U.S.
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 EXCHANGE ACT OF
1934





For the
quarterly period ended March 31, 2007





 ̈
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the
transition period
from              to





Commission
File Number 000-26175





China
Water Group, Inc.





(Exact
name of small business issuer as specified in its charter)





Nevada
                  
                  88-0409151(State
      or other jurisdiction of
                  
                  (IRS
      Employerincorporation
      or organization)
                  
                  Identification
      No.)




Suite
7A01, Baicheng Building


584
Yingbin Road


Dashi,
Panyu District


Guangzhou,
Guangdong, China


(Address
of principal executive offices)


86-20-3479
9708


(Issuer’s
telephone number)





NA


(Former
name, former address and former fiscal year, if changed since last
report)







Check whether the issuer (1) filed all
reports required to be filed by Section 13 or 15(d) of the Exchange Act during
the past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) hasbeen subject to such filing
requirements for the past 90 days. YES ̈NO x




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





Large Accelerated Filer ̈
                  
                  Accelerated
      Filer  ̈
                  
                  Non-Accelerated
      Filer ̈
                  
                  Smaller
      Reporting Company x




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YES  ̈ NO
x




State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date: 139,383,450 shares of common stock, par value
$.0001 per share, as of March 18, 2009.




Transitional Small Business Disclosure
Format (Check one). YES ̈NOx





PART
I. - FINANCIAL INFORMATION


ITEM 1. FINANCIAL
STATEMENTS.




CHINA
WATER GROUP, INC.
 
 CONSOLIDATED
FINANCIAL STATEMENTS
 
 MARCH
31, 2007 AND 2006
  
 Table
of Contents
 
 PageConsolidated
      Financial StatementsReport
      of Independent Registered Public Accounting Firm
                              
                              
                              4Consolidated
      Balance Sheets
                              
                              
                              5Consolidated
      Statements of Operations and Comprehensive Income (Loss)
                              
                              
                              6Consolidated
      Statements of Cash Flows
                              
                              
                              7Notes
      to Consolidated Financial Statements
                              
                              
                              8 -
      16
  
  REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 To the
Board of Directors and Stockholders of
 China
Water Group, Inc.
 
 We have
reviewed the accompanying consolidated balance sheet of China Water Group, Inc.
(the “Company”) and its subsidiaries as of March 31, 2007, and the related
consolidated statements of operations and comprehensive income, and cash flows
for the three months ended March 31, 2007 and 2006. These consolidated financial
statements are the responsibility of the Company's management.
 
 We
conducted our reviews in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an
opinion.
 
 Based on
our review, we are not aware of any material modifications that should be made
to the accompanying financial statements for them to be in conformity with
accounting principles generally accepted in the United States of
America.
 
 Parsippany,
New Jersey
 March 10,
2009
  4
  CHINA
WATER GROUP, INC.
 
 Consolidated
Balance Sheets
 
 March 31,
                  
                  
                  December 31,2007
                  
                  
                  2006Assets:Current
      assets:Cash
      and cash equivalents
                  
                  $
                  4,123,823
                  
                  
                  $
                  4,144,484Accounts
      receivable, net of allowance of doubtful accounts of $-0- and $4,402,743,
      respectively
                  
                  
                  2,008,645
                  
                  
                  
                  2,140,575Prepayment,
      deposits and other receivables
                  
                  
                  1,130,585
                  
                  
                  
                  1,494,039Due
      from related companies
                  
                  
                  4,841,931
                  
                  
                  
                  3,423,961Due
      from affiliated companies
                  
                  
                  2,896,592
                  
                  
                  
                  1,824,529Deferred
      tax assets
                  
                  
                  1,812,993
                  
                  
                  
                  1,796,377Total
      current assets:
                  
                  
                  16,814,569
                  
                  
                  
                  14,823,965Property,
      plant and equipment, net
                  
                  
                  4,708,964
                  
                  
                  
                  4,739,533Construction
      in progress
                  
                  
                  32,572
                  
                  
                  
                  3,619,559Interests
      in affiliated companies
                  
                  
                  1,968,607
                  
                  
                  
                  1,080,562Total
      assets:
                  
                  $
                  23,524,712
                  
                  
                  $
                  24,263,619Liabilities
      and stockholders’ equity:Current
      liabilities:Warrant
      liability
                  
                  
                  1,380,040
                  
                  
                  
                  2,305,880Note
      payable
                  
                  
                  25,837
                  
                  
                  
                  25,600Accounts
      payable
                  
                  
                  6,482,886
                  
                  
                  
                  6,854,174Accrued
      liabilities
                  
                  
                  2,982,338
                  
                  
                  
                  3,062,829Due
      to directors
                  
                  
                  1,366,518
                  
                  
                  
                  1,371,627Due
      to related companies
                  
                  
                  1,751,570
                  
                  
                  
                  1,779,943Income
      tax payable
                  
                  
                  1,695,635
                  
                  
                  
                  1,680,094Total
      current liabilities:
                  
                  
                  15,684,824
                  
                  
                  
                  17,080,147Minority
      interests
                  
                  
                  273,586
                  
                  
                  
                  541,105Total
      liabilities:
                  
                  
                  15,958,410
                  
                  
                  
                  17,621,252Stockholders'
      equity:Preferred
      stock, US$0.001 par value, 50,000,000 authorized shares,  no
      shares issued and outstanding
                  
                  
                  -
                  
                  
                  
                  -Common
      stock, US$0.001 par value, 200,000,000 shares
      authorized;  135,903,698 and 135,903,698 shares issued and
      outstanding
                  
                  
                  103,704
                  
                  
                  
                  103,704Additional
      paid-in capital
                  
                  
                  4,837,392
                  
                  
                  
                  4,837,392Retained
      earnings
                  
                  
                  1,949,233
                  
                  
                  
                  1,249,882Accumulated
      other comprehensive income
                  
                  
                  675,973
                  
                  
                  
                  451,389Total
      stockholders' equity:
                  
                  
                  7,566,302
                  
                  
                  
                  6,642,367Total
      Liabilities and Stockholders' Equity:
                  
                  $
                  23,524,712
                  
                  
                  $
                  24,263,619
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  5
  CHINA
WATER GROUP, INC.
 
 Consolidated
Statements of Operations and Comprehensive Income
 For
the Three Months Ended March 31, 2007 and 2006
 
 2007
                  
                  
                  2006Revenue:Revenue
      from turn-key engineering projects
                  
                  $
                  -
                  
                  
                  $
                  814,746Revenue
      from BOT wastewater treatment services
                  
                  
                  203,150
                  
                  
                  
                  239,342Revenue
      from sales of bottled water
                  
                  
                  3,147
                  
                  
                  
                  -Total
      revenue:
                  
                  
                  206,297
                  
                  
                  
                  1,054,088Cost
      of revenue:Cost
      of revenue for turn-key engineering projects
                  
                  
                  -
                  
                  
                  
                  (395,277
                  )Cost
      of revenue for BOT wastewater treatment services
                  
                  
                  (58,507
                  )
                  
                  
                  (125,432
                  )Cost
      of revenue from sale of bottled water
                  
                  
                  (2,043
                  )
                  
                  
                  -Depreciation
      and amortization
                  
                  
                  (83,852
                  )
                  
                  
                  (10,352
                  )Sales
      taxes
                  
                  
                  (364
                  )
                  
                  
                  (50,273
                  )Total
      cost of revenue:
                  
                  
                  (144,766
                  )
                  
                  
                  (581,334
                  )Gross
      profit:
                  
                  
                  61,531
                  
                  
                  
                  472,754Operating
      expenses:Other
      general and administrative expenses
                  
                  
                  (188,362
                  )
                  
                  
                  (113,574
                  )(Loss)/
      Income from operations:
                  
                  
                  (126,831
                  )
                  
                  
                  359,180Other
      income (expense):Other
      (expenses) /income
                  
                  
                  643
                  
                  
                  
                  42,609Interest
      expense
                  
                  
                  -
                  
                  
                  
                  (231
                  )Penalty
      for late effectiveness of registration statement
                  
                  
                  (23,093
                  )
                  
                  
                  (246,269
                  )Gain/(loss)
      on financial instruments
                  
                  
                  925,840
                  
                  
                  
                  (4,452,683
                  )Share
      of results in associates - Xin Le and Han Dan
                  
                  
                  61,262
                  
                  
                  
                  57,797Total
      other income (expenses):
                  
                  
                  964,652
                  
                  
                  
                  (4,598,777
                  )Income/(loss)
      before income tax and minority interests:
                  
                  
                  837,821
                  
                  
                  
                  (4,239,597
                  )Income
      tax expense:
                  
                  
                  (212
                  )
                  
                  
                  (117,076
                  )Income/(loss)
      before minority interests:
                  
                  
                  837,609
                  
                  
                  
                  (4,356,673
                  )Minority
      interests:
                  
                  
                  (11,147
                  )
                  
                  
                  (35,879
                  )Net
      income/(loss):
                  
                  
                  826,462
                  
                  
                  
                  (4,392,552
                  )Other
      Comprehensive income:Foreign
      currency translation adjustment
                  
                  
                  224,584
                  
                  
                  
                  46,929Comprehensive
      income:
                  
                  $
                  1,051,046
                  
                  
                  $
                  (4,345,623
                  )Basic
      net income/(loss) per share:
                  
                  $
                  0.01
                  
                  
                  $
                  (0.03
                  )Diluted
      net income/(loss) per share:
                  
                  $
                  0.01
                  
                  
                  $
                  (0.03
                  )
 
 The
accompanying notes are an integral part of these consolidated financial
statements.
  6
  CHINA
WATER GROUP, INC.
 
