring our common stock, for investment purposes for their own respective accounts and not as nominees or agents, and not with a view to the resale or distribution thereof, and that each Investor understood that the shares of our common stock may not be sold or otherwise disposed of without registration under the Securities Act or an applicable exemption.

Certain of the investors had previously signed subscription agreements for the purchase of shares at a price of $0.60 per share. These investors signed a restated subscription agreement that reflected the $0.40 per share purchase price.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following analysis of the results of operations and financial condition should be read in conjunction with our consolidated financial statements for the nine months ended September 30, 2008 and notes thereto contained in this quarterly report on Form 10-Q.

Overview

Prior to November 13, 2007, we were a public reporting blind pool company with no assets. On November 13, 2007, we executed and completed the transactions contemplated by the share exchange agreement with Fulland and its stockholders and Synergy, which was then principal stockholder. Pursuant to this agreement, simultaneously with the financing as discussed below, (i) the Company issued 36,577,704 shares of common stock to the former stockholders of Fulland, (ii) purchased 8,006,490 shares of common stock from Synergy for $625,000 and cancelled such shares, (iii) issued Synergy 291,529 shares of common stock for professional services, and (iv) paid cash fees of $415,000 in connection with the exchange agreement. Aggregate payments of $1,040,000 were made from the proceeds of the financing, including the $625,000 paid to Synergy as described above.

Fulland conducts its business operations through its wholly-owned subsidiary, Green Power, in PRC as a wholly-owned foreign limited liability company. Green Power, through the Huayang Companies, is engaged in the design, manufacture and sale of a variety of high and low temperature dyeing and finishing machinery, the manufacture of high precision forged rolled rings for the wind power industry and other industries and the design, manufacture and sale of electric power auxiliary apparatuses (including coking equipment), sewage-treatment equipment and related parts or fittings. Green Power operates and controls the Huayang Companies through contractual arrangements. Fulland used the contractual arrangements to acquire control of the Huayang Companies, instead of acquiring the business of Huayang Companies in order not to violate the laws of the PRC that significantly restrict a PRC company from selling its assets to a foreign entity other than for cash and otherwise impose restriction on foreign investment in PRC companies.

Additionally, on August 27, 2008, the Company incorporated Wuxi Fulland Wind Energy Equipment Co. , Ltd. (“Fulland Wind Energy”). Fulland owns 100% of Fulland Wind Energy, which is a wholly foreign-owned enterprise (“WFOE”) organized under the laws of the PRC.

The acquisition of Fulland was accounted for as a reverse merger because on a post-merger basis, the former shareholders of Fulland held a majority of our outstanding common stock on a voting and fully-diluted basis. As a result of the share exchange, Fulland was deemed to be the acquirer for accounting purposes. Accordingly, the financial statement data presented are those of Fulland (including the Huayang Companies) for all periods prior to our acquisition of Fulland on November 13, 2007, and the financial statements of the consolidated companies from the acquisition date forward. Since Fulland did not have any separate operations prior to November 13, 2007, the financial statements of Fulland reflect the operations of the Huayang Companies.Overview

Our revenues are derived from two unrelated businesses – (1) the manufacture of dyeing and& finishing equipment and (2) the manufacture of forged rolled rings and other components for the wind power and other industries and electric power auxiliary apparatuses (including coking equipment). We market products from these two segments with independent marketing groups to different customer bases.

Dyeing and finishing equipment segment
TheHistorically, the dyeing and finishing equipment business has been the principal source of our revenue and operating income, accounting for 54.5%44.9% of revenue for the ninethree months ended September 30, 2008March 31, 2009 and 81.1%55.1% of revenues for the yearthree months ended DecemberMarch 31, 2007.2008.  Substantially all of our sales of these products are made to companies in the PRC. As a result, we are dependent upon the continued growth of the textile industry in the PRC. To the extent that growth in this industry stagnates in the PRC, whether as a result of export restrictions from countries such as the United States, who are major importers of Chinese-made textiles, or shifts in international manufacturing to countries which may have a lower cost than the PRC, or overexpansion of the Chinese textile industry, we will have more difficulty in selling these products in the PRC, and we may have difficulty exporting our equipment. Further, as the textile industry seeks to lower costs by purchasing equipment that uses the most technological developments to improve productivity, reduce costs and have less adverse environmental impact, if we are not able to offer products utilizing the most current technology, our ability to market our products will suffer. AlthoughThe Chinese textile industry has been severely impacted by the worldwide economic downturn, which has resulted in a substantial decline in exports.  Additionally, the export market can also be subject to protectionist measures imposed by importing countries seeking to protect their own industries in a time of a declining demand for products.    As a result, we seek to work withare experiencing a significant decline in this segment of our customers in designing equipment to meet their anticipated needs,business, and we cannot assure you thatpredict when, if at all, business in this segment will improve.  If we will beare not able to develop productsgenerate sufficient business, we may discontinue this phase of our operations and enhancements that are required or desired by the industry.

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Forged rolledconcentrate on our forged rings and electricelectrical power equipment segmentsegment.

In our forged rolled rings and electrical power equipment segment, we manufacture high precision forged rolled rings for the wind power industry and other industries. Additionally, we also manufacture specialty equipment used in the production of coal generated electricity. Revenue from our forged rolled rings and electrical power equipment segment accounted for 49.4%55.1% of revenue for the three months ended September 30, 2008, 45.5% of revenues for the nine months ended September 30, 2008, and 18.9% of revenues for the year ended December 31, 2007 and is summaries as follows:

  
For the Three
Months Ended
September 30,
2008
 
For the Nine
Months Ended
September 30,
2008
 
For the Year Ended
December 31, 2007
 
Forged rolled rings - wind power industry $2,494,123 $5,124,872 $458,988 
Forged rolled rings – other industries  2,764,328  7,419,590  1,443,930 
Electrical equipment  553,084  1,729,806  2,722,433 
           
Total forged rolled rings and electric equipment segment revenues 
$
5,811,535
 
$
14,274,268
 
$
4,625,351
 

During 2007, we began to generate revenue from the forging of rolled rings for the wind power and other industries. These activities accounted for 44.7% of net revenues for the three months ended September 30, 2008, 40.0%March 31, 2009, and 44.9% of revenues for the ninethree months ended September 30, 2008March 31, 2008.

The following table sets forth information as to revenue of our forged rolled rings and 7.8% for the year ended December 31, 2007. electrical power equipment segment in dollars and as a percent of revenue:

  Three months ended March 31, 
   2009  2008 
  Dollars  %  Dollars  % 
Forged rolled rings - wind power industry $2,724,131   62.9% $961,290   25.4%
Forged rolled rings – other industries  1,607,295   37.1%  2,242,976   59.1%
Electrical equipment  -   -   589,670   15.5%
                 
Total $4,331,426   100% $3,793,936   100%

We expect that rolled rings will become a more significant percentage of total revenues in the future, and, in this connection we arehave expanding our manufacturing facilities to enable us to manufacture forged rolled rings with a larger diameter in order to meet the perceived needs of the wind power industry. We experienced a decrease in revenues from forged rolled rings – other industries as discussed below in results of operations,

We acquired
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In 2007, we purchased property from an affiliated company for a net price of approximately $10,950,000,$10,950,000. The property consists of an approximately 100,000 square foot factory, which was substantially completed in 2005 together with the related land use rights, employee housing facilities and other leasehold improvements.  As of September 30, 2008, the purchase price was fully paid. Furthermore, through September 30, 2008, we have incurred additional costs of approximately $2.2 million for leasehold improvements to upgrade this facility for the eventual manufacture of larger roll rings and other components with a focus on the wind power industry. Although we have received the land use rights, as of the date of this report, we have not received title to the factory facilities and the property has not been placed in service. We intend to useare using this new facility to manufacture forged rolled rings and other components for use in the wind power and other industries.  To date, most ofWith our rolled ring sales have been for non-wind applications.  As we expand ourexpanded facilities designed to accommodate the manufacture of rolled rings with larger diameters, we plan to develop products for whichdesigned to meet the needs of the wind industry is a more important target market.power industry. Wind power accounts for an insignificant percentage of the power generated in the PRC, and our ability to market to this segment is dependent upon both the growth of the acceptance of wind power as an energy source in the PRC and the acceptance of our products.

In addition to manufacturing forged rollrolled rings, we market electrical power equipment to operators of coal-fired electricity generation plants. Our ability to market these products is dependent upon the continued growth of coal-generated power plants and our ability to offer products that enable the operators of the power plants to produce electricity through a cleaner process than would otherwise be available at a reasonable cost. To the extent that government regulations are adopted that require the power plants to reduce or eliminate polluting discharges from power plants, our equipment would need to be redesigned to meet such requirements.  With the completion of our new plant facilities we have concentrated our marketing effort to the wind-related forging business, and have reduced our marketing effort directed to the electrical power equipment markets.  As a result of this shift in marketing combined with the commencement of operations at our new forging facility and the seasonable swings in business resulting from the Chinese New Year holiday, we did not receive any orders for our auxiliary electric power equipment segment during the first quarter of 2009.  We also believe that potential customers in this market are seeking price reductions which could impair our overall gross margins.  Our revenue from the sale of electric power equipment was 5.5% of total revenue in 2008.  We do not expect to generate significant revenue from the sale of electrical power equipment during the remainder of 2009.

