UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)





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





For the
quarterly period ended September 30, 2009





oTRANSITION REPORT UNDER
SECTION 13 OR 15 (D) OF THE EXCHANGE ACT





For the
transition period from __________ to __________





COMMISSION
FILE NUMBER:  33-16335





CHINA WIND SYSTEMS,
INC.


(Name
of Registrant as specified in its charter)




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




No.
9 Yanyu Middle Road


Qianzhou
Township, Huishan District, Wuxi City


Jiangsu Province, China
150090


(Address
of principal executive office)





(86)
51083397559


(Registrant’s
telephone number)





Not
applicable


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





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes þNo o





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every


Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation
S-T (§232.405 of this chapter) during the


preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).


Yes oNo o





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





Large
      accelerated filer
            o
            Accelerated
      filer
            oNon-accelerated
      filer
              (Do
      not check if smaller reporting company)
            o
            Smaller
      reporting company
            þ





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act) Yes oNo þ





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.  15,463,090 shares of common
stock are issued and outstanding as of November 16, 2009.









CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


FORM
10-Q


September
30, 2009






TABLE
OF CONTENTS




Page
      No.PART
      I. - FINANCIAL INFORMATIONItem
      1.
                            
                            Financial
      Statements
                            3Consolidated
      Balance Sheets as of September 30, 2009 (Unaudited) and December 31,
      2008
                            3Consolidated
      Statements of Income and Comprehensive Income for the Three and Nine
      Months Ended September 30, 2009 and 2008 (unaudited)
                            4Consolidated
      Statements of Cash Flows for the Nine Months Ended September 30, 2009 and
      2008 (unaudited)
                            5Notes
      to Unaudited Consolidated Financial Statements.
                            6Item
      2.
                            
                            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                            27Item
      3
                            
                            Quantitative
      and Qualitative Disclosures About Market Risk.
                            42Item
      4
                            
                            Controls
      and Procedures.
                            42PART
      II - OTHER INFORMATIONItem
      2.
                            
                            Unregistered
      Sales of Equity Securities and Use of Proceeds.
                            44Item
      6.
                            
                            Exhibits.
                            44






FORWARD
LOOKING STATEMENTS




This report contains forward-looking
statements regarding our business, financial condition, results of operations
and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,”
“believes,” “seeks,” “estimates” and similar expressions or variations of such
words are intended to identify forward-looking statements, but are not deemed to
represent an all-inclusive means of identifying forward-looking statements as
denoted in this report. Additionally, statements concerning future matters are
forward-looking statements.




Although forward-looking statements in
this report reflect the good faith judgment of our management, such statements
can only be based on facts and factors currently known by us. Consequently,
forward-looking statements are inherently subject to risks and uncertainties and
actual results and outcomes may differ materially from the results and outcomes
discussed in or anticipated by the forward-looking statements. Factors that
could cause or contribute to such differences in results and outcomes include,
without limitation, those specifically addressed under the headings “Risks
Factors” and “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” in our annual report on Form 10-K, in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” in
this Form 10-Q and in other reports that we file with the
SEC.   You are urged not to place undue reliance on these
forward-looking statements, which speak only as of the date of this
report.




We file reports with the SEC. The SEC
maintains a website (www.sec.gov) that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC, including us. You can also read and copy any materials we file
with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington,
DC 20549. You can obtain additional information about the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330.




We undertake no obligation to revise or
update any forward-looking statements in order to reflect any event or
circumstance that may arise after the date of this report, except as required by
law. Readers are urged to carefully review and consider the various disclosures
made throughout the entirety of this quarterly report, which are designed to
advise interested parties of the risks and factors that may affect our business,
financial condition, results of operations and prospects.




2




PART
1 - FINANCIAL INFORMATION





Item
1.     Financial
Statements.




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


September
      30,
                                            
                                            
                                            December
      31,2009
                                            
                                            
                                            2008(Unaudited)
                                            
                                            
                                            (Audited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                                            
                                            $
                                            1,158,988
                                            
                                            
                                            $
                                            328,614Notes
      receivable
                                            
                                            
                                            87,750
                                            
                                            
                                            
                                            269,549Accounts
      receivable, net of allowance for doubtful accounts (Note
2)
                                            
                                            
                                            6,004,737
                                            
                                            
                                            
                                            4,518,259Inventories,
      net of reserve for obsolete inventory (Note 3)
                                            
                                            
                                            3,011,994
                                            
                                            
                                            