 Consolidated
Statements of Cash Flows
 For
the Three Months Ended March 31, 2007 and 2006
 
 2007
                          
                          
                          2006Cash flows from operating
      activities:Net
      income/(loss)
                          
                          $
                          826,462
                          
                          
                          $
                          (4,392,552
                          )Adjustments
      to reconcile net income to net cash provided by operating activities
      :Depreciation
      and amortization
                          
                          
                          83,852
                          
                          
                          
                          10,352(Gain)/loss
      in financial instruments
                          
                          
                          (925,840
                          )
                          
                          
                          4,452,683Minority
      interests
                          
                          
                          (3,891
                          )
                          
                          
                          35,879Share
      of results in an associated company - Xin Le
                          
                          
                          (61,262
                          )
                          
                          
                          (57,797
                          )Changes
      in operating assets and liabilities :Accounts
      receivable
                          
                          
                          151,135
                          
                          
                          
                          (211,232
                          )Prepayment,
      deposits and other receivables
                          
                          
                          324,557
                          
                          
                          
                          (170,625
                          )Due
      from related companies
                          
                          
                          (104,415
                          )
                          
                          
                          (141,722
                          )Due
      from  affiliated companies
                          
                          
                          (64,384
                          )
                          
                          
                          -Accounts
      payable
                          
                          
                          (215,782
                          )
                          
                          
                          282,591Accruals
      and other liabilities
                          
                          
                          (69,332
                          )
                          
                          
                          147,264Due
      to a related company
                          
                          
                          (44,662
                          )
                          
                          
                          -Due
      to directors
                          
                          
                          (17,727
                          )
                          
                          
                          -Income
      tax payable
                          
                          
                          -
                          
                          
                          
                          232,419Total
      adjustments:
                          
                          
                          (40,610
                          )
                          
                          
                          138,695Net
      cash (used in)/provided by operating activities:
                          
                          
                          (121,289
                          )
                          
                          
                          187,260Cash
      flows used in investing activities:Disposal
      of interest in a subsidiary
                          
                          
                          15,038
                          
                          
                          
                          -Dividend
      received from an associated company - Xin Le
                          
                          
                          90,074
                          
                          
                          
                          -Acquisition
      of property, plant and equipment
                          
                          
                          (42,588
                          )
                          
                          
                          (59,407
                          )Net
      cash provided by/(used in) investing activities:
                          
                          
                          62,524
                          
                          
                          
                          (59,407
                          )Cash
      flows from financing activities:Repayment
      of unsecured loans
                          
                          
                          -
                          
                          
                          
                          (37,313
                          )Net
      cash provided by/(used in) financing activities:
                          
                          
                          -
                          
                          
                          
                          (37,313
                          )Effect
      of foreign currency translation on cash and cash
    equivalents:
                          
                          
                          38,104
                          
                          
                          
                          (75,141
                          )Net
      (decrease)/increase in cash and cash equivalents:
                          
                          
                          (20,661
                          )
                          
                          
                          15,399Cash
      and cash equivalents, beginning of period:
                          
                          
                          4,144,484
                          
                          
                          
                          175,224Cash
      and cash equivalents, end of period:
                          
                          $
                          4,123,823
                          
                          
                          $
                          190,623
 
 The accompanying notes are an
integral part of these consolidated financial
statements.
  7
  CHINA
WATER GROUP, INC.
 
 Notes
to Consolidated Financial Statements
 March
31, 2007 and 2006
  NOTE1 -
BASIS OF PRESENTATION
  In these
notes, the terms “CHWG,” “we,” “us,” and “our” mean China Water Group, Inc.
(formerly China Evergreen Environmental Corporation) and subsidiary
companies.
  The
condensed consolidated financial statements of CWG included herein have been
prepared by CHWG, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (the “SEC”). Certain information and footnote
disclosures normally included in consolidated financial statements prepared in
conjunction with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. These condensed consolidated
financial statements should be read in conjunction with the financial statements
and the notes thereto included in CHWG's Annual Report on Form 10-KSB for the
period ended December 31, 2006.
  The
accompanying unaudited quarterly consolidated financial statements reflect all
adjustments of a normal and recurring nature which are, in the opinion of
management, necessary to present fairly the financial position, results of
operations and cash flows of CHWG for the periods presented. The results of
operations for these periods are not necessarily comparable to, or indicative
of, results of any other quarterly period or for the fiscal year taken as a
whole. Factors that affect the comparability of financial data from year to year
and for comparable quarterly periods include non-recurring expenses associated
with CHWG's costs incurred to reorganize CHWG, raise capital, and issue stock
options and awards. Certain financial information that is not required for
interim financial reporting purposes has been omitted.
 
 NOTE 2 - DESCRIPTION OFBUSINESS
  We were
organized as a Nevada corporation on September 10, 1996 under the name
“Discovery Investments, Inc.” and were previously engaged in the business of
seeking, investigating and, if such investigation warranted, acquiring an
interest in a business opportunity.
  On
October 15, 2004, we were the subject of a reverse acquisition by Evergreen
Asset Group Limited, an International Business Company organized under the laws
of the British Virgin Islands (“Evergreen”), pursuant to which we acquired 100%
of the outstanding shares of Evergreen capital stock in exchange for a
controlling interest in our common stock. Pursuant to a securities purchase
agreement dated September 9, 2004, as amended, we issued 83,500,000 shares
of our common stock (representing 83.5% of our outstanding capital stock) in
exchange for all of the issued and outstanding shares of Evergreen capital stock
transferred to us by the Evergreen shareholders at the closing (the “Reverse
Acquisition”). Following the close of the Reverse Acquisition, we changed our
corporate name from “Discovery Investments, Inc.” to “China Evergreen
Environmental Corporation.” On November 7, 2006, we changed our name to
“China Water Group, Inc.” to reflect our focus on China’s water treatment and
supply needs.
  As a
result of the Reverse Acquisition, Evergreen became our wholly owned subsidiary.
Evergreen has three majority owned subsidiaries: Guang Dong Xin Xing Mei Biology
Company Limited (“Xinxingmei”), and Hai Yang City Sheng Shi Environment
Protection Company Limited (“Haiyang”). Through Xinxingmei and Haiyang, we
provide wastewater turn-key engineering, equipment and chemical trading.
Evergreen currently holds 90% of Xinxingmei. Xinxingmei provides turn-key
wastewater treatment engineering design and contracting. Xinxingmei also holds
90% and 35% respectively in the equity interest of the following two water
treatment facilities operated through build, operate and transfer (BOT)
arrangements with the PRC government: (i) Tian Jin Shi Sheng Water
Treatment Company Limited (“Tian Jin”), which commissioned water treatment in
November 2003 and has a daily treatment capacity of approximately 10,000 cubic
meters and (ii) Xin Le Sheng Mei Water Purifying Company Limited (“Xin
Le”), which also commissioned water treatment in November 2003 and has a daily
treatment capacity of 40,000 cubic meters. Xinxingmei was retained to manage
both Tian Jin and Xin Le.
  8
  CHINA
WATER GROUP, INC.
 
 Notes
to Consolidated Financial Statements
 March
31, 2007 and 2006
 
 NOTE 2 - DESCRIPTION OFBUSINESS (CONTINUED)
 
 Xinxingmei’s
management fees from Xin Le and Tian Jin did not represent a material portion of
our revenue during the first quarter of 2007.
 