Our products are sold for use by manufacturers of industrial equipment.  Because of the recent decline in oil prices and the general international economic trends, the demand for products used in manufacturing in general in the dyeing and finishing as well asincluding wind power industries, may beis uncertain.  Although we believe that over the long term, the wind power segment will expand, and the government of the PRC has announced its desire to increase the use of wind power as an energy source, in the short term these factors may affect the requirements by our customers and potential customers for our products.  To the extent that the demand for our forged rolled rings declines, our revenue and net income will be affected.

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A major element of our cost of sales is raw materials, principally steel and other metals. These metals are subject to fluctuation prices,price fluctuations, and recently these fluctuations have been significant.  In times of increasing prices, we need to try to fix the price at which we purchases raw materials in order to avoid increases in costs which we cannot recoup through increases in sales prices.  Similarly, in times of decreasing prices, we may have purchased metals at prices which are high in terms of the price at which we can sell our products, which also can impair our margins. During both the three and nine month periods ended September 30, 2008, are gross margins decreased from the prior year largely as a result of increases in the price of steel and other metals that we were not able to pass on to our customers.

Critical Accounting Policies and Estimates

Use of Estimates
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our consolidatedthese financial statements requires us to make estimates and assumptionsjudgments that affect the reported amounts of assets, liabilities, revenues and liabilitiesexpenses, and therelated 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, weliabilities. We continually evaluate our estimates, including those related to bad debts, inventories, recovery of long-lived assets, income taxes, and assumptions.the valuation of equity transactions. We base our estimates on historical experience and on various other factorsassumptions that we believe arebelieved to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying valuevalues of assets and liabilities that are not readily apparent from other sources. Any future changes to these estimates and assumptions could cause a material change to our reported amounts of revenues, expenses, assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. SignificantWe believe the following critical accounting policies affect our more significant judgments and estimates used in 2008 and 2007 include the allowance for doubtful accounts,preparation of the allowance for obsolete inventory, the useful life of property and equipment and intangible assets, and accruals for taxes due.financial statements


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Variable Interest Entities

Pursuant to Financial Accounting Standards Board Interpretation No. 46 (Revised), “Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51” (“FIN 46R”) we are required to include in our consolidated financial statements the financial statements of variable interest entities.  FIN 46R requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss for the variable interest entity or is entitled to receive a majority of the variable interest entity’s residual returns. Variable interest entities are those entities in which we, through contractual arrangements, bear the risk of, and enjoy the rewards normally associated with ownership of the entity, and therefore we are the primary beneficiary of the entity.

The Huayang Companies are considered variable interest entities (“VIE”), and we are the primary beneficiary. On November 13, 2007, we entered into agreements with the Huayang Companies pursuant to which we shall receive 100% of the Huayang Companies net income. In accordance with these agreements, the Huayang Companies shall pay consulting fees equal to 100% of its net income to our wholly-owned foreign subsidiary, Green Power, and Green Power shall supply the technology and administrative services needed to service the Huayang Companies.

The accounts of the Huayang Companies are consolidated in the accompanying financial statements pursuant to FIN 46R. As a VIE, the Huayang Companies sales are included in our total sales, its income from operations is consolidated with our, and our net income includes all of the Huayang Companies net income. We do not have any non-controlling interest and accordingly, did not subtract any net income in calculating the net income attributable to us. Because of the contractual arrangements, we have pecuniary interest in the Huayang Companies that require consolidation of our financial statements and the Huayang Companies financial statements with our financial statements.

Accounts receivable

We have a policy of reserving for uncollectible accounts based on our best estimate of the amount of probable credit losses in our existing accounts receivable.  We periodically review our accounts receivable and other receivables to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt.  Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

As a basis for accurately estimating the likelihood of collection has been established, we consider a number of factors when determining reserves for uncollectable accounts.   We believe that we use a reasonably reliable methodology to estimate the collectability of our accounts receivable. We review our allowances for doubtful accounts on at least a quarterly basis. We also consider whether the historical economic conditions are comparable to current economic conditions. If the financial condition of our customers or other parties that we have business relations with were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.  Should we become unable to reasonably estimate the collectability of our receivables, our results of operations could be negatively impacted.

Inventories

Inventories, consisting of raw materials and finished goods related our products are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, we will record additional reserves for the difference between the cost and the market value. These reserves are recorded based on estimates.  We review inventory quantities on hand and on order and record, on a quarterly basis, a provision for excess and obsolete inventory, if necessary. If the results of the review determine that a write-down is necessary, we recognize a loss in the period in which the loss is identified, whether or not the inventory is retained. Our inventory reserves establish a new cost basis for inventory and are not reversed until we sell or dispose of the related inventory. Such provisions are established based on historical usage, adjusted for known changes in demands for such products, or the estimated forecast of product demand and production requirements.

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Property and equipment

Property and equipment are stated at cost less accumulated depreciation.  In 2008, in connection with the acquisition of a factory, leasehold improvement and employee facilities from a related party, we reclassified approximately $5,517,000, which represents the related party’s cost of constructing the factory and related leasehold improvements and employee housing facilities to property and equipment and reclassified approximately $404,000, which represents the excess of amounts paid by the Company for the factory facilities over the original cost of the factory facilities acquired, to a distribution to related parties. These amounts have previously been classified as deposits of long-term assets – related party.  Depreciation is computed using straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets are as follows:

  Useful Life
Building and building improvements 20 Years Years
Manufacturing equipment 5 – 10 Years Years
Office equipment and furniture 5 Years Years
Vehicle 5 Years Years

The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition.

Long-livedIncluded in property and equipment is construction-in-progress which consists of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are reviewed periodically or more often if circumstances dictate, to determine whethercompleted and ready for their carrying value has become impaired. We consider assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. We also re-evaluate the amortization periods to determine whether subsequent events and circumstances warrant revised estimates of useful lives.intended use.

In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. We recognize an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value.

Land use rights

There is no private ownership of land in the PRC. All land in the PRC is owned by the government and cannot be sold to any individual or company. The government grants a land use right that permits the holder of the land use right to use the land for a specified period. Our land use rights were granted forwith a term of 45  or 50 years.  Any transfer of the land use right requires government approval.  We have recorded as land use rightsan intangible asset the costs paid to acquire a land use rights.right. The land use rights are amortized on the straight-line method over the land use right termsterms.  In 2008, in connection with the acquisition of land use rights from a related party, we received the certificate of land use rights from the government. At the time we received the land use rights, $5,617,000 was carried as a deposit on long-term assets – related party.  As a result of the grant of the land use rights, we reclassified this amount as follows: (i) approximately $3,304,000 to land use rights and (ii) approximately $2,313,000 to distributions to related parties.  The distribution to related parties represents the amount by which range from 45 to 50 years.our purchase price for the land use right exceeds the cost of the land use rights by the related parties.

Revenue recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectability is reasonably assured. We account for the product sales as a multiple element arrangement. Revenue from multiple element arrangements is allocated among the separate accounting units based on the residual method. Under the residual method, the revenue is allocated to undelivered elements based on fair value of such undelivered elements and the residual amounts of revenue allocated to delivered elements. We recognize revenue from the sale of dyeing and electric equipment upon shipment and transfer of title. The other elements may include installation and generally a one-year warranty.

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Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally within a close to the date of delivery of the equipment.

Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the three and nine months ended September 30,March 31, 2009 and 2008, amounts allocated to warranty revenues were not material. Based on historical experience, warranty service calls and any related labor costs have been minimal.
 
All other product sales, including the forging of parts, with customer specific acceptance provisions, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.

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Research and development

Research and development costs are expensed as incurred, and are included in general and administrative expenses. These costs primarily consist of cost of material used and salaries paid for the development of our products and fees paid to third parties. Our totalWe had no research and development expense through September 30, 2008 has not been significant.expenses during the three months ended March 31, 2009 and 2008.

Income taxes

We are governed by the Income Tax Law of the PRC. Income taxes are accounted for under Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. The charge for taxes is based on the results for the year as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.
 
Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probably that taxable profit will be available against which deductible temporary differences can be utilized.

Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity.

Deferred tax assets and liabilities are offset when they related to income taxes levied by the same taxation authority and the Company intends to settle its current tax assets and liabilities on a net basis.

We adopted FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), as of January 1, 2007. 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 adoption had no affect on our financial statements.

Recent accounting pronouncements

In June 2007, the Emerging Issues Task Force of the FASB issued EITF Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities, (“EITF 07-3”) which is effective for fiscal years beginning after December 15, 2007. EITF 07-3 requires that nonrefundable advance payments for future research and development activities be deferred and capitalized. Such amounts will be recognized as an expense as the goods are delivered or the related services are performed. The adoption of EITF 07-3 did not have a material impact on our results of operations, financial position or liquidity.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008. The adoption of SFAS 141(R) may have an impact on accounting for future business combinations once adopted.combinations.