                                            1,892,090Advances
      to suppliers
                                            
                                            
                                            270,329
                                            
                                            
                                            
                                            117,795Due
      from related party
                                            
                                            
                                            -
                                            
                                            
                                            
                                            437,688Prepaid
      value-added taxes on purchases
                                            
                                            
                                            312,314
                                            
                                            
                                            
                                            -Prepaid
      expenses and other
                                            
                                            
                                            120,517
                                            
                                            
                                            
                                            21,744Total
      Current Assets
                                            
                                            
                                            10,966,629
                                            
                                            
                                            
                                            7,585,739PROPERTY
      AND EQUIPMENT - net (Note 4)
                                            
                                            
                                            31,254,373
                                            
                                            
                                            
                                            25,939,596OTHER
      ASSETS:Land
      use rights, net (Note 5)
                                            
                                            
                                            3,750,822
                                            
                                            
                                            
                                            3,806,422Total
      Assets
                                            
                                            $
                                            45,971,824
                                            
                                            
                                            $
                                            37,331,757LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Loans
      payable (Note 7)
                                            
                                            $
                                            1,359,511
                                            
                                            
                                            $
                                            1,021,272Accounts
      payable
                                            
                                            
                                            2,653,637
                                            
                                            
                                            
                                            2,485,137Accrued
      expenses
                                            
                                            
                                            454,435
                                            
                                            
                                            
                                            187,605VAT
      and service taxes payable
                                            
                                            
                                            216,272
                                            
                                            
                                            
                                            97,341Advances
      from customers
                                            
                                            
                                            65,623
                                            
                                            
                                            
                                            45,748Income
      taxes payable
                                            
                                            
                                            862,709
                                            
                                            
                                            
                                            569,371Total
      Current Liabilities
                                            
                                            
                                            5,612,187
                                            
                                            
                                            
                                            4,406,474LONG-TERM
      LIABILITIES:Loan
      payable - net of current portion and debt discount (Note
7)
                                            
                                            
                                            665,001
                                            
                                            
                                            
                                            -Total
      Liabilities
                                            
                                            
                                            6,277,188
                                            
                                            
                                            
                                            4,406,474COMMITMENTS
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -STOCKHOLDERS'
      EQUITY: (Note 6)Preferred
      stock $0.001 par value;(September
      30, 2009 and December 31, 2008 - 60,000,000 shares authorized, all of
      which were designated as series A convertible preferred, 14,459,088 and
      14,028,189 shares issued and outstanding; at September 30, 2009 and
      December 31, 2008, respectively) (Liquidation value $5,407,699 at
      September 30, 2009)
                                            
                                            
                                            14,459
                                            
                                            
                                            
                                            14,028Common
      stock ($0.001 par value; 150,000,000 shares authorized;15,463,090
      and 14,965,182 shares issued and outstandingat
      September 30, 2009 and December 31, 2008, respectively)
                                            
                                            
                                            15,463
                                            
                                            
                                            
                                            14,965Additional
      paid-in capital
                                            
                                            
                                            17,822,284
                                            
                                            
                                            
                                            15,601,219Retained
      earnings
                                            
                                            
                                            17,692,703
                                            
                                            
                                            
                                            13,639,641Statutory
      reserve
                                            
                                            
                                            1,031,171
                                            
                                            
                                            
                                            621,203Other
      comprehensive gain - cumulative foreign currency translation
      adjustment
                                            
                                            
                                            3,118,556
                                            
                                            
                                            
                                            3,034,227Total
      Stockholders' Equity
                                            
                                            
                                            39,694,636
                                            
                                            
                                            
                                            32,925,283Total
      Liabilities and Stockholders' Equity
                                            
                                            $
                                            45,971,824
                                            
                                            
                                            $
                                            37,331,757




See notes
to unaudited consolidated financial statements





3




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME


For
      the Three Months Ended
                                          
                                          
                                          For
      the Nine Months EndedSeptember
      30,
                                          
                                          
                                          September
      30,2009
                                          
                                          
                                          2008
                                          
                                          
                                          2009
                                          
                                          
                                          2008(Unaudited)
                                          
                                          
                                          (Unaudited)
                                          
                                          
                                          (Unaudited)
                                          
                                          
                                          (Unaudited)NET
      REVENUES
                                          
                                          $
                                          16,132,270
                                          
                                          
                                          $
                                          11,770,162
                                          
                                          
                                          $
                                          37,577,167
                                          
                                          
                                          $
                                          31,400,186COST
      OF SALES
                                          
                                          
                                          12,242,778
                                          
                                          
                                          