 The
principal activities of the Group are the research and development of waste
water, garbage treatment and aqueous purifying techniques, investment and
construction of waste water treatment plant and sales of environment protection
related products.
  On
January 22 2007, the minority shareholder of Han Dan Cheng Sheng Water Affairs
Company Limited (“Han Dan”), Guang Dong Xin Sheng Environmental Protection
Company Limited (“GDXS”), subscribed all of the remaining capital injection of
Han Dan and there was no further injection of share capital from the Company. As
a result, the percentage of equity in Han Dan hold by the Company decreased from
90% to 34.32% and Han Dan became an associated company of the Company instead of
a subsidiary company.
 
 NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  Revenue
      recognition. We recognize revenue using various revenue recognition
      policies based on the nature of the sale and the terms of the
      contract.
  Revenues
      from turn-key engineering projects are recognized on the
      percentage-of-completion method for individual contracts. We follow the
      guidance of the American Institute of Certified Public Accountants
      (“AICPA”) Statement of Position (“SOP”) 81-1, Accounting for
      Performance of Construction-Type and Certain Production-Type Contracts,
      for our accounting policy relating to the use of the
      percentage-of-completion method, estimated costs and claim recognition for
      construction contracts. Revenues are recognized in the ratio that costs
      incurred bear to total estimated contract costs to the extent we believe
      related collection is probable. The use of the percentage-of-completion
      method of revenue recognition requires estimates of percentage of project
      completion. Changes in job performance, estimated profitability and final
      contract settlements may result in revisions to costs and income in the
      period in which the revisions are determined. Provisions for any estimated
      losses on uncompleted contracts are made in the period in which such
      losses are determinable. In instances when the work performed on fixed
      price agreements is of a relatively short duration, we use the completed
      contract method of accounting whereby revenue is recognized when the work
      is completed. From 5% to 10% of the total contract value will be treated
      as retention monies withheld to ensure performance of the contract during
      the warranty period of up to 12 months, as stipulated in both long-term
      and short-term fixed-price
contracts.
  Revenues
      arising from wastewater treatment are recognized based on wastewater
      treated as recorded daily by meters read at rates, in RMB/ton, as
      prescribed under the BOT agreements in accordance with SEC Staff
      Accounting Bulletin (“SAB”) Topic 13, Revenue Recognition. We meet the
      following four criteria for revenue recognition outlined in SAB Topic
      13:
  1.
      There is sufficient evidence to support that sales arrangements
      exist;
  2.
      The price to the buyer is fixed through signed
  contracts;
  3.
      Meter readings illustrate that delivery of treated wastewater has
      occurred; and
  4.
      Collectibility is reasonably assured through one or more of the following:
      due diligence prior to contract signing; historical payment practices; or
      required upfront payments.
  9
 CHINA
WATER GROUP, INC.
 
 Notes
to Consolidated Financial Statements
 March
31, 2007 and 2006
 
 NOTE3 - SUMMARYOFSIGNIFICANTACCOUNTINGPOLICIES
(CONTINUED)
 
 Revenues
from the sale of environment protection-related products and provision of
technical services are recognized when goods are delivered or when services are
performed. The contractual terms of the purchase agreements or consultancy
agreements dictate the recognition of revenues by us. We recognize revenue in
accordance with SAB No. 104. Accordingly, four basic criteria must be met
before revenue can be recognized: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the selling price is fixed and
determinable; and (4) collectibility is reasonably assured. Determination
of criteria (3) and (4) is based on management’s judgments regarding
the fixed nature of the selling prices of the products or services delivered and
the collectibility of those amounts. Provisions for discounts and rebates to
customers, estimated returns and allowances, and other adjustments are provided
for in the same period the related sales are recorded. We defer any revenue for
which the product has not been delivered or is subject to refund until such time
that we and our customer jointly determine that the product has been delivered
or no refund will be required.
  Impairment
of assets. Our
policy is to periodically review and evaluate whether there has been a permanent
impairment in the value of long-lived assets. Factors we consider in this
evaluation include current operating results, trends and anticipated
undiscounted future cash flows that we expect to result from the use of the
asset, or other measure of fair value, and whether such factors reflect that the
value of the asset has been impaired.
  Allowances
for accounts receivable. Our provisioning policy for bad and doubtful
debt is based on the evaluation of collectibility and aging analysis of accounts
receivable and on management's judgment. We do not require collateral or other
security to support client receivables. We conduct periodic reviews of our
clients' financial condition and customer payment practices to minimize
collection risk on accounts receivable. This review is based on a considerable
amount of judgment which is required in assessing the ultimate realization of
these receivables, including the current creditworthiness and the past
collection history of each customer. During the first quarter of 2007, we made
no allowances for doubtful debts.
  Financial
instruments. The carrying amounts of all financial instruments
approximate fair value. The carrying amounts of cash, accounts receivable,
related party receivables, unsecured loans, accounts payable and related party
payables approximate fair value due to the short-term nature of these items. The
carrying amounts of borrowings approximate the fair value based on our expected
borrowing rate for debt with similar remaining maturities and comparable
risk.
  Income
per share. Basic income per share is computed by dividing the net income
for the year by the weighted average number of common shares outstanding during
the year. Diluted income per share is computed by dividing the net income for
the year by the weighted average number of common and common equivalent shares
outstanding during the year. Common equivalent shares (which includes
incremental common shares issuable upon the exercise of stock options, unvested
restricted common stock and shares that may be issued on a contingent basis) are
included in diluted income per share to the extent such shares are dilutive. In
accordance with Statement of Financial Accounting Standards (“SFAS”)
No. 128, Earnings Per Share, we use income from continuing operations, net
of income taxes, as the “control number” in determining whether common
equivalent shares are dilutive or anti-dilutive in periods where discontinued
operations are reported.
  10
  CHINA
WATER GROUP, INC.
 
 Notes
to Consolidated Financial Statements
 March
31, 2007 and 2006
 
 NOTE3 - SUMMARYOFSIGNIFICANTACCOUNTINGPOLICIES
(CONTINUED)
 
 Recently
issued accounting pronouncements
 
 In
September 2006, the FASB issued SFAS No. 157 “Fair Value Measurement” (“SFAS
157”).  SFAS 157 defines fair value, establishes a framework for
measuring fair value, and expands disclosures about fair value
measurements.  This Statement shall be effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years.  Earlier application is
encouraged, provided that the reporting entity has not yet issued financial
statements for that fiscal year, including any financial statements for an
interim period within that fiscal year.  The provisions of this
statement should be applied prospectively as of the beginning of the fiscal year
in which this Statement is initially applied, except in some circumstances where
the statement shall be applied retrospectively. The Company is currently
evaluating the effect, if any, of SFAS 157 on its financial
statements.
 
 In
September 2006, the FASB released SFAS No. 158 “Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Plans: an amendment of FASB
Statements No. 87, 88, 106, and 132(R)” which requires an employer to recognize
the over funded or under funded status of defined benefit and other
postretirement plans as an asset or liability in its statement of financial
position and to recognize changes in that funded status in the year in which the
changes occur through an adjustment to comprehensive income.  This
statement also requires an employer to measure the funded status of a plan as of
the date of its year-end statement of financial position, with limited
exceptions. The Company is currently evaluating the impact of adopting SFAS
No.158
on its financial statements.
 
 In
February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for
Financial Assets and Financial Liabilities—including an amendment of FASB
Statement No. 115” (“SFAS No. 159”), which permits entities to choose to
measure many financial instruments and certain other items at fair value. The
fair value option established by this Statement permits all entities to choose
to measure eligible items at fair value at specified election dates. A business
entity shall report unrealized gains and losses on items for which the fair
value option has been elected in earnings at each subsequent reporting date.
Adoption is required for fiscal years beginning after November 15, 2007.
Early adoption is permitted as of the beginning of a fiscal year that begins on
or before November 15, 2007, provided the entity also elects to apply the
provisions of SFAS Statement No. 159.  The Company is currently
evaluating the impact of adopting SFAS No.159 on its
financial statements.
 
 In
December 2007, the FASB issued SFAS No. 141, “Business Combinations” (“SFAS
141”).  SFAS 141 defines the acquirer as the entity that obtains
control of one or more businesses in the business combination and establishes
the acquisition date as the date that the acquirer achieves control, and
requires an acquirer to recognize the assets acquired, the liabilities assumed,
and any noncontrolling interest in the acquiree at the acquisition date,
measured at their fair values as of that date, with limited exceptions specified
in the Statement. SFAS 141 applies prospectively to business combinations for
which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008.
 