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In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements – an amendment of Accounting Research Bulletin No. 51” (“SFAS 160”), which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the non-controlling interest, changes in a parent’s ownership interest and the valuation of retained non-controlling equity investments when a subsidiary is deconsolidated. The Statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008. We have not determined the effect that the applicationThe adoption of SFAS No. 160 willdid not have a material impact on the preparation of our consolidated financial statements.

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities””.. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. We are currently evaluating theThe adoption of SFAS No. 161 did not have a material impact of adopting SFAS 161 on our consolidated financial statements.

In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon either mandatory or optional conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s non-convertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company will adopt FSP APB 14-1 beginning in the first quarter of fiscal 2009, and this standard must be applied on a retrospectiveretroactive basis. The Company is evaluating the impact the adoption of FSP APB 14-1 willdid not have an effect on itsour consolidated financial position and results of operations.

In May 2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 162, The Hierarchy of Generally Accepted Accounting Principles. This standard is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with generally accepted accounting principles in the United States for non-governmental entities. SFAS No. 162 is effective 60 days following approval by the U.S. Securities and Exchange Commission (“SEC”) of the Public Company Accounting Oversight Board’s amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company does not expectadoption of SFAS No. 162 todid not have a material impact on the preparation of itsour consolidated financial statements.

On June 16, 2008, the FASB issued final Staff Position (FSP) No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” to address the question of whether instruments granted in share-based payment transactions are participating securities prior to vesting. TheAs provided in the FSP, determines that unvested share-based payment awards that contain rights to dividend payments should be included in earnings per share calculations. The guidance will be effective commencing in the three months ended December 31, 2009. The adoption of the requirements of EITF 03-6-1 did not have a material impact on our consolidated financial statements.

In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP FAS 140-4 and FIN 46(R)-8”). FSP FAS 140-4 and FIN 46(R)-8 amends FAS 140 and FIN 46(R) to require additional disclosures regarding transfers of financial assets and interest in variable interest entities. FSP FAS 140-4 and FIN 46(R)-8 is effective for interim or annual reporting periods ending after December 15, 2008. The adoption of FSP FAS 140-4 and FIN 46(R)-8 did not have an impact on our consolidated financial position and results of operations.
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At its June 25, 2008 meeting, the Financial Accounting Standards Board ratified the consensus reached by the Emerging Issues Task Force Issue 07-5 Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock  (EITF 07-5).  The adoption of EITF 07-5’s requirements will affect accounting for convertible instruments and warrants with down-round provisions.   Convertible instruments and warrants which are derivatives and have down-round protection will no longer be recorded in equity.  EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company is currently evaluating2008, and interim periods within those fiscal years.  After reviewing FAS 133 and EITF 07-5, we do not believe that EITF 07-5 has a material effect on the requirementsCompany’s financial condition, results of (FSP) No. EITF 03-6-1operations or cash flows.

Currency Exchange Rates

All of our sales are denominated in RMB. As a result, changes in the relative values of U.S. Dollars and RMB affect our reported levels of revenues and profitability as wellthe results are translated into U.S. Dollars for reporting purposes. In particular, fluctuations in currency exchange rates could have a significant impact on our financial stability due to a mismatch among various foreign currency-denominated sales and costs. Fluctuations in exchange rates between the U.S. dollar and RMB affect our gross and net profit margins and could result in foreign exchange and operating losses.

Our exposure to foreign exchange risk primarily relates to currency gains or losses resulting from timing differences between signing of sales contracts and settling of these contracts. Furthermore, we translate monetary assets and liabilities denominated in other currencies into RMB, the functional currency of our operating business. Our results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in our statement of shareholders’ equity. We have not used any forward contracts, currency options or borrowings to hedge our exposure to foreign currency exchange risk. We cannot predict the impact of future exchange rate fluctuations on our results of operations and may incur net foreign currency losses in the adoptionfuture. As our sales denominated in foreign currencies, such as RMB and Euros, continue to grow, we will consider using arrangements to hedge our exposure to foreign currency exchange risk.

Our financial statements are expressed in U.S. dollars but the functional currency of our operating subsidiary is RMB. The value of your investment in our stock will be affected by the foreign exchange rate between U.S. dollars and RMB. To the extent we hold assets denominated in U.S. dollars, any appreciation of the RMB against the U.S. dollar could result in a change to our statement of operations and a reduction in the value of our U.S. dollar denominated assets. On the other hand, a decline in the value of RMB against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results, the value of your investment in our company and the dividends we may pay in the future, if any, all of which may have a material adverse effect on its consolidated financial statements.

the price of our stock.
33

RESULTS OF OPERATIONS

The following table sets forth the results of our operations for the periods indicated as a percentage of net revenues:

33

  Three Months Ended September 30, Nine Months Ended September 30, 
  2008 2007 2008 2007 
  ($) (%) ($) (%) ($) (%) ($) (%) 
Net Revenues  11,770,162  100.0  8,000,293  100.0  31,400,186  100.0  16,589,475  100.0 
Cost of Revenues  8,816,389  74.9  5,633,977  70.4  23,508,720  74.8  11,831,546  71.3 
Gross Profit  2,953,773  25.1  2,366,316  29.6  7,891,466  25.2  4,757,929  28.7 
Operating Expenses  483,790  4.1  291,771  3.7  1,909,366  6.1  773,981  4.7 
Income from Operations  2,469,983  21.0  2,074,545  25.9  5,982,100  19.1  3,983,948  24.0 
Other Income (Expenses)  (18,352) (0.2) 6,761,587  84.5  (2,308,584) (7.4) 6,740,454  40.6 
Income Before Provision for Income Taxes  
2,451,631
  
20.8
  
8,836,132
  
110.4
  3,673,516  11.7  10,724,402  64.6 
Provision for Income Taxes  590,769  5.0  714,840  8.9  1,651,331  5.3  1,315,094  7.9 
Net Income  1,860,862  15.8  8,121,292  101.5  2,022,185  6.4  9,409,308  56.7 
Other Comprehensive Income:                         
  Foreign Currency Translation Adjustment  
67,269
  
0.6
  
299,690
  
3.7
  1,679,553  5.4  523,986  3.2 
                      
Comprehensive Income  1,928,131  16.4  8,420,982  105.2  3,701,738  11.8  9,933,294  59.9 

  Three Months Ended March 31, 
  2009  2008 
  Dollars  Percent  Dollars  Percent 
NET REVENUES $7,860,867   100.0% $8,447,074   100.0%
                 
COST OF REVENUES  6,264,218   79.7%  6,272,826   74.3%
                 
GROSS PROFIT  1,596,649   20.3%  2,174,248   25.7%
                 
OPERATING EXPENSES  578,478   7.3%  694,588   8.2%
                 
INCOME FROM OPERATIONS  1,018,171   13.0%  1,479,660   17.5%
                 
OTHER INCOME (EXPENSES)  (35,452)  0.5%  (2,275,490)  (26.9)%
                 
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES  982,719   12.5%  (795,830)  (9.4)%
                 
PROVISION FOR INCOME TAXES  336,661   4.3%  454,031   5.4%
                 
NET INCOME (LOSS)  646,058   8.2%  (1,249,861)  (14.8)%
                 
OTHER COMPREHENSIVE INCOME                 
Foreign currency translation adjustment  41,540   0.5%  1,007,245   11.9%
                 
COMPREHENSIVE INCOME (LOSS) $687,598   8.7% $(242,616)  (2.9)%
The following table sets forth information as to the gross margin for our two lines of business for the three and nine months ended September 30, 2008March 31, 2009 and 2007.2008.
 