                                          8,816,389
                                          
                                          
                                          
                                          28,986,366
                                          
                                          
                                          
                                          23,508,720GROSS
      PROFIT
                                          
                                          
                                          3,889,492
                                          
                                          
                                          
                                          2,953,773
                                          
                                          
                                          
                                          8,590,801
                                          
                                          
                                          
                                          7,891,466OPERATING
      EXPENSES:Depreciation
                                          
                                          
                                          83,053
                                          
                                          
                                          
                                          69,712
                                          
                                          
                                          
                                          243,976
                                          
                                          
                                          
                                          228,189Selling,
      general and administrative
                                          
                                          
                                          386,702
                                          
                                          
                                          
                                          414,078
                                          
                                          
                                          
                                          1,397,058
                                          
                                          
                                          
                                          1,681,177Total
      Operating Expenses
                                          
                                          
                                          469,755
                                          
                                          
                                          
                                          483,790
                                          
                                          
                                          
                                          1,641,034
                                          
                                          
                                          
                                          1,909,366INCOME
      FROM OPERATIONS
                                          
                                          
                                          3,419,737
                                          
                                          
                                          
                                          2,469,983
                                          
                                          
                                          
                                          6,949,767
                                          
                                          
                                          
                                          5,982,100OTHER
      INCOME (EXPENSE):Interest
      income
                                          
                                          
                                          530
                                          
                                          
                                          
                                          2,075
                                          
                                          
                                          
                                          858
                                          
                                          
                                          
                                          11,719Interest
      expense
                                          
                                          
                                          (54,251
                                          )
                                          
                                          
                                          (20,427
                                          )
                                          
                                          
                                          (253,980
                                          )
                                          
                                          
                                          (2,298,874
                                          )Foreign
      currency loss
                                          
                                          
                                          (3,395
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (3,406
                                          )
                                          
                                          
                                          -Grant
      income
                                          
                                          
                                          15
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          146,145
                                          
                                          
                                          
                                          -Debt
      issuance costs
                                          
                                          
                                          (2,000
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (14,000
                                          )
                                          
                                          
                                          (21,429
                                          )Total
      Other Income (Expense)
                                          
                                          
                                          (59,101
                                          )
                                          
                                          
                                          (18,352
                                          )
                                          
                                          
                                          (124,383
                                          )
                                          
                                          
                                          (2,308,584
                                          )INCOME
      BEFORE INCOME TAXES
                                          
                                          
                                          3,360,636
                                          
                                          
                                          
                                          2,451,631
                                          
                                          
                                          
                                          6,825,384
                                          
                                          
                                          
                                          3,673,516INCOME
      TAXES
                                          
                                          
                                          862,199
                                          
                                          
                                          
                                          590,769
                                          
                                          
                                          
                                          1,900,354
                                          
                                          
                                          
                                          1,651,331NET
      INCOME
                                          
                                          
                                          2,498,437
                                          
                                          
                                          
                                          1,860,862
                                          
                                          
                                          
                                          4,925,030
                                          
                                          
                                          
                                          2,022,185DEEMED
      PREFERRED STOCK DIVIDEND
                                          
                                          
                                          (462,000
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (462,000
                                          )
                                          
                                          
                                          (2,884,062
                                          )NET
      INCOME (LOSS) ALLOCABLE TO COMMON SHAREHOLDERS
                                          
                                          $
                                          2,036,437
                                          
                                          
                                          $
                                          1,860,862
                                          
                                          
                                          $
                                          4,463,030
                                          
                                          
                                          $
                                          (861,877
                                          )NET
      INCOME
                                          
                                          $
                                          2,498,437
                                          
                                          
                                          $
                                          1,860,862
                                          
                                          
                                          $
                                          4,925,030
                                          
                                          
                                          $
                                          2,022,185OTHER
      COMPREHENSIVE INCOME:Unrealized
      foreign currency translation gain
                                          
                                          
                                          39,536
                                          
                                          
                                          
                                          67,269
                                          
                                          
                                          
                                          84,329
                                          
                                          
                                          
                                          1,679,553COMPREHENSIVE
      INCOME
                                          
                                          $
                                          2,537,973
                                          
                                          
                                          $
                                          1,928,131
                                          
                                          
                                          $
                                          5,009,359
                                          
                                          
                                          $
                                          3,701,738NET
      INCOME (LOSS) PER COMMON SHARE:Basic
                                          
                                          $
                                          0.13
                                          
                                          
                                          $
                                          0.14
                                          
                                          
                                          $
                                          0.29
                                          
                                          
                                          $
                                          (0.07
                                          )Diluted
                                          