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS
160”).  SFAS 160 clarifies that a noncontrolling interest in a
subsidiary is an ownership interest in the consolidated entity that should be
reported as equity in the consolidated financial statements. SFAS 160 requires
consolidated net income to be reported at amounts that include the amounts
attributable to both the parent and the noncontrolling interest, and also
requires that a parent recognize a gain or loss in net income when a subsidiary
is deconsolidated. The requirements of SFAS 160 are effective for our fiscal
year beginning January 1, 2009.
  11
 
 CHINA
WATER GROUP, INC.
 
 Notes
to Consolidated Financial Statements
 March
31, 2007 and 2006
 
 NOTE 4 - BASIC NET LOSS PER SHARE
 
 (i)
              The
      basic net income/(loss) per share is calculated using the net income and
      the weighted average number of shares outstanding during the
      year.
 
 Three
      months ended March 31,2007
                        
                        
                        2006Net
      income/(loss) (US$)
                        
                        $
                        826,462
                        
                        
                        $
                        (4,392,552
                        )Weighted
      average number of commonshares
      outstanding
                        
                        
                        135,903,698
                        
                        
                        
                        135,903,698Basic
      net income/(loss) per share (US$)
                        
                        $
                        0.01
                        
                        
                        $
                        (0.03
                        )
 
 (ii)
              The
      diluted net income/(loss) per share is calculated using the net
      income/(loss) and the weighted average number of shares outstanding during
      the year together with incremental common shares issuable upon the
      exercise of all warrants issued.
 
 Three
      months ended March 31,2007
                        
                        
                        2006Net
      income/(loss) (US$)
                        
                        $
                        826,462
                        
                        
                        $
                        (4,392,552
                        )Weighted
      average number of commonshares
      outstanding
                        
                        
                        135,903,698
                        
                        
                        
                        135,903,698Diluted
      net income/(loss) per share (US$)
                        
                        $
                        0.01
                        
                        
                        $
                        (0.03
                        )
 
 As the
April Warrants and the September Warrants are anti-dilutive, they are being
excluded from the calculation of diluted earnings per shares.
 
 NOTE 5 - PREPAYMENT, DEPOSITS ANDOTHER RECEIVABLES
 
 March
      31,
                      
                      
                      December
      31,2007
                      
                      
                      2006Prepayment
                      
                      $
                      51,677
                      
                      
                      $
                      106,767Deposits
                      
                      
                      41,403
                      
                      
                      
                      42,303Other
      receivables:Amounts
      receivable from Beijing Hao Tai
                      
                      
                      742,994
                      
                      
                      
                      737,284Advances
      and miscellaneous receivables
                      
                      
                      294,511
                      
                      
                      
                      607,685Total
                      
                      $
                      1,130,585
                      
                      
                      $
                      1,494,039
 
 The
management believes that all other receivables are collectible.
  12
 
 CHINA
WATER GROUP, INC.
 
 Notes
to Consolidated Financial Statements
 March
31, 2007 and 2006
 
 NOTE 6 - PROPERTY, PLANT ANDEQUIPMENT, NET
 
 Property,
plant and equipment, net consisted of the following:-
 
 March
      31,
                        
                        
                        December
      31,2007
                        
                        
                        2006Purchase
      cost :-Office
      equipment
                        
                        $
                        30,097
                        
                        
                        $
                        31,364Furniture
      and fixtures
                        
                        
                        14,356
                        
                        
                        
                        14,401Tools
      and equipment
                        
                        
                        3,475
                        
                        
                        
                        2,393Motor
      vehicles
                        
                        
                        48,832
                        
                        
                        
                        48,384Waste
      water treatment plants
                        
                        
                        5,129,875
                        
                        
                        
                        5,072,771Total
                        
                        
                        5,226,635
                        
                        
                        
                        5,169,313Less
      : Accumulated depreciation and amortization
                        
                        
                        (517,671
                        )
                        
                        
                        (429,780
                        )Property,
      plant and equipment, net
                        
                        $
                        4,708,964
                        
                        
                        $
                        4,739,533
 
 Depreciation
and amortization expenses for the three months ended March 31, 2007 and 2006
amounted to US$83,852 and US$10,352 respectively.
 
 NOTE 7 - WARRANT LIABILITY
  The fair
values of the warrant liability as of March 31, 2007 and December 31, 2006 are
as below:-
 
 March
      31,
                        
                        
                        December
      31,2007
                        
                        
                        2006Warrants
      issued in April, at fair value
                        
                        $
                        150,000
                        
                        
                        $
                        200,000Warrants
      issued in September, at fair value
                        
                        
                        1,197,840
                        
                        
                        
                        2,073,680Shares
      issued in September, accounted for as liability
                        
                        
                        32,200
                        
                        
                        
                        32,200Total
                        
                        $
                        1,380,040
                        
                        
                        $
                        2,305,880
  The Group
conducted a private placement in April 2005 (“April Private Placement”) of 20
investment units, at US$25,000 per unit, for gross proceeds of US$500,000. Each
unit consisted of (a) a 12% convertible debenture in the original principal
amount of US$25,000, convertible into shares of our common stock at the rate of
the lesser of (i) US$0.20 per share or (ii) a 10% discount to the
price per share of common stock (or conversion price per share of common stock)
of the next private placement conducted by us prior to any conversion of the
debenture, and (b) 125,000 detachable warrants to purchase one share each
of our common stock at an exercise price of US$0.20 per share, expiring ten
years from their date of issuance (“April Warrants”). As a result of the
September 2005 private placement, pursuant to Section 5(d) of the warrant
agreement, the exercise price has been adjusted to $0.15 per share on
September 14, 2005. The debentures were due and payable August 1,
2005. The debenture holders, however, extended the payment period to
September 30, 2005. The debentures were converted into 3,703,701 shares of
common stock on October 1, 2005.
  13
 
 CHINA
WATER GROUP, INC.
 
 Notes
to Consolidated Financial Statements
 March
31, 2007 and 2006
 
 NOTE 7 - WARRANT LIABILITY
(CONTINUED)
  The Group
used the Black-Scholes model in calculating the fair market value of the April
Warrants and allocated US$148,531, US$74,266 and US$185,664 of the US$408,461
net proceeds to the Convertible Debenture, the Bifurcated Conversion Feature of
the Debenture and the April Warrants, respectively. The differences between the
fair value of each of the Convertible Debenture, the Bifurcated Conversion
Feature of the Debenture and the April Warrants and the respective allocated
amounts are recorded as non-cash financing charges and expensed of at the date
of issuance. The principal assumptions used in the computation of the April
Warrants are: expected term of 10 years; a risk-free rate of return of 4.24%;
dividend yield of zero percent; and a volatility of 70%.
  The Group
granted to the holders of the April Warrants certain piggy-back and demand
registration rights. Pursuant to the agreements surrounding the April Private
Placement, in the event that the Group determined to undertake a registration of
securities, the Group would include, at the request of the holder of
“Registrable Securities”, the Registrable Securities in the registration
statement. If the Group did not file a registration statement by the 120th day
from the closing of such financing, and the Group shall have received a written
request signed by the holders holding the majority of the Registrable
Securities, then the Group was obligated to file, at its expense, a registration
statement covering the Registrable Securities. Once such registration statement
has been filed and declared effective, the Group is obligated to keep such
registration statement effective until the earlier of (i) the date that all
of the Registrable Securities have been sold pursuant to such registration
statement, (ii) all Registrable Securities have been otherwise transferred
to persons who may trade such shares without restriction under the Securities
Act, and the Group has delivered a new certificate or other evidence of
ownership for such securities not bearing a restrictive legend, or
(iii) all Registrable Securities may be sold at any time, without volume or
manner of sale limitations pursuant to Rule 144(k) or any similar provision then
in effect under the Securities Act. As of March 31, 2007, the Group has not
received any written request signed by the holders holding the majority of the
Registrable Securities.
  Under
EITF No. 00-19, Accounting for Derivative Financial Instruments Indexed to and
Potentially Settled in a Company’s Own Stock, the fair value of the April
Warrants should be reported as a liability. Pursuant to the related warrant
agreement, because there is currently no effective registration statement
covering the shares of common stock underlying these warrants, these warrants
are currently subject to a cashless exercise whereby the warrant holders may
surrender their warrants to the company in exchange for shares of common stock.
The number of shares of common stock into which a warrant would be exchangeable
in such a cashless exercise depends on both the exercise price of the warrants
and the market price of the common stock, each at or near the time of exercise.
Because both of these factors are variable, it is possible that we could have
insufficient authorized shares to satisfy a cashless exercise. In this scenario,
if we were unable to obtain shareholder approval to increase the number of
authorized shares, we could be obligated to settle such a cashless exercise with
cash rather than by issuing shares of common stock. Further, EITF No. 00-19
requires that we record the potential settlement obligation at each reporting
date using the current estimated fair value of the warrants, with any changes
being recorded through our statement of operations. We will continue to report
the potential settlement obligation as a liability until such time as the
warrants are exercised or expire or we are otherwise able to modify the warrant
agreement to remove the provisions which require this treatment.
  The
conversion feature of the convertible debenture issued in April did not qualify
for the scope of exception from the provisions of SFAS 133 because the
convertible debentures are convertible into a variable number of shares. As
such, the conversion feature was bifurcated from the convertible debenture and
accounted for as a derivative at fair value with changes in fair value recorded
in earnings. Upon the conversion of the convertible debentures in October 2005,
the convertible debenture was recorded in equity as additional
capital.
  14
 
 CHINA
WATER GROUP, INC.
 