  
For the Three Months Ended
September 30,
 
For the Nine Months Ended
September 30,
 
  2008 2007 2008 2007 
Dyeing and finishing equipment:
         
Net revenues $5,958,627 $6,287,788 $17,125,918 $14,487,221 
Cost of sales  4,388,985  4,419,881  12,655,396  10,259,754 
Gross profit  1,569,642  1,867,907  4,470,523  4,227,467 
Gross margin  26.3% 29.7% 26.1% 29.1%
Forged rolled rings and electric power equipment
             
Net revenues $5,811,535 $1,712,505 $14,274,268 $2,102,254 
Cost of sales  4,427,404  1,214,096  10,853,324  1,571,792 
Gross profit  1,384,131  498,409  3,420,944  530,462 
Gross margin  23.8% 29.1% 24.0% 25.2%
  Three Months Ended December 31, 
  2009  2008 
Dyeing and finishing equipment:      
Revenue $3,529,441  $4,653,138 
Cost of sales  2,778,325   3,439,227 
Gross profit  751,116   1,213,911 
Gross margin  21.3%  26.1%
         
Forged rolled rings and electric power equipment:        
Revenue $4,331,426  $3,793,936 
Cost of sales  3,485,893   2,833,599 
Gross profit  845,533   960,337 
Gross margin  19.5%  25.3%
Revenues. For the three months ended March 31, 2009, we had revenues of $7,860,867, as compared to revenues of $8,447,074 for the three months ended March 31, 2008, a decrease of approximately 6.9%. The decrease in total revenue was attributable to decrease in Dyeing revenues offset by an increase in revenue from forged rolled rings and is summarized as follows:

34

Nine Months Ended September 30, 2008 and 2007
  
For the Three
Months Ended
March 31, 2009
  
For the Three
Months Ended
March 31,
2008
  
 
Increase
(Decrease)
  
 
Percentage
Change
 
Dyeing and finishing equipment $3,529,441  $4,653,138  $(1,123,697)  (24.1)%
Forged rolled rings - wind power industry  2,724,131   961,290   1,762,841   183.4%
Forged rolled rings – other industries  1,607,295   2,242,976   (635,681)  (28.3)%
Electrical equipment  -   589,670   (589,670)  (100.0)%
                 
  Total net revenues $7,860,867  $8,447,074  $(586,207)  6.9%

Revenues. ForThe decrease in revenues from the nine months ended September 30, 2008, we had revenuessale of $31,400,186, as compared to revenues of $16,589,475 for the nine months ended September 30, 2007, an increase of approximately 89.3%. The increase in total revenuedyeing and finishing equipment was attributable to increases from bothdecreased sales of our segmentsequipment to the textile industry due to the impact that the global recession had on the textile industry in China.  We have experienced, and is summarizedwe are continuing to experience, a decline in orders for our textile dyeing machines and domestic competition have required us to lower our selling prices to compete with other companies in China that sell similar products. We are currently evaluating the market and cannot predict when the textile market will recover from this downturn.  Although we believe that recent policy measures initiated by the Chinese government may stimulate the textile industry and we have seen an increase in orders for textile equipment, we are experienced pricing pressures from other suppliers. We cannot predict the level of revenues associated with the lowering of our sale price as follows:we continue to evaluate profitability.  However, we do not plan to seek or accept orders at prices which we do not believe will generate an acceptable margin.

  
For the Nine
Months Ended
September 30,
2008
 
For the Nine
Months Ended
September 30,
2007
 Increase  
Percentage
Change
 
Dyeing and finishing equipment $17,125,918 $14,487,221 $2,638,697  18.2%
Forged rolled rings - wind power industry  5,124,872  75,619  5,049,253  * 
Forged rolled rings – other industries  7,419,590  293,836  7,125,754  * 
Electrical equipment  1,729,806  1,732,799  (2,993) 0.1%
              
Total net revenues $31,400,186 $16,589,475 $14,810,711  89.3%

* Because the salesRevenues from forging of rolled rings for the ninewind power industry amounted to $2,724,131 and revenues from other forging operations amounted to $1,607,295.  Due to the deliberate shift in focus of our sales effort to the wind segment, we increased sales of forged rolled rings to the wind power industry by 183% in the quarter compared to the same quarter in 2008, while we experienced a 28% decline in forging revenues from other industries such as the railway, heavy machinery manufacturing, petrochemical, metallurgical, sea port machinery, and defense and radar industry.  As the wind power industry continues to grow, we expect the shortage of key components such as gearboxes and bearings to continue.  As a result, we expect to see continued demand for our forged products coming from the wind power industry.  As described under “Overview,” we did not generate any revenue from auxiliary electric power equipment during the three months ended September 30, 2007 was minimal,March 31, 2009.  As China continues to promote renewable energy and environmental sustainability while seeking to expand its economy, we expect to gradually move away from the percentage increase is not meaningful.

Ourauxiliary electric power equipment business (which generated about 5.5% of our revenue increases were attributable to:in 2008) and focus more on the forging business, particularly for the wind power industry.
 
·The increase in revenues from the sale of dyeing and finishing equipment was attributable to continued strong sales of our equipment to the textile industry. However, the recent economic slowdown has affected various countries, especially the export sector in China. We expect to see a decreasing trend in our dyeing and finishing equipment business as we see the textile industry impacted by recessions in other countries. Yet, we remain confident with the outlook of our forging business for the wind power industry as the Chinese government is committed to supporting wind power in order to reduce the Country’s reliance on coal.
·We have experienced an increase in revenues from the sale of forged rings to the other industries such as the railway, heavy machinery manufacturing, petrochemical, metallurgical, sea port machinery, and defense and radar industry. This source of revenue was nominal for the nine months ended September 30, 2007.
·Revenue from the sale of forged rings to the wind power industry, which was nominal in the nine months ended September 30, 2007 increased to $5 million and is attributable to the demand for our forged rolled rings that will be used in the production of wind turbine components such as gear boxes and yaw bearings. During the period, the wind power industry experienced tremendous growth and the industry faced a serious shortage of various components, principally gearboxes and bearings.
·The change in revenues from the sale of standard and custom auxiliary equipment for use in the power industry in China was minimal and is attributable to the continued sale of additional pieces of equipment to the power industry.

Cost of sales. Cost of sales for the ninethree months ended September 30, 2008 increased $11,677,174March 31, 2009 decreased $8,608, or 98.7%0.1%, from $11,831,546$6,272,826 for the ninethree months ended September 30, 2007March 31, 2008 to $23,508,720$6,264,218 for the ninethree months ended September 30, 2008.March 31, 2009. Cost of goods sold for Dyeing was $12,655,396$2,778,325 for the ninethree months ended September 30, 2008,March 31, 2009, as compared to $10,259,754$3,439,227 for the nine months ended September 30, 2007.same period year in 2008. Cost of sales related to the manufacture of forged rolled rings and other components and electric power generating equipment and was $10,853,324$3,485,893 for the ninethree months ended September 30, 2008March 31, 2009 as compared to $1,571,792$2,833,599 for the nine months ended September 30, 2007.same period year 2008.

Gross profit and gross margin. Our gross profit was $7,891,466$1,596,649 for the ninethree months ended September 30, 2008March 31, 2009 as compared to $4,757,929$2,174,248 for the nine months ended September 30, 2007,same period in 2008, representing gross margins of 25.2%20.3% and 28.7%25.7%, respectively. Gross profit for Dyeing was $4,470,523$751,116 for the ninethree months ended September 30, 2008March 31, 2009 as compared to $4,227,467$1,213,911 for the nine months ended September 30, 2007,comparable period in 2008, representing gross margins of approximately 26.1%21.3% and 29.1%26.1%, respectively. The modest decrease in our gross margin for Dyeing was attributable to an increase in the cost of raw material costsmaterials, such as steel and other metals, which could not be passed on to our customers during that period.period as well as a reduction of our sales price due to stronger competition resulting from the downturn in the textile industry in China. Gross profitsprofit from forged rolled rings and electric power equipment segment were $3,420,944was $845,533 for the ninethree months ended September 30, 2008March 31, 2009 as compared to $530,462$960,337 for the nine months ended September 30, 2007,same period in 2008, representing gross margins of approximately 24.0%19.5% and 25.2%25.3%, respectively. The decrease in our gross margin for forging was attributable to an increase in the cost of raw materials, such as steel and other metals, which could not be passed on to our customers, and operational inefficiencies as we operated at low production levels, as we manufactured sample units for customers, but incurred significant start-up costs in addition to the normal fixed-costs associated with operating our new forging facilities.  Some of the costs incurred in the first quarter related to costs of test production runs, utilities to power our new production ovens, and payroll costs. We expect gross margins to improve as we become more efficient and produce larger quantities for inventory.

35

Depreciation. Depreciation and amortization expense. Forwas $175,113 for the ninethree months ended September 30,March 31, 2009 and $159,062 for the comparable period in 2008, and 2007, depreciation expense amounted to $482,376 and $450,881, of which $254,187$97,583 in the 2009 quarter and $243,006$81,042 in the 2008 quarter is included in cost of sales and $228,189$77,530 in the 2009 quarter and $207,875$78,020 in the 2008 quarter is included in operating expenses, respectively. The overall increaseexpenses. Commencing in the second quarter of 2009, we will commence depreciation on our new factory building and amortization reflects additionrelated equipment, which we purchased.will increase our depreciation expense.