                                          $
                                          0.09
                                          
                                          
                                          $
                                          0.08
                                          
                                          
                                          $
                                          0.20
                                          
                                          
                                          $
                                          (0.07
                                          )WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING:Basic
                                          
                                          
                                          15,406,842
                                          
                                          
                                          
                                          13,454,407
                                          
                                          
                                          
                                          15,141,927
                                          
                                          
                                          
                                          12,878,103Diluted
                                          
                                          
                                          23,506,936
                                          
                                          
                                          
                                          22,396,370
                                          
                                          
                                          
                                          21,969,692
                                          
                                          
                                          
                                          12,878,103


See notes
to unaudited consolidated financial statements




4




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS




For
      the Nine Months EndedSeptember
      30,2009
                                                            
                                                            
                                                            2008(Unaudited)
                                                            
                                                            
                                                            (Unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                                                            
                                                            $
                                                            4,925,030
                                                            
                                                            
                                                            $
                                                            2,022,185Adjustments
      to reconcile net income from operations to net cashprovided
      by operating activities:Depreciation
                                                            
                                                            
                                                            1,237,922
                                                            
                                                            
                                                            
                                                            482,376Amortization
      of debt discount to interest expense
                                                            
                                                            
                                                            32,495
                                                            
                                                            
                                                            
                                                            2,263,661Amortization
      of debt offering costs
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            21,429Rent
      expense associated with prepaid land use rights
                                                            
                                                            
                                                            64,794
                                                            
                                                            
                                                            
                                                            63,346Increase
      in allowance for doubtful accounts
                                                            
                                                            
                                                            132,073
                                                            
                                                            
                                                            
                                                            171,816Interest
      expense related to debt conversion
                                                            
                                                            
                                                            128,489
                                                            
                                                            
                                                            
                                                            -Stock-based
      compensation expense
                                                            
                                                            
                                                            157,778
                                                            
                                                            
                                                            
                                                            75,000Changes
      in assets and liabilities:Notes
      receivable
                                                            
                                                            
                                                            182,322
                                                            
                                                            
                                                            
                                                            -Accounts
      receivable
                                                            
                                                            
                                                            (1,606,523
                                                            )
                                                            
                                                            
                                                            (1,777,797
                                                            )Inventories
                                                            
                                                            
                                                            (1,114,510
                                                            )
                                                            
                                                            
                                                            (124,107
                                                            )Prepaid
      value-added taxes on purchases
                                                            
                                                            
                                                            (312,090
                                                            )
                                                            
                                                            
                                                            -Prepaid
      and other current assets
                                                            
                                                            
                                                            (52,097
                                                            )
                                                            
                                                            
                                                            280,762Advances
      to suppliers
                                                            
                                                            
                                                            (152,139
                                                            )
                                                            
                                                            
                                                            726,728Due
      from related party
                                                            
                                                            
                                                            438,436
                                                            
                                                            
                                                            
                                                            -Accounts
      payable
                                                            
                                                            
                                                            162,519
                                                            
                                                            
                                                            
                                                            1,189,915Accrued
      expenses
                                                            
                                                            
                                                            266,205
                                                            
                                                            
                                                            
                                                            2,343VAT
      and service taxes payable
                                                            
                                                            
                                                            118,609
                                                            
                                                            
                                                            
                                                            (389,946
                                                            )Income
      taxes payable
                                                            
                                                            
                                                            291,746
                                                            
                                                            
                                                            
                                                            48,284Advances
      from customers
                                                            
                                                            
                                                            19,750
                                                            
                                                            
                                                            
                                                            (16,345
                                                            )NET
      CASH PROVIDED BY OPERATING ACTIVITIES
                                                            
                                                            
                                                            4,920,809
                                                            
                                                            
                                                            
                                                            5,039,650CASH
      FLOWS FROM INVESTING ACTIVITIES:Decrease
      in due from related parties
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            145,808Proceeds
      from sale of cost-method investee
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            35,720Deposit
      on long-term assets - related party
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            (89,721
                                                            )Purchase
      of property and equipment
                                                            
                                                            
                                                            (6,485,956
                                                            )
                                                            