 Notes
to Consolidated Financial Statements
 March
31, 2007 and 2006
 
 NOTE 7 - WARRANT LIABILITY
(CONTINUED)
  On
September 14, 2005, the Group closed the private placement sale to
accredited investors of units consisting of shares of our common stock and
warrants to purchase shares of our common stock for aggregate gross proceeds of
US$4.83 million (“September Private Placement”). Pursuant to the subscription
agreements entered into with the investors, we issued to the investors 161 units
at a price of US$30,000 per unit. Each unit consisted of 200,000 shares of our
common stock, priced at US$0.15 per share, and warrants to purchase 200,000
shares of our common stock over a five year period at an exercise price of
US$0.20 per share. Pursuant to the terms of the subscription agreements, we
granted the investors limited registration rights for all common shares
comprising the units, including the common shares issuable on exercise of the
warrants. The Group also issued to Westminster Securities Corporation, as
partial compensation for their placement agent services 7,728,000 placement
agent warrants to purchase one share each of our common shares, a portion of
which has been assigned by Westminster Securities Corporation to certain of its
officers and employees (the warrants issued in the September Private Placement
together with the placement agent warrants are hereinafter referred to as
“September Warrants”).
  The Group
used the Black-Scholes model in calculating the fair market value of the
September Warrants and allocated US$4,140,535 of the US$4,172,735 net proceeds
to the September Warrants. The difference between the fair value of the
September Warrants and the allocated amount is recorded as non-cash financing
charges and expensed of at the date of issuance. The principal assumptions used
in the computation of the September Warrants are: expected term of 5 years; a
risk-free rate of return of 4.24%; dividend yield of zero percent; and a
volatility of 70%.
  Under the
subscription agreement for the September Private Placement, we agreed to prepare
and file with the SEC (and did so file), at our own expense, a registration
statement covering the registrable securities related to that placement. We
agreed that in the event that the registration statement is not declared
effective by the SEC within the earlier of 120 days from the final closing, we
would pay to the investors in the September Private Placement liquidated damages
in the amount of 2.0% of the purchase price of the registrable securities for
each month until the registration statement is declared effective. These
liquidated damages began accruing on January 12, 2006. We agreed that if we
do not remit payment of these liquidated damages, we will pay the investors in
the September Private Placement interest at the rate of 12% per year until
the liquidated damages are paid in full. The subscription agreement provides
that if a registration statement is not effective at any time after one year
following the issuance date of the September Warrants, these liquidated damages
obligations will stop accruing. As of September 14, 2006 the liquidated
damages obligations stopped accruing. As of March 31, 2007, we have made an
accrual of $1,026,438 for registration right liability.
  Under
paragraphs 12–32 of EITF 00-19, contracts that include any provision that could
require net-cash settlements cannot be accounted for as equity. Accordingly, the
proceeds of the September Private Placement allocated for par value of the
common stock and the September Warrants have been recorded as a liability on the
balance sheet. Upon the effectiveness of the registration statement, the amount
will be recorded as equity.
  15
  CHINA
WATER GROUP, INC.
 
 Notes
to Consolidated Financial Statements
 March
31, 2007 and 2006
 
 NOTE 8 - INTERESTS INAFFILIATED COMPANIES
  Interests
in associated companies as of March 31, 2007 and December 31, 2006 are as
below:
  March
      31,
                          
                          
                          December
      31,2007
                          
                          
                          2006Xin
      Le Sheng Mei Water Purifying Company Limited (“Xin Le”)
                          
                          $
                          1,061,631
                          
                          
                          $
                          1,080,562Han
      Dan Cheng Sheng Water Affairs Company Limited (“HanDan”)
                          
                          
                          906,976
                          
                          
                          
                          -Total
                          
                          $
                          1,968,607
                          
                          
                          $
                          1,080,562
  NOTE 9 - INCOME TAXES
 
 The
income tax benefit consisted of the following:-
 
 Three
      Months Ended March 31,2007
                        
                        
                        2006Current
      tax :PRC
                        
                        $
                        (212
                        )
                        
                        $
                        (117,076
                        )Deferred
      tax :PRC
                        
                        
                        -
                        
                        
                        
                        -Total
      income tax benefit
                        
                        $
                        (212
                        )
                        
                        $
                        (117,076
                        )
 
 The
provision for income tax represents the provision for PRC enterprise income tax
calculated at the standard income tax rate of 33% on the assessable profits of
the PRC’s subsidiaries and the standard withholding income tax rate of 10% on
the total revenue generated by Evergreen, a company incorporated in the British
Virgin Islands, in the PRC.
  NOTE 10 - EMPLOYEE WELFARE PLAN
  The
Company has established an employee welfare plan in accordance with Chinese law
and regulations. The Company makes monthly contributions of 12% of all
employees' salaries to the employee welfare plan.
  NOTE 11 - CONCENTRATION
 
 Our major
customers for the three months ended March31, 2007
were:
 
 (i) Hai
Yang City Zoning and Construction Management Bureau, which accounted for
approximately 64% of our total revenue for the three months ended March 31,
2007; the revenues from this customer arose from BOT-waste water treatment
service; and
 
 (ii)
Tianjin City Wuqing Zone Environment Protection Bureau, which accounted for
approximately 34% of our total revenue for the three months ended March 31,
2007; the revenues from this customer arose from BOT-waste water treatment
service.
  16





ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS





FORWARD-LOOKING
INFORMATION





Much of
the discussion in this Item is “forward looking” as that term is used in Section
27A of the Securities Act and Section 21E of the Securities Exchange Act of
1934, as amended (the “Exchange Act”). Actual operations and results may
materially differ from present plans and projections due to changes in economic
conditions, new business opportunities, changes in business conditions, and
other developments. Other factors that could cause results to differ materially
are described in our filings with the SEC.





The
following are factors that could cause actual results or events to differ
materially from those anticipated, and include, but are not limited to general
economic, financial and business conditions, changes in and compliance with
governmental laws and regulations, including various state and federal
environmental regulations, our ability to obtain additional financing from
outside investors and/or bank and mezzanine lenders; and our ability to generate
sufficient revenues to cover operating losses and position us to achieve
positive cash flow.





Readers
are cautioned not to place undue reliance on the forward-looking statements
contained herein, which speak only as of the date hereof. We believe the
information contained in this Form 10-Q to be accurate as of the date hereof.
Changes may occur after that date. We will not update that information except as
required by law in the normal course of our public disclosure
practices.





Additionally,
the following discussion regarding our financial condition and results of
operations should be read in conjunction with the financial statements and
related notes contained in Item 1 of Part I of this Form 10-Q.





RESULTS
OF OPERATIONS





Total revenue. We reported total
revenue of $206,297 for the three months ended March 31, 2007 as compared to
$1,054,088 for the three months ended March 31, 2006.  Nearly all of
the difference was the lack of any revenue from turn-key engineering projects
during the 2007 quarter as compared to $814,746 of revenue from turn-key
engineering projects during the first quarter of 2006. We reported revenue from
BOT wastewater treatment services of $203,150 during the first quarter of 2007
as compared to revenue of $239,342 during the first quarter of
2006.  We also recognized revenue of $3,147 from the sale of bottled
water.  We have determined to leave the field of providing turn-key
engineering projects and to concentrate our future efforts on the sale of
bottled water.  We continue to provide BOT wastewater treatment
services in existing facilities, but are not seeking to operate additional
facilities and,  the Company will from time to time seek to dispose of
existing facilities to concentrate on its bottled water
business.


17


Cost of revenue. Our total
cost of revenue, exclusive of depreciation, amortization and sales taxes,
decreased from $520,709 for the three months ended March 31, 2006 to $60,550 for
the three months ended March 31, 2007. This was primarily due our decreased
levels of operation during the quarter ended March 31, 2007 as we moved away
from turn-key engineering projects.