Selling, general and administrative expenses. Selling, general and administrative expenses totaled $1,681,177$500,948 for the ninethree months ended September 30, 2008,March 31, 2009, as compared to $566,106$616,568 for the nine months ended September 30, 2007, an increasesame period in 2008, a decrease of $1,115,071$115,620 or approximately 197.0%18.8%. Selling, general and administrative expenses consisted of the following:

  
Nine Months Ended
September 30, 2008
 
Nine Months Ended
September 30, 2007
 
Professional fees $398,724 $- 
Payroll and related benefits  334,314  55,166 
Travel  175,199  130,249 
Bad debt expense  171,816  182,882 
Other  601,124  197,809 
  $1,681,177 $566,106 
  2009  2008 
Professional fees $147,559  $241,705 
Bad debt  1,109   - 
Compensation and related benefits  102,664   119,816 
Travel  38,268   82,392 
Other  211,348   172,655 
  $500,948  $616,568 

 ·●Since the share exchange in November 2007, we have incurred professional fees, principally as a result of our status as a public company. For the ninethree months ended September 30,March 31, 2008, professional fees amountedwe incurred additional legal expense of approximately $110,000 related to $398,724 as compared to $0 in the 2007 period. Our professional fees consisted primarilyfiling of legal feesa registration statement covering stock issuable upon exercise of $165,027, audit fees of $103,020, investor relation fees of $108,055, and other professional fees.warrants.
 ·●PayrollBad debt increased by $1,109. In 2008, we did not have any bad debt expense.  Based on our periodic review of accounts receivable balances, we recorded bad debt expense and increased the allowance for doubtful accounts after considering management’s evaluation of the collectability of individual receivable balances, including the analysis of subsequent collections, the customers’ collection history, and recent economic events.
●Compensation and related benefits increaseddecreased for the ninethree months ended September 30, 2008March 31, 2009 by $279,148,$17,152, or 506.0%14.3%, as compared to the ninesame period in 2008. For the three months ended September 30, 2007. In November 2007,March 31, 2009, we hired additional personnel in accounting, our chief financial officer, a translator, and administration staff due to our increased operations and additional workload in connection with being a public company. Additionally, thehad an increase in payrollcompensation and related benefits reflected stock based compensation of $75,000$8,317 in both our dying and rolled rings operations resulting from the issuanceexpansion of common stock to two independent directors,our rolled rings operations, and net decrease in compensation for our unallocated overhead of $25,469 consisting of a decrease in stock-based compensation of $37,969 offset by an increase in executive compensation of $12,500.
 ·●Travel expense for the ninethree months ended September 30, 2008 increasedMarch 31, 2009 decreased by $44,950,$44,124, or 34.5%53.6%, as compared to the nine months ended September 30, 2007.same period in 2008. The increasedecrease is related to increaseda decrease in travel by sales personnel and engineers as well as increaseddecreased travel due tofor investor road shows.
·Bad debts expenses decreased by $11,066 for the nine months ended September 30, 2008 as compared to the nine months ended September 30, 2007 based on our analysis of accounts receivable balances.
 ·●Other selling, general and administrative expenses increased by $403,315$38,693 for the ninethree months ended September 30, 2008March 31, 2009 as compared towith the nine months ended September 30, 2007 due to increased operations, increasessame period in insurance expense due to our directors’ and officers’ liability policy, and increase in rent expense related to our land use rights.2008.

Income from operations. For the ninethree months ended September 30, 2008,March 31, 2009, income from operations was $5,982,100$1,018,171, as compared to $3,983,948$1,479,660 for the ninethree months ended September 30, 2007, an increaseDecember 31, 2008, a decrease of $1,998,152$461,489 or 50.2%31.2%.

Other income (expenses). For the ninethree months ended September 30, 2008,March 31, 2009, other expense amounted to $2,308,584$35,452 as compared to other incomeexpense of $6,740,454$2,275,490 for the ninesame period in year 2008.  For the three months ended September 30, 2007. March 31, 2009, other income (expense) included:
●interest expense of $23,671, consisting of non-cash interest expense of $1,500 from the amortization of debt discount arising from our March 2009 financing and interest expense of $22,171 incurred on our outstanding loans:;
●amortization of debt issuance costs of $12,000; and
●nominal foreign currency losses and interest income.
36

For the ninethree months ended September 30,March 31, 2008, other expenses included i) interest expense of $2,298,874 consisting of non-cash interest expense of $2,263,661 from the amortization of the balance of debt discount arising from the valuation of the beneficial conversion features recorded in connection with our November 2007 private placement offset by the reversal of accrued interest of $20,719 and ii) amortization of debt issuance costs of $21,429 and iii) interest income of $11,719. For the nine months ended September 30, 2007, other income consisted of interest expense of $31,360 offset by interest income of $372.included:
Additionally, in the 2007 period, other income includes a gain from the forgiveness of income and value-added taxes of $6,771,442 and reflects the reversal of tax accruals previously made resulting from the grant by the local tax agency to the Huayang Companies of a special tax exemption and release from any unpaid corporate income tax and value added tax liabilities and any related penalties through September 30, 2007. This waiver covered all tax reporting periods through September 30, 2007.
●non-cash interest expense of $2,263,661from the amortization of the balance of debt discount arising from the valuation of the beneficial conversion features recorded in connection with our November 2007 private placement offset by the reversal of accrued interest of $20,719;
●amortization of debt issuance costs of $21,429, and
●interest income of $5,633.
 
.           Income tax expense. Income tax expense increased $336,237decreased $117,370, or approximately 25.5% during25.8%, for the ninethree months ended September 30,March 31, 2009 as compared to the comparable period in 2008 primarily as a result of the increasedecrease in taxable income generated by our operating entities.

36

Net income (loss).For the nine months ended September 30, 2008, we recorded net income of $2,022,185 as compared to net income of $9,409,308 for the nine months ended September 30, 2007. For the nine months ended September 30, 2008, we recorded a deemed beneficial dividend related to the fair value of warrants granted in March 2008 as As a result of the automaticfactors described above, our net income for the three months ended March 31, 2009 was $646,058, or $0.01 per share (basic and diluted).  For the three months ended March 31, 2008, we had a net loss of $1,249,861.   The conversion of our convertible debtnotes into shares of series A preferred stock and warrants uponin the amendmentfirst quarter of our certificate of incorporation to create2008 resulted in a class ofdeemed preferred stock anddividend of $2,884,923, representing the creationvalue of the series A preferred stock. This deemed dividend reducedwarrants issued to the investors.  As a result, the net income availableloss attributable to common stockholders. Accordingly, for the nine months ended September 30, 2008, we generated a net loss available to common stockholders of $861,877shareholders was $4,133,923, or $(0.02)$(0.11) per share (basic and diluted) as compared to net income per common share of $0.26 (basic and diluted) for the nine months September 30, 2007..

Foreign currency translation gain. The functional currency of our subsidiaries operating in the PRC is the Chinese Yuan or Renminbi (“RMB”). The financial statements of our subsidiaries are translated to U.S. dollars using period end rates of exchange for assets and liabilities, and average rates of exchange (for the period) for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations. As a result of these translations, which are a non-cash adjustment, we reported a foreign currency translation gain of $1,679,553$41,540 for the ninethree months ended September 30, 2008March 31, 2009 as compared to $523,986$1,007,245 for comparablethe same period in 2007.year 2008. This non-cash gain had the effect of increasing our reported comprehensive income.
 
Comprehensive income (loss). income. For the ninethree months ended September 30, 2008,March 31, 2009, comprehensive income of $3,701,738$687,598 is derived from the sum of our net income of $2,022,185$646,058 plus foreign currency translation gains of $3,701,738.$41,540.

Three Months Ended September 30, 2008 and 2007Non-GAAP Information

Revenues. ForWe believe that net income, as adjusted for certain non-cash expenses, which is a non-GAAP performance measure, is reasonable means of understanding our business in view of the three months ended September 30,significant non-cash charges which we believe do not relate to the operation of our business.  In connection with our November 2007 private placement, we issued 3% convertible notes to the investors in the principal amount of the $5,525,000.  Because of the favorable conversion terms, the debt was issued deemed issued as a discount of $2,610,938.  Upon the conversion of the debt into equity in March 2008, we had revenuesthe unamortized debt discount of $11,770,162,$2,263,661 was fully amortized and treated as comparedadditional interest, and the relative fair value of the warrants granted in March 2008 related to revenuesour November 2007 private placement of $8,000,293$2,884,062 was classified as a deemed dividend to the holders of the series A preferred stock. The amortization of the debt discount and the deemed dividend are non-cash events which do not affect our operations.  The following table shows the relationship between net income (loss) allocable to common shareholders and net income, as adjusted, for the three months ended September 30, 2007, an increase of $3,769,869 or approximately 47.1%. The increase in total revenue was attributable to increases from both of our segmentsMarch 31, 2009 and is summarized as follows:2008.

  
For the Three
Months Ended
September 30,
2008
 
For the Three
Months Ended
September 30,
2007
 Increase  
Percentage
Change
 
Dyeing and finishing equipment $5,958,627 $6,287,788 $(329,161) (5.2)%
Forged rolled rings - wind power industry  2,494,123  66,994  2,427,129  * 
Forged rolled rings – other industries  2,764,328  267,973  2,496,355  * 
Electrical equipment  553,084  1,377,538  (824,454) (59.8)%
              
Total net revenues $11,770,162 $8,000,293 $3,769,869  47.1%

*    Because the sales for the three months ended September 30, 2007 was minimal, the percentage increase is not meaningful.