Gross profit. Gross profit, as
a percentage of total revenue for the three months ended March 31, 2007 and
2006, was approximately 30%, or $61,531, and approximately 45%, or $472,754,
respectively.   Decreased gross profits and margins reflect the
Company’s transition away from turn-key engineering projects.





General and administrative
expenses. Our total general and administrative expenses for the three
months ended March 31, 2007 and 2006 were $188,362 and $113,574, respectively.
The principal components of general and administrative expenses were
administrative salaries and benefits, depreciation and amortization, traveling
expenses, rental expenses and other general administration costs. The increase
in general and administrative expenses for the three months ended March 31, 2007
as compared to the three months ended March 31, 2006 was primarily due to the
increase of traveling expenses and general meeting cost for the management
to seek more potential expansion opportunities.





.Penalty for late effectiveness of
registration statementThis amount represents the liquidated damages
payment obligation we accrued in connection with the September Private Placement
by missing the deadline we agreed to for effectiveness of the registration
statement we filed in connection with that financing. Under the subscription
agreement for the September Private Placement, we agreed to prepare and file
with the SEC (and did so file), at our own expense, a registration statement
covering the registrable securities related to that placement. We agreed that in
the event that the registration statement is not declared effective by the SEC
within the earlier of 120 days from the final closing, we would pay to the
investors in the September Private Placement liquidated damages in the amount of
2.0% of the purchase price of the registrable securities for each month until
the registration statement is declared effective. These liquidated damages began
accruing on January 12, 2006. We agreed that if we do not remit payment of these
liquidated damages, we will pay the investors in the September Private Placement
interest at the rate of 12% per year until the liquidated damages are paid in
full. The subscription agreement provides that if a registration statement is
not effective at any time after one year following the issuance date of the
September Warrants, these liquidated damages obligations will stop accruing. As
of September 14, 2006 the liquidated damages obligations stopped accruing for a
period of time and then other related damages began to accrue. As of September
30, 2006, we had made an accrual of $828,027 for such liquidated
damages.


18


Under
paragraphs 12–32 of EITF 00-19, contracts that include any provision that could
require net-cash settlements cannot be accounted for as equity. Accordingly, the
proceeds of the September Private Placement allocated for par value of the
common stock and the September Warrants have been recorded as a liability on the
balance sheet. Upon the effectiveness of the registration statement, the amount
will be recorded as equity.





Unrealized gain/(loss) on financial
instruments. Unrealized gains or losses on financial instruments
represent the change in the fair market value of the financial instruments at
each reporting date. The unrealized gain on financial instruments
was  $925,840 for the three months ended March 31, 2007. The
unrealized loss on financial instruments for the three months ended March
31, 2006 was  $(4,452,683).





Share of results in an
associates. CWG holds a 35% interest in the net profits in XL and a
34.32% interest in Han Dan. Our share of results in XL for the three months
ended March 31, 2007 and 2006 was $61,262 and $57,797, respectively. The
increase in our share of net profits in 2007 was as a result of increase in net
profit of our associates.





Net (loss)/income. We had a
net income, after income tax and minority interests, of $826,462 for the three
months ended March 31, 2007, and a net loss, after income tax and minority
interests, of $(4,392,552) for the three months ended March 31,
2006.





LIQUIDITY
AND CAPITAL RESOURCES





Our
principal sources of liquidity are our cash and cash flow generated from
operations. Net cash provided by operating activities during the three months
ended March 31, 2007 was a negative $(121,289). Net cash provided by operating
activities in the three months ended March 31, 2007, consisted of net income of
$826,462, less an adjustment for non-cash items of $990,793, less adjustments
for net changes in operating assets of $(40,610).  The total decrease
in net cash for the three months ended March 31, 2007 was $(20,661) which is
less than 1% of our cash and cash equivalents of $4,123,823 at the end of the
period.  While our capital resources appear adequate for our current
operations, we may require additional capital to fully launch our proposed
bottled water operations.  We do not have any written commitments to
raise any additional capital.





APPLICATION
OF CRITICAL ACCOUNTING POLICIES





Our
financial statements and accompanying notes are prepared in accordance with
accounting principles generally accepted in the United States of America.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. Critical accounting policies include revenue
recognition, impairment of assets and accounting for allowance of accounts
receivable.


19


Revenue
recognition. We recognize revenue using various revenue recognition policies
based on the nature of the sale and the terms of the contract.





Revenues
from turn-key engineering projects are recognized on the
percentage-of-completion method for individual contracts. We follow the guidance
of the American Institute of Certified Public Accountants (“AICPA”) Statement of
Position (“SOP”) 81-1, Accounting for Performance of Construction-Type and
Certain Production-Type Contracts, for our accounting policy relating to the use
of the percentage-of-completion method, estimated costs and claim recognition
for construction contracts. Revenues are recognized in the ratio that costs
incurred bear to total estimated contract costs to the extent we believe related
collection is probable. The use of the percentage-of-completion method of
revenue recognition requires estimates of percentage of project completion.
Changes in job performance, estimated profitability and final contract
settlements may result in revisions to costs and income in the period in which
the revisions are determined. Provisions for any estimated losses on uncompleted
contracts are made in the period in which such losses are determinable. In
instances when the work performed on fixed price agreements is of a relatively
short duration, we use the completed contract method of accounting whereby
revenue is recognized when the work is completed. From 5% to 10% of the total
contract value will be treated as retention monies withheld to ensure
performance of the contract during the warranty period of up to 12 months, as
stipulated in both long term and short term fixed price contracts.





Revenues
arising from wastewater treatment are recognized based on wastewater treated as
recorded daily by meters read at rates, in RMB/ton, as prescribed under the BOT
agreements in accordance with SAB Topic 13, Revenue Recognition. We meet the
following four criteria for revenue recognition outlined in SAB Topic
13:





1. There
is sufficient evidence to support that sales arrangements exist;





2. The
price to the buyer is fixed through signed contracts;





3. Meter
readings illustrate that delivery of treated wastewater has occurred;
and





4.
Collectibility is reasonably assured through one or more of the following: due
diligence prior to contract signing; historical payment practices; or required
upfront payments.


20


Revenues
from the sale of environment protection-related products and provision of
technical services are recognized when goods are delivered or when services are
performed. The contractual terms of the purchase agreements or consultancy
agreements dictate the recognition of revenues by us. We recognize revenue in
accordance with SAB No. 104. Accordingly, four basic criteria must be met before
revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2)
delivery has occurred; (3) the selling price is fixed and determinable; and (4)
collectibility is reasonably assured. Determination of criteria (3) and (4)
are based on management’s judgments regarding the fixed nature of the selling
prices of the products or services delivered and the collectibility of those
amounts. Provisions for discounts and rebates to customers, estimated returns
and allowances, and other adjustments are provided for in the same period the
related sales are recorded. We defer any revenue for which the product has not
been delivered or is subject to refund until such time that we and our customer
jointly determine that the product has been delivered or no refund will be
required.





Impairment
of assets. Our policy is to periodically review and evaluate whether there has
been a permanent impairment in the value of long-lived assets. Factors
considered in this evaluation include current operating results, trends and
anticipated undiscounted estimated future cash flows that are expected to result
from the use of the asset, or other measure of fair value, and whether such
factors reflect that the value of the asset has been impaired.





Allowances
for accounts receivable. Our provisioning policy for bad and doubtful debt is
based on the evaluation of collectibility and aging analysis of accounts
receivable and on management's judgment. We do no require collateral or other
security to support client receivables. We conduct periodic reviews of our
clients' financial condition and customer payment practices to minimize
collection risks on accounts receivable. This review is based on a considerable
amount of judgment which is required in assessing the ultimate realization of
these receivables, including the current creditworthiness and the past
collection history of each customer. During the third quarter of 2006, we made
no allowances for doubtful debts.





Financial
instruments. The carrying amounts of all financial instruments approximate fair
value. The carrying amounts of cash, accounts receivable, related party
receivables, unsecured loans, accounts payable and related party payables
approximate fair value due to the short-term nature of these items. The carrying
amounts of borrowings approximate the fair value based on our expected borrowing
rate for debt with similar remaining maturities and comparable
risk.





Income
per share. Basic income per share is computed by dividing the net income for the
year by the weighted average number of common shares outstanding during the
year. Diluted income per share is computed by dividing the net income for the
year by the weighted average number of common and common equivalent shares
outstanding during the year. Common equivalent shares (which includes
incremental common shares issuable upon the exercise of stock options, unvested
restricted common stock and shares that may be issued on a contingent basis) are
included in diluted income per share to the extent such shares are dilutive. In
accordance with SFAS 128, Earnings Per Share, we use income from continuing
operations, net of income taxes, as the “control number” in determining whether
common equivalent shares are dilutive or anti-dilutive in periods where
discontinued operations are reported.


21


New
accounting pronouncements





In May
2006, the SEC announced that the compliance date for non-accelerated filers
pursuant to Section 404 of the Sarbanes-Oxley Act had been extended. Under the
latest extension, a company that is not required to file its annual and
quarterly reports on an accelerated basis must begin to comply with the internal
control over financial reporting requirements for its first fiscal year ending
on or after July 15, 2008, which, for us, is effective for fiscal 2008 beginning
January 1, 2008. This is a one-year extension from the previously established
July 15, 2007 compliance date established in September 2005. The SEC similarly
extended the compliance date for these companies relating to requirements
regarding evaluation of internal control over financial reporting and management
certification requirements. We are currently evaluating the impact of Section
404 of the Sarbanes-Oxley Act on our results of operations, cash flows or
financial condition.





In July
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes - An
Interpretation of FASB Statement No. 109. This Interpretation provides guidance
for recognizing and measuring uncertain tax positions, as defined in Statement
of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes.
FIN No. 48 prescribes a threshold condition that a tax position must meet for
any of the benefit of an uncertain tax position to be recognized in the
financial statements. Guidance is also provided regarding derecognition,
classification and disclosure of uncertain tax positions. FIN No. 48 is
effective for fiscal years beginning after December 15, 2006. The Company does
not expect that this Interpretation will have a material impact on their
financial position, results of operations or cash flows.





In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“FAS
157”). FAS 157 defines fair value, establishes a framework for measuring fair
value and expands disclosures about fair value measurements but does not require
any new fair value measurements. FAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years. The Company has not yet determined
the impact of applying FAS 157.





In
September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans (“FAS 158”). FAS 158 requires an
employer to recognize the overfunded or underfunded status of a defined benefit
postretirement plan (other than a multiemployer plan) as an asset or liability
in its statement of financial position and to recognize changes in that funded
status in the year in which the changes occur through comprehensive income. FAS
158 is effective for financial statements as of December 31, 2006. The Company
does not expect any material impact from applying FAS 158.


22


In
September 2006, the SEC issued SAB 108, which provides interpretive guidance on
how the effects of the carryover or reversal of prior year misstatements should
be considered in quantifying a current year misstatement. SAB 108 is effective
for the first interim period following the first fiscal year ending after
November 15, 2006, which, for us, is effective for fiscal 2007 beginning January
1, 2007. We believe that the adoption of SAB 108 will not have a material impact
on our results of operations, cash flows or financial
condition.





Off-Balance
Sheet Arrangements





We do not
have any off-balance sheet arrangements.





ITEM
3. CONTROLS AND PROCEDURES





Our
disclosure controls and procedures are designed to ensure that information
required to be disclosed by us in the reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the rules and forms of the Securities and Exchange
Commission’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that such
information required to be disclosed by us in the reports that we file under the
Exchange Act is accumulated and communicated to our management, including our
principal executive and financial officers, as appropriate, to allow timely
decisions regarding required disclosure. Our Chief Executive Officer and Chief
Financial Officer have reviewed the effectiveness of our disclosure
controls and procedures and have concluded that the disclosure controls and
procedures are not effective as of the end of the period covered by this report
as discussed below. There were no significant changes in our internal controls
or in other factors that could significantly affect these controls subsequent to
the last day they were evaluated.





Our Chief
Executive Officer and Chief Financial Officer have evaluated the effectiveness
of our disclosure controls and procedures (as this term is defined under the
rules of the SEC) as of August 10, 2006. Based on this evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that, as of August 10,
2006, our disclosure controls and procedures were not effective in recording,
processing, summarizing and reporting, on a timely basis, information required
to be disclosed by us in the reports that we file or submit under the Exchange
Act as a result of material weaknesses in our internal control over financial
reporting described below.





In the
process of filing our registration statement, we identified certain accounting
errors in our reported US GAAP annual results for fiscal 2004 and 2005 and
certain quarterly results in 2005 and 2006. As a result, we have restated the
amounts and disclosures in those annual financial statements.





The
financial statements which should no longer be relied upon
include:


23


(i)           the
audited consolidated financial statements contained in our report on Form 10-KSB
for the fiscal year ended December 31, 2004 (the “2004 10-KSB”), filed with the
SEC on April 15, 2005, Amendment No. 1 to the 2004 10-KSB filed on July 15,
2005, and Amendment No. 2 to the 2004 10-KSB filed on January 13, 2006
;





(ii)           the
audited consolidated financial statements contained in our report on Form 10-KSB
for the fiscal year ended December 31, 2005 (the “2005 10-KSB”), filed with the
SEC on April 17, 2006;





(iii)           the
unaudited consolidated financial statements contained in our quarterly report on
Form 10-QSB for the quarterly period ended March 31, 2005 (the “March 31, 2005
10-QSB”), filed with the SEC on May 24, 2005;





(iv)           the
unaudited consolidated financial statements contained in our quarterly report on
Form 10-QSB for the quarterly period ended June 30, 2005 (the “June 30, 2005
10-QSB”), filed with the SEC on August 15, 2005;





(v)           the
unaudited consolidated financial statements contained in our quarterly report on
Form 10-QSB for the quarterly period ended September 30, 2005 (the “ September
30, 2005 10-QSB”), filed with the SEC on November 15, 2005 and Amendment No. 1
to the September 30, 2005 10-QSB filed on January 13, 2006; and





(vi)           the
unaudited consolidated financial statements contained in our quarterly report on
Form 10-QSB for the quarterly period ended March 31, 2006 (the “March 31, 2006
10-QSB”), filed with the SEC on May 15, 2006.





Gain on
disposal of the XY





As
previously disclosed in our 2004 10-KSB, including amendments thereto, and
comparative figures in our 2005 10-KSB, we recorded a gain on disposal of
$2,029,720 in 2004 for the disposal of our 90% attributable interest in Xian
Yang Bai Sheng Water Purifying Company Limited (“XY”) to True Global Limited
(“TGL”), an independent party, at a consideration of $4,130,435 (RMB34.2
million). The disposal was made pursuant to a tri-party framework agreement
between Evergreen Asset Group Limited (“EGAG”), TGL and Guang Dong Xin Sheng
Environmental Protection Company Limited (“GDXS”) in which EGAG transferred 90%
of its equity interest in XY to TGL while GDXS continued to own 10% of its
equity interest in XY. The transaction was consummated on October 26, 2004 and
the gain represents the difference between the disposal proceeds and our
attributable share of net assets of XY at the date of disposal. In the same
year, we also recognized an amount of $9,115,942 for the construction revenue of
XY using the percentage-of-completion method, estimated costs and claim
recognition for construction contracts. The amount accounted for 97% of our
total revenue in 2004.


24


In the
previously filed 2004 10-KSB, as amended to date, and comparative figures in our
original filing of the 2005 10-KSB, the accounting treatment for the
construction revenue of XY does not comply with SOP 81-1 or EITF 00-21. As a
result, we will file an amendment to the 2004 10-KSB and 2005 10-KSB with
adjusted disclosure to record the transaction as part of the gain on the
disposal of the XY subsidiary rather than as revenue from construction of
wastewater treatment plant. As such our adjusted total revenue for the fiscal
year ended December 31, 2004 was $250,571 and the adjusted gain on disposal of
interest in a subsidiary - XY was $5,220,299. Due to the same reason, account
receivable from TGL amounted to $9,416,039 as of December 31, 2004 will be or
have been reclassified to prepayment, deposits and other receivables in our
upcoming amendment to the 2004 10-KSB and comparative figures in the recent
amendments to the 2005 10-KSB, June 30, 2005 10-QSB and September 30, 2005
10-QSB.





Group
reorganization





In Note
2(ii) and 2(iii) to the consolidated financial statements contained in the 2004
10-KSB and 2005 10-KSB and Note 2 to the consolidated financial statements
contained in the originally filed March 31, 2005 10-QSB, June 30, 2005 10-QSB,
September 30, 2005 10-QSB and March 31, 2006 10-QSB, we disclosed group
reorganization transactions. Pursuant to rules promulgated by the SEC, the
merger or acquisition of a private operating company into a non-operating public
shell corporation with nominal net assets is considered a capital transaction,
rather than a business combination. As such, no disclosures are required under
FAS 141 because the transactions described were not business combinations. For
accounting purposes, the transaction has been treated as a reverse acquisition
and a recapitalization, and pro-forma information is not presented.
Accordingly, the recent or upcoming amendments to the 2004 10-KSB, 2005 10-KSB,
March 31, 2005 10-QSB, June 30, 2005 10-QSB, and September 30, 2005 10-QSB and
this amendment to the March 31, 2006 10-QSB do or will not include or references
to CWG reorganization transactions throughout the financial statements. We will
also restate or have restated the common stock immediately after the
recapitalization to $100,000 in the amended March 31, 2005 10-QSB and June
30, 2005 10-QSB.