  
Three Months Ended
March 31,
 
  2009  2008 
Net income (loss) allocable to common shareholders $646,058  $(4,133,923)
Add back of:        
    Deemed dividend to preferred stockholders  -   2,884,062 
    Non-cash interest from amortization of debt discount  23,671   2,263,661 
    Amortization of debt issuance costs  -   21,429 
    Reversal of accrued interest      (20,719)
         
Net income, as adjusted $669,729  $1,014,510 
·Increases in revenues for the three months ended September 30, 2008 as compared to the three months ended September 30, 2007 are attributable to similar explanations provided in our discussion of results of operations for the nine month period. We had a decrease in revenues of dyeing and finishing machines. The recent economic slowdown has affected various countries, especially the export sector in China. We expect to see a decreasing trend in our dyeing and finishing equipment business as we see the textile industry impacted by recessions in other countries. Yet, we remain confident with the outlook of our forging business for the wind power industry as the Chinese government is committed to supporting wind power in order to reduce the China’s reliance on coal. For the three months ended September 30, 2007, we had recognized increased revenues from the shipment of more units of electrical equipment as compared to the three months ended September 30, 2008.

37

CostFor the reasons discussed under “Results of sales. Cost of salesOperations,” our net income, as adjusted, decreased from $1,014,510, or $0.027 per share (basic) and $0.016  (diluted), for the three months ended September 30,March 31, 2008 increased $3,182,412to $669,729, or 56.4%$0.01 per share (basic and diluted), from $5,633,977 for the three months ended September 30, 2007 to $8,816,389 for the three months ended September 30, 2008. Cost of goods sold for Dyeing was $4,388,985 for the three months ended September 30, 2008, as compared to $4,419,881 for the three months ended September 30, 2007. Cost of sales related to the manufacture of forged rolled rings and other components, and electric power generating equipment and was $4,427,404 for the three months ended September 30, 2008 as compared to $1,214,096 for the three months ended September 30, 2007.March 31, 2009.

Gross margin. Our gross profit was $2,953,773 for the three months ended September 30, 2008 as compared to $2,366,316 for the three months ended September 30, 2007, representing gross margins of 25.1% and 29.6%, respectively. Gross profit for Dyeing was $1,569,642 for the three months ended September 30, 2008 as compared to $1,867,907 for the three months ended September 30, 2007, representing gross margins of approximately 26.3% and 29.7%, respectively. Gross profit related to the forged rolled rings and electric power equipment was $1,384,131 for the three months ended September 30, 2008 as compared to $498,409 for the three months ended September 30, 2007, representing gross margins of approximately 23.8% and 29.1%, respectively. The decrease in our gross margin was attributable to an increase in raw material costs such as steel and other metals which could not be passed on to our customers during that period as well as a decrease in revenues.

Depreciation and amortization expense. Depreciation and amortization amounted to $159,454 for the three months ended September 30, 2008 and $151,430 for the three months ended September 30, 2007, of which $89,742 and $82,823 is included in cost of sales and $69,712 and $68,607 is included in operating expenses, respectively. The overall increase in depreciation and amortization reflects addition equipment which we purchased.

Selling, general and administrative expenses. Selling, general and administrative expenses totaled $483,790 for the three months ended September 30, 2008, as compared to $291,771 for the three months ended September 30, 2007, an increase of $192,019 or approximately 86%. Selling, general and administrative expenses consisted of the following:

  
Three Months Ended
September 30, 2008
 
Three Months Ended
September 30, 2007
 
Professional fees $18,204 $- 
Payroll and related benefits  111,793  32,537 
Travel  73,003  46,281 
Bad debt  1,792  49,190 
Other  209,286  95,156 
  $414,078 $223,164 

·Since the share exchange in November 2007, we have incurred professional fees, principally as a result of our status as a public company. For the three months ended September 30, 2008, professional fees amounted to $18,204 as compared to $0 in the 2007 period.
·Payroll and related benefits increased for the three months ended September 30, 2008 by $79,256, or 243.6%, as compared to the three months ended September 30, 2007. In November 2007, we hired additional personnel in accounting, our chief financial officer, a translator, and administration staff due to our increased operations and additional workload in connection with being a public company.
·For the three months ended September 30, 2008, travel expense increased by $26,722, or 57.7%, as compared to the three months ended September 30, 2007 as a result of increased travel by sales personnel as well as increased travel for investor road shows.
·Bad debts expenses increased by $1,792 for the three months ended September 30, 2008 as compared to the three months ended September 30, 2007 based on our analysis of accounts receivable balances.
·Other selling, general and administrative expenses increased by $114,130 for the three months ended September 30, 2008 as compared with the three months ended September 30, 2007 primarily resulting from an increase in insurance expense and rent expense related to prepaid land use rights.

Income from operations. For the three months ended September 30, 2008, income from operations was $2,469,983 as compared to $2,074,545 for the three months ended September 30, 2007, an increase of $395,438 or 19.1%.

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Other income (expenses). For the three months ended September 30, 2008, other expense amounted to $18,352 as compared to other income of $6,761,587 for the three months ended September 30, 2007. For the three months ended September 30, 2008, other expenses reflected interest expense of $20,427 offset by interest income of $2,075. For the three months ended September 30, 2007, other income consisted of interest expense of $9,946 offset by interest income of $91. Additionally, for the three months ended September 30, 2007, other income includes a gain from the forgiveness of income and value-added taxes of $6,771,442 and reflects the reversal of tax accruals previously made resulting from the grant by the local tax agency to the Huayang Companies of a special tax exemption and release from any unpaid corporate income tax and value added tax liabilities and any related penalties through September 30, 2007. This waiver covered all tax reporting periods through September 30, 2007.

Income tax expense. Income tax expense decreased $124,071 or approximately 17.4% during the three months ended September 30, 2008 primarily as a result of the increase in taxable income generated by our operating entities offset by a reduction in the statutory rate from 33% to 25%.
Net income.For the three months ended September 30, 2008, we recorded net income of $1,860,862, or $0.05 per share (basic) and $0.03 per share (diluted) as compared to net income of $8,121,292, or $0.22 per share (basic and diluted) for the three months ended September 30, 2007. 

Foreign currency translation gain. The functional currency of our subsidiaries operating in the PRC is the Chinese Yuan or Renminbi (“RMB”). The financial statements of our subsidiaries are translated to U.S. dollars using period end rates of exchange for assets and liabilities, and average rates of exchange (for the period) for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations. As a result of these translations, which are a non cash adjustment, we reported a foreign currency translation gain of $67,269 for the three months ended September 30, 2008 as compared to $299,690 for comparable period in 2007. This non-cash gain had the effect of increasing our reported comprehensive income.
Comprehensive income. For the three months ended September 30, 2008, comprehensive income of $1,928,131 is derived from the sum of our net income of $1,860,862 plus foreign currency translation gains of $67,269.

Liquidity and Capital Resources

Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis.  At September 30, 2008March 31, 2009 and December 31, 2007,2008, we had cash balances of $744,885$107,910 and $5,025,434,$328,614, respectively. These funds are located in financial institutions located as follows:

  
September 30, 2008
 
December 31, 2007
 
Country:             
United States $29,308  3.9%$171,121  3.4%
China  715,577  96.1% 4,854,313  96.6%
Total cash and cash equivalents $744,885  100.0%$5,025,434  100.0%
  March 31, 2009  December 31, 2008 
Country:            
United States $11,759   10.9% $832   0.3%
China  96,151   89.1%  327,782   99.7%
Total cash and cash equivalents $107,910   100.0% $328,614   100.0%

The following table sets forth information as to the principal changes in the components of our working capital from December 31, 2008 to March 31, 2009 (dollars in thousands):
     
December 31, 2008 to
March 31, 2009
 
Category 2009  2008  Change  Percent
Change		 
Current assets:            
Cash and cash equivalents $108  $329   (221)  (67.2) %
Notes receivable  200   270   (70)  (25.9)%
Accounts receivable, net  4,900   4,518   382   8.5%
Inventory  2,410   1,892   518   27.4%
Advances to suppliers  102   118   (16)  (13.5) %
Due from related party  -   437   (437)  (100.0)%
Prepaid expenses and other current assets  79   22   57   259.1%
Current liabilities:                
Loans payable  1,315   1,021   294   28.8%
Accounts payable  2,446   2,485   (39)  (1.6)%
Accrued expenses  234   188   46   24.5%
VAT and service taxes payable  -   97   (97)  (100.0) %
Advances from customers  100   46   54   117.4%
Income tax payable  337   569   (232)  (40.8)%
Working capital:                
Total current assets  7,799   7,586   213   2.8%
Total current liabilities  4,431   4,406   25   * 
Working capital  3,368   3,180   188   5.9%
*           Less than 1%.

Our working capital position decreased $1,112,090increased approximately $188,000 to $2,073,185$3,368,000 at September 30, 2008March 31, 2009 from working capital of $3,185,275$3,179,265 at December 31, 2007.2008. This decreaseincrease in working capital is primarily attributable to a decrease in cash of $4,280,549 and an increase in accounts payable of $1,356,837 offset by a net increase into.

At March 31, 2009, our accounts receivable were $4,900,064, of $1,784,182which $1,960,910 were generated from our Dyeing segment and $2,939,153 were generated by our forged rolled rings segment.   We believe that our collection remains strong and that our reserves for bad debts reflect the conversionrisk of convertible debt of $3,261,339 into shares ofnonpayment by our series A preferred stock and warrants.customers. However, the worldwide economic downturn may affect our customers’ ability to pay, particularly in the Dyeing segment.
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Net cash flow provided by operating activities was $5,039,650$188,547 for the ninethree months ended September 30, 2008March 31, 2009 as compared to net cash flow provided byused in operating activities was $6,168,220of $2,096,821 for the ninethree months ended September 30, 2007, a decreaseMarch 31, 2008, an increase of $1,128,570.$2,285,368. Net cash flow provided by operating activities for the ninethree months ended September 30, 2008March 31, 2009 was mainly due to net income of $2,022,185,$646,058, the add-back of non cash items such as depreciation of $175,113 the amortization of debt discount of $1,500, the amortization of land-use rights of $21,585 and stock-based compensation of $42,031,  a decrease in notes receivable of $70,041, a decrease in due from related party of $438,174, an increase of accrued expense of $45,669 and an increase in advances from customers of $54,282, offset by an increase in inventory of $515,182, a decrease in income tax payable of $233,343 and an increase in accounts receivable of $377,183. For the three months ended March 31, 2008, net cash flow used in operating activities was mainly due to the decrease in accounts payable of $1,225,962, an increase in accounts receivable of $1,263,740 and an increase in inventories of $1,136,507, which was offset by the add-back of non-cash items of depreciation and amortization of $482,376,$159,062, the amortization of debt discount of $2,263,661, the amortization of deferred debt costs of $21,429 the increase in our allowance for bad debt of $171,816, non-cash rent expense associated with prepaid land use rights of $63,346, and the add-back of stock-based compensation of $75,000, the decrease in prepaid and other assets of $280,762 and advances to suppliers of $726,728 and an increase in accounts payable of $1,189,915 offset by an increase in accounts receivable of $1,777,797, inventories of $124,107, and the payment of VAT and service taxes of $389,946. Net cash flow provided by operating activities for the nine months ended September 30, 2007 was mainly due to our net income of $9,409,308, a decrease in inventories of $426,386, and increase in accounts payable of $1,153,705, an increase in VAT and services taxes payable of $1,011,064, an increase in income taxes payable of $957,899, and increase in advanced from customers of $1,830,260, and the add-back of non-cash items of depreciation and amortization of $450,881 offset by an increase in accounts receivable of $2,538,272, increases in advances to suppliers of $127,886, and the add back of other income from forgiveness of income and VAT taxes of $6,771,442.

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$45,000.
 
Net cash flow used in investing activities was $11,537,578$951,736 for the ninethree months ended September 30, 2008March 31, 2009, as compared to net cash used in investing activities of $6,269,587$694,629 for the ninethree months ended September 30, 2007.March 31, 2008. For the ninethree months ended September 30,March 31, 2009, we used cash to purchase of property and equipment of $951,736.  For the three months ended March 31, 2008, we received cash from the repayment of amounts due from related parties of $145,808$96,650 and from the sale of our cost-method investee of $35,720$34,840 offset by the purchase of property and equipment of $11,629,385$3,907 and the payment of deposits on factory equipment of $89,721. For the nine months ended September 30, 2007, we used cash for advances for amounts due from related parties of $486,032 and for the purchase of property and equipment of $17,581, and cash used deposits on long-term assets – related party of $5,792,030.$822,212.

Net cash flow provided by financing activities was $2,051,476$542,116 for the ninethree months ended September 30, 2008March 31, 2009 as compared to net cash provided by financing activities of $260,561$226,259 for the ninesame period in 2008. For the three months ended September 30, 2007.March 31, 2009, we received gross proceeds from our loans payable of $542,116. For the ninethree months ended September 30,March 31, 2008, we received proceeds from short-term bank loans of $142,880,$139,360, and proceeds from the exercise of warrants of $2,011,575$187,340 offset by the repayment of related party advances of $102,979. For the nine months ended September 30,$100,441.

On November 13, 2007, we receivedraised gross proceeds from short-term bank loans of $260,561.

In July 2007, in connection with the expansion of our forged rolled ring and electrical power equipment segment to develop and market forged rolled rings and related equipment to the wind power industry, we acquired a factory, together with the related land use rights, employee housing facilities and other leasehold improvements$5,525,000 from a related party for a net price of approximately $10,500,000. As of September 30, 2008, the amount was paid in full. We also incurred additional construction and improvement costs and acquired new equipment of approximately $11.6 million for our planned expansion of our rolled ring business to enable us to manufacture larger rolled rings and other components.

At September 30, 2008, we required approximately $2,000,000 in order for us to continue the planned expansion of our business. We raised funds in October 2008 through the sale of debt and equity securities. On October 17, 2008, we entered into a purchase agreement with Eos Holdings LLC for the sale of a 17.4% subordinated note, due six months from the date of issuance (the “Note”)our 3% convertible notes in the principal amount of $575,000, for a$5,525,000. On March 28, 2008, the notes were automatically converted into an aggregate of 14,787,135 shares of series A preferred stock and warrants to purchase price of $575,000. Under the terms of the purchase agreement and the Note, we may prepay the Note, in whole or in part, at any time prior to the maturity date of the Note upon five days’ notice to Eos Holdings. On November 14, 2008, we repaid the principal balance of $575,000 in full.
As a condition to the sale of the Note, the purchase agreement requires that Eos Holdings exercise certain common stock purchase warrants having a total exercise price of not less than $175,000, at a per share exercise price of $.58. On October 17, 2008, Eos Holdings purchased the Note and exercised the warrants.
Payment of our obligations of the Note were initially secured by a pledge of and conversion right with respect to 959,000 shares (the “Pledged Shares”) of the Company’s common stock owned by Jianhua Wu, the Company’s chief executive officer and principal beneficial owner of common stock. The pledge and conversion right enables Eos Holdings to convert any or all of the principal amount of the Note into Pledged Shares at any time or from time to time until the Note shall be paid in full or until Eos Holdings shall have exercised the conversion right in full, at an initial conversion price of $.60 per share (the “Conversion Price”). The number of Pledged Shares to be delivered shall be determined by dividing the principal amount of the Note being converted by the Conversion Price, with any fractional shares to be rounded to the nearest whole share. The Pledged Shares shall be held in escrow.
On October 23, 2008, pursuant to a restated pledge and conversion right agreement, the number of Pledged Shares was increased to 1,437,50011,176,504 shares of common stock at $0.58 per share, 5,588,252 shares of common stock at $0.83 per share, and 2,065,000 shares of common stock at $0.92 per share upon the Conversion Pricefiling of the restated certificate of incorporation and a statement of designations setting forth the rights of the holders of the series A convertible preferred stock. In November 2008, as a result of our sale of common stock at $0.40 per share, the exercise price of warrants to purchase 6,501,077 shares of common stock was reduced to $0.40 per share.

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share, and the exercise price of warrants to purchase 9,232,424 was reduced to $0.567 per share, which was further reduced to $0.566 as a result of the issuance of warrants in our March 2009 debt financing.

In connection with2008, we received $2,187,566 from the issuanceexercise of warrants to purchase 3,096,255 shares of common stock.  As of the Note, on October 17, 2008, we entered into a consulting agreement with Eos Asia Investments Ltd., an affiliate of Eos Holdings, for the provision of consulting services. Pursuant to the consulting agreement, we shall pay consulting fees at a rate of $31,662.50 per month until the Company repays the Note in full or until Eos Holdings LLC exercises its right to receive the Pledged Shares. Assuming the Note is paid on the maturity date of April 20, 2009,this report, the total payments made by usmarket price for our common stock is less than the exercise price of the warrants and we have not registered the shares of common stock underlying the warrants.  As a result, we do not anticipate that we will receive any proceeds from the exercise of the warrants issued in the November  private placement unless the market price of the stock is greater than the exercise price, as interest onto which we can give no assurance, and we have registered the $575,000 Note and as consulting fees under the consulting agreement would total $240,000. On November 14, 2008, we repaid the principal balance of $575,000 in full.underlying common stock.

During the period from October 23, 2008 through November 7, 2008,In March 2009, we sold anto two investors our 18-month, 15% notes in the aggregate principal amount of 3,400,000$250,000 and warrants to purchase 437,500 shares of the Company’s common stock at a purchasean exercise price of $0.40 per share.  Pursuant to the related purchase agreements, our chief executive officer placed 1,531,250 shares of common stock into escrow.  The note holders have the right to take these shares, valued at $0.20 per share, in payment of the interest or principal, as the case may be, if we do not pay the interest on or principal of the note before it becomes an event of default.  Pursuant to the loan documents, in the event of that Leo Wang ceases to be employed by us as our chief financial officer the holders of not less than $126,000 principal amount of the notes, shall have the right, on not less than 60 days’ notice, to declare the notes in default.  If Mr. Wang ceases to be employed by us as a result of his death, disability or a termination for an aggregatecause, than we shall have 60 days to replace Mr. Wang with a chief financial officer acceptable to investors.