25


Reclassification of April
warrants




In our
originally filed 2005 10-KSB, June 30, 2005 10-QSB and March 31, 2006 10-QSB, we
recorded as equity the warrants issued as part of the units sold in our April
2005 convertible debt issuance. Under EITF No. 00-19, the fair value of these
warrants should be reported as a liability. Pursuant to the Warrant Agreement,
because there is currently no effective registration statement covering the
shares of common stock underlying these warrants, these warrants are currently
subject to a cashless exercise whereby the warrant holders may surrender their
warrants to the company in exchange for shares of common stock. The number of
shares of common stock into which a warrant would be exchangeable in such a
cashless exercise depends on both the exercise price of the warrants and the
market price of the common stock, each at or near the time of exercise. Because
both of these factors are variable, it is possible that we could have
insufficient authorized shares to satisfy a cashless exercise. In this scenario,
if we were unable to obtain shareholder approval to increase the number of
authorized shares, we could be obligated to settle such a cashless exercise with
cash rather than by issuing shares of common stock. Further, EITF No. 00-19
requires that we record the potential settlement obligation at each reporting
date using the current estimated fair value of the warrants, with any changes
being recorded through our statement of operations. We will continue to report
the potential settlement obligation as a liability until such time as the
warrants are exercised or expire or we are otherwise able to modify the warrant
agreement to remove the provisions which require this treatment. We have
recently restated our 2005 10-KSB, June 30, 2005 10-QSB and March 31, 2006
10-QSB to reclassify the April 2005 warrants as a liability.





April and
September 2005 Private Placements—non-cash financing charges





In our
June 30, 2005 10-QSB, we did not record any non-cash financing charges and in
our September 30, 2005 10-QSB (original filing and Amendment No. 1), we did not
properly record the non-cash financing charges. Non-cash financing charges
represent the amount by which the fair value of derivative liabilities issued
exceeds the amount of proceeds received, as an expense at the date of issuance
of the April convertible debenture and the September private placement. We have
restated our June 30, 2005 10-QSB and September 30, 2005 10-QSB to record the
non-cash financing charges, which represent the amount by which the fair value
of derivative liabilities issued exceeds the amount of proceeds received, as an
expense at the date of issuance of the April convertible debenture and the
September private placement. As a result of the recording of non-cash financing
charges, certain expenses which were previously recorded under general and
administrative expenses in our September 30, 2005 10-QSB have recently been
reclassified under non-cash financing charges.





April
2005 Private Placements—unrealized gains or losses in financial
instruments





In our
June 30, 2005 10-QSB and our September 30, 2005 10-QSB (original filing and
Amendment No. 1), we did not record properly the unrealized gains or losses in
financial instruments, which represent the change in fair market value of the
financial instruments at each reporting date for the April warrants and the
bifurcated conversion feature for the convertible debenture. The unrealized
gains or losses in financial instruments should have been reported in those
filings. We have restated the June 30, 2005 10-QSB and September 30, 2005 10-QSB
to record the unrealized gains or losses in financial instruments which
represent the change in fair market value of the financial instruments at each
reporting date for the April warrants and the bifurcated conversion feature for
the convertible debenture.


26


Interest
in associate


In our
June 30, 2005 10-QSB and our September 30, 2005 10-QSB (original filing and
Amendment No. 1), the comparative figures for our interest in associate as of
December 31, 2004 were recorded based on an effective percentage of equity
attributable to CWG of 31.5% instead of a direct interest of 35%. We have
restated the comparative figures for our interest in associate as
of December 31, 2004 in the June 30, 2005 10-QSB and September 30, 2005
10-QSB to include our interest in associate based on a direct interest of
35%.





Prior
Restatements





On
January 13, 2006, we amended our 2004 10-KSB. Prior to the January 13, 2006
amendment, in our 2004 10-KSB we recorded our interest in associate based on an
effective percentage of equity attributable to CWG of 31.5% instead of a direct
interest of 35%. In the January 13, 2006 restatement of our 2004 10-KSB, we
reported our interest in associate based on a direct interest of 35%. In
addition, we have restated the common stock immediately after the
recapitalization to $100,000.





On
January 13, 2006, we amended our September 30, 2005 10-QSB. Prior to the January
13, 2006 amendment, the September 30, 2005 10-QSB classified as equity the
proceeds of our April Debenture and September 2005 private placement allocated
to the warrants issued in these transactions. Both the April warrants and
September warrants should have been classified as a liability. The restated
financial statements in the January 13, 2006 amendment of the September 30, 2005
10-QSB reflect this reclassification. In addition, prior to the January 13, 2006
amendment, the September 30, 2005 10-QSB did not originally report the
unrealized gains or losses in financial instruments, which represent the change
in fair market value of the financial instruments at each reporting date. The
unrealized gains or losses in financial instruments should have been reported in
the original filing. Accordingly, the January 13, 2006 restatement of the
September 30, 2006 10-QSB reported the unrealized gains or losses in financial
instruments, which represent the change in fair market value of the financial
instruments at each reporting date. The restatement to the unrealized gains or
losses in financial instruments, however, required to be further restated (see
discussion above). In addition, we have restated the common stock immediately
after the recapitalization to $100,000.





Material
Weaknesses





In
connection with the above matters, we have identified material weaknesses in our
internal control over financial reporting, which weaknesses we have reported to
our auditors. These material weaknesses comprise:





(a)           insufficient
knowledge and experience among our internal accounting personnel regarding the
application of US GAAP and SEC requirements;


27


(b)           insufficient
written policies and procedures for accounting and financial reporting with
respect to the requirements and application of US GAAP and SEC disclosure
requirements; and





We have
communicated with our auditors, Patrizio & Zhao, LLC


and
concluded that these deficiencies constituted material weaknesses, as defined by
Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting
Performed in Conjunction with an Audit of Financial Statements, established by
the Public Company Accounting Oversight Board, or PCAOB.





In order
to address these material weaknesses our senior management has conducted a
thorough review of our US GAAP financial reporting processes and prepared and
implemented a US GAAP action plan. This plan was designed to generally improve
our US GAAP reporting processes and to strengthen our control processes and
procedures in order to prevent a recurrence of the circumstances that resulted
in the need to restate our quarterly financial statements. The US GAAP action
plan incorporates, among other matters, the following initiatives:





1.
arrange for our senior management and certain accounting and finance-related
personnel to attend training sessions on US GAAP and financial reporting
responsibilities and SEC disclosure requirements;





2.
modify the mandate of our internal audit function to place greater emphasis on
the adequacy of, and compliance with, procedures relating to internal controls
over US GAAP financial reporting and engage an internationally recognized
accounting firm, which is not affiliated with  our former audotors.
,to assist our accounting department and internal audit function in the
preparation of our US GAAP consolidated financial statements;





3.
recruit an accounting staff member with US GAAP expertise and who is not
affiliated with our former audotorsy.





Our board
of directors discussed the matters disclosed in this filing with the
registrant’s independent accountant. On September 25, 2006, we filed a current
report on Form 8-K relating to these matters, including a response from our
independent account relating to the statements contained therein.





Other
than those disclosed above, there were no changes in our internal controls,
which are included within disclosure controls and procedures, during our most
recently completed fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal controls.


28


PART
II. OTHER INFORMATION





ITEM
1. LEGAL PROCEEDINGS





As of the
date of this report, we are not involved in any legal proceedings other than
routine litigation that is incidental to the business.





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





None.





ITEM
3. DEFAULTS UPON SENIOR SECURITIES





None.





ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS





None.





ITEM 5. OTHER
INFORMATION





None.





ITEM
6. EXHIBITS





Exhibit
No.





Description


31.1           Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.





31.2           Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.





32.1           Certification
of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.


32.2           Certification
of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.


29


Table
of Contents





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
      WATER GROUP, INC.(Registrant)Dated:
      March 30, 2009
              By:
      /s/ Wenge FangWenge
      Fang,Chief
      Executive OfficerDated:
      March 30, 2009
              By:  /s/
      Ding RencaiDing
      Rencai,Chief
      Financial Officer