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We are currently engaged in negotiating the terms of $1,360,000.a loan of RMB 6 million to RMB 10 million (approximately $875,000  to $1.5 million) from a bank in Wuxi, using our newly completed forging facility and the land it sits on as collateral.  We can give no assurance that we will be able to obtain such financing.   We are also looking into ways to speed up the collection of our accounts receivable to improve our cash flow.   If we are unable to obtain such financing, we may need to seek financing from other sources.  During the fourth quarter of 2008 and the first quarter of 2009 we raised funds through the sale of equity and the issuance of notes on terms that were not favorable.  In the event that we require additional financing, we cannot assure you we will be able to obtain funding on favorable terms, if any.  We expect that any equity financing would result in dilution to our stockholders.

Certain of the investors had previously signed subscription agreements for the purchase of shares at a price of $0.60 per share. These investors signed a restated subscription agreement that reflected the $0.40 per share purchase price.
Contractual Obligations and Off-Balance Sheet Arrangements
 
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 have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, 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 tables summarize our contractual obligations as of September 30, 2008,March 31, 2009, and the effects ofeffect these obligations are expected to have on our liquidity and cash flows in future periods.

  
Payments Due by Period
 
  
Total
 
Less than
1 year
 
1-3 Years
 
3-5
Years
 
5 Years
+
 
Contractual Obligations :
           
Bank indebtedness (1) $1,021,138 $1,021,138 $- $- $- 
Equipment purchases  2,000,000  2,000,000             
Total Contractual Obligations: $3,021,138 $3,021,138 $- $- $- 
 Payments Due by Period 
 Total Less than
1 year		 1-3 Years 
3-5
Years
 
5 Years
+
 
   
Contractual Obligations :
          
Bank indebtedness (1) $1,168,634  $1,168,634  $-  $-  $- 
Loans payable  396,079   146,079   250,000   -   - 
Total Contractual Obligations: $1,564,713  $1,314,713  $250,000  $-  $- 
 
(1)Bank indebtedness includes short term bank loans and notes payable.
(1)Bank indebtedness consists of short term bank loans.
 
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 shareholder’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.

Foreign Currency Exchange Rate Risk

We produce and sell almost all our products in China. Thus, most of our revenues and operating results may be impacted by exchange rate fluctuations between RMB and US dollars.  For the three months ended March 31, 2009, we has unrealized foreign currency translation gain of $41,540, because of the change in the exchange rate.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Foreign Currency Exchange Rate RiskNot required for smaller reporting companies.

We produce and sell almost all our products in China. Thus, most of our revenues and operating results may be impacted by exchange rate fluctuations between RMB and US dollars. For the nine months ended September 30, 2008, we has unrealized foreign currency translation gain of $1,679,553, because of the change in the exchange rate.

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ITEMITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As required by Rule 13a-15 under the Exchange Act, our management, including our Chief Executive Officer,chief executive officer and our Chief Financial Officer,chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2008.March 31, 2009.

Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.

Management conducted its evaluation of disclosure controls and procedures under the supervision of our chief executive officer and our chief financial officer. Based on that evaluation, we concluded that because of the significant deficiencies in internal control over financial reporting described below, our disclosure controls and procedures were not effective as of DecemberMarch 31, 2007.2009.
 
Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act.  Our management is also required to assess and report on the effectiveness of our internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”).   Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007.2008.  In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework.  During our assessment of the effectiveness of internal control over financial reporting as of December 31, 2007,2008, management identified significant deficiencies related to (i) the U.S. GAAP expertise of our internal accounting staff, (ii) our internal audit functions and and (iii) a lack of segregation of duties within accounting functions.

Although we wereWe became a black check shellreporting company prior toin November 13, 2007 with reporting obligations, our present business did not become subject to the reporting requirements of the Exchange Act until November 13, 2007.  We began preparing to be in compliance with the internal control obligations, including Section 404, for our fiscal year ending December 31, 2007.  During most of 2007 our internal accounting staff was primarily engaged in ensuring compliance with PRC accounting and reporting requirements for our operating affiliates and was not required to meet or apply U.S. GAAP requirements.  We addressed this condition byAs a result, with the exception of certain additional persons hired at the end of 2007 to address these deficiencies, including the hiring of our chief financial officer, whoour current internal accounting department responsible for our financial reporting, on a consolidated basis, is familiar withrelatively new to U.S. GAAP and under his supervision, we are implanting the related internal control procedures required of U.S. public companies, including providingcompanies.  Although our accounting staff is professional and experienced in accounting requirements and procedures generally accepted in the PRC, management has determined that they require additional training and assistance of our accounting staff in U.S. GAAP matters.  We also have elected independent directors and have established an audit committee which meets with management and our independent auditors.  Management has determined that our internal audit function is also significantly deficient due to insufficient qualified resources to perform internal audit functions, and we are seeking to address this deficiency.functions.

DueIn order to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible.  However, tocorrect the extent possible,foregoing deficiencies, we will implement procedures to assure thathave taken the initiation of transactions, the custody of assets and the recording of transactions will be performed by separate individuals.  following remediation measures:
·In late 2007, we engaged Adam Wasserman, a senior financial executive from the U.S. to serve as our chief financial officer on a part-time basis.   In December 2008, we hired Leo Wang as our chief financial officer on a full-time basis and Mr. Wasserman became vice president of financial reporting.  Mr. Wasserman has extensive experience in internal control and U.S. GAAP reporting compliance, and, together with our chief executive and financial officers will oversee and manage our financial reporting process and required training of the accounting staff.  
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·We have committed to the establishment of effective internal audit functions, however, due to the scarcity of qualified candidates with extensive experience in U.S. GAAP reporting and accounting in the region, we were not able to hire sufficient internal audit resources before March 31, 2009. However, we will increase our search for qualified candidates with assistance from recruiters and through referrals.
·Since 2008, we have elected independent directors to serve on our audit committee and we have set up a compensation committee to be headed by one of our independent directors.
·Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible.  However, to the extent possible, we will implement procedures to assure that the initiation of transactions, the custody of assets and the recording of transactions will be performed by separate individuals.  
We believe that the foregoing steps have significantly remediatedwill remediate the deficiencies previously reported,significant deficiency identified above, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate.  

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A material weakness (within the meaning of PCAOB Auditing Standard No. 5) is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting.

Our management is not aware of any material weaknesses in our internal control over financial reporting, and we are addressing the significant weaknesses in internal controls over financial reporting. Nothingnothing has come to the attention of management that causes them to believe that any material inaccuracies or errors exist in our financial statement as of September 30, 2008.March 31, 2009.  The reportable conditions and other areas of our internal control over financial reporting identified by us as needing improvement have not resulted in a material restatement of our financial statements. WeNor are notwe aware of any instance where such reportable conditions or other identified areas of weakness have resulted in a material misstatement of omission in any report we have filed with or submitted to the Commission.   

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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 and procedures may deteriorate.

Auditor Attestation

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

Changes in Internal Controls over Financial Reporting

There were no changes in our internal controls over financial reporting during the thirdfirst quarter of fiscal year 20082009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION

ITEM 2.         UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During the three months ended September 30, 2008,On January 1, 2009, we issued 1,152,17570,000 shares of ourits common stock for investor relations services. We valued these shares at the fair value of the common shares on date of grant of $35,000 or $0.50 per share and recorded professional fees of $35,000.

On March 3, 2009, we issued 232 shares of its common stock for services rendered. The shares were valued at fair value on the date of grant and we recorded stock-based compensation of $87.

On March 31, 2009, we issued 13,889 shares of its common stock to our chief financial officer for services rendered pursuant to an exerciseemployment agreement.  The shares were valued at fair value on the date of warrants with an exercise pricegrant and we recorded stock-based compensation of $0.92.$6,944.

The above recipient is a sophisticated investor who had such knowledge and experience in financial, investment and business matters that they were capable of evaluating the merits and risks of the prospective investment in our securities. The recipient had access to business and financial information concerning our company. The issuance was exempt from registration under the Securities Act in reliance on an exemption provided by Section 4(2) of that act.Act.  Each person to whom the shares were issued acquired the shares for investment and not with a view to the sale or distribution and received information concerning us, our business and our financial condition, and the stock certificates bear an investment legend.  No brokerage fees were paid in connection with any of these stock issuances.

ITEM 6. EXHIBITS

31.131.1           Rule 13a-14(a)/15d-14(a) certification of Chief Executive Officer
31.231.2           Rule 13a-14(a)/15d-14(a) certificate of Principal Financial Officer
32.132.1           Section 1350 certification of Chief Executive Officer and Chief Financial Officer

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SIGNATURES

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

 CHINA WIND SYSTEMS, INC.
   
Date: NovemberMay 14, 20082009By:/s/ Jianhua Wu
 Jianhua Wu, Chief Executive Officer
   
Date: NovemberMay 14, 20082009By:/s/ Adam WassermanLeo Wang
 Adam Wasserman,     Leo Wang, Chief Financial Officer

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