                                                            
                                                            (11,629,385
                                                            )NET
      CASH USED IN INVESTING ACTIVITIES
                                                            
                                                            
                                                            (6,485,956
                                                            )
                                                            
                                                            
                                                            (11,537,578
                                                            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from loans payable
                                                            
                                                            
                                                            1,213,689
                                                            
                                                            
                                                            
                                                            142,880Proceeds
      from exercise of warrants
                                                            
                                                            
                                                            83,112
                                                            
                                                            
                                                            
                                                            2,011,575Proceeds
      from sale of preferred stock, net
                                                            
                                                            
                                                            1,098,000Payments
      on related party advances
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            (102,979
                                                            )NET
      CASH PROVIDED BY FINANCING ACTIVITIES
                                                            
                                                            
                                                            2,394,801
                                                            
                                                            
                                                            
                                                            2,051,476EFFECT
      OF EXCHANGE RATE ON CASH AND CASH EQUIVALENTS
                                                            
                                                            
                                                            720
                                                            
                                                            
                                                            
                                                            165,903NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                                                            
                                                            
                                                            830,374
                                                            
                                                            
                                                            
                                                            (4,280,549
                                                            )CASH
      AND CASH EQUILAVENTS - beginning of year
                                                            
                                                            
                                                            328,614
                                                            
                                                            
                                                            
                                                            5,025,434CASH
      AND CASH EQUIVALENTS - end of period
                                                            
                                                            $
                                                            1,158,988
                                                            
                                                            
                                                            $
                                                            744,885SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid for:Interest
                                                            
                                                            $
                                                            83,782
                                                            
                                                            
                                                            $
                                                            55,932Income
      taxes
                                                            
                                                            $
                                                            1,623,260
                                                            
                                                            
                                                            $
                                                            1,603,047NON-CASH
      INVESTING AND FINANCING ACTIVITIES:Debt
      discount for grant of warrants
                                                            
                                                            $
                                                            92,985
                                                            
                                                            
                                                            $
                                                            -Deemed
      preferred stock dividend reflected in paid-in capital
                                                            
                                                            $
                                                            462,000
                                                            
                                                            
                                                            $
                                                            2,884,062Reclassification
      of long-term deposit-related party to distribution
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            2,717,099Common
      stock issued for future service
                                                            
                                                            $
                                                            46,667
                                                            
                                                            
                                                            $
                                                            -Convertible
      debt converted to series A preferred stock
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            5,525,000Deposit
      on long-term assets-related party reclassified to intangible
      assets
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            3,286,935Series
      A preferred converted to common shares
                                                            
                                                            $
                                                            669
                                                            
                                                            
                                                            $
                                                            759Reclassification
      of common stock to paid-in capital due to reverse split
                                                            
                                                            $
                                                            30,926
                                                            
                                                            
                                                            $
                                                            -Common
      stock issued for debt
                                                            
                                                            $
                                                            152,963
                                                            
                                                            
                                                            $
                                                            -




See notes
to unaudited consolidated financial statements.




5




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


NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Organization





China
Winds Systems, Inc. (the “Company”) was incorporated in Delaware on June 24,
1987 under the name of Malex, Inc.  On December 18, 2007, the
Company’s corporate name was changed to China Wind Systems,
Inc.  Through its affiliated companies and subsidiaries, the Company
manufactures and sells high precision forged rolled rings for the wind power
industry and other industries, specialty equipment used in the production of
coal generated electricity and textile dyeing and finishing machines. The
Company is the sole stockholder of Fulland Limited, a Cayman Island limited
liability company, which was incorporated on May 9, 2007.  Fulland
owns 100% of the capital stock of Green Power Environment Technology (Shanghai)
Co., Ltd. (“Green Power”) and Wuxi Fulland Wind Energy Equipment Co., Ltd.
(“Fulland Wind Energy”), which are wholly foreign-owned enterprises (“WFOE”)
organized under the laws of the People’s Republic of China (“PRC” or
“China”).  Green Power is a party to a series of contractual
arrangements, as fully described below, dated October 12, 2007 with Wuxi Huayang
Electrical Power Equipment Co., Ltd. (“Electrical”) and Wuxi Huayang Dyeing
Machinery Co., Ltd. (“Dyeing”), both of which are limited liability companies
organized under the laws of, and based in, the PRC.   Electrical
and Dyeing are sometimes collectively referred to as the “Huayang
Companies.”





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





Electric
was formed on May 21, 2004, and Fulland Wind Energy was formed on August 27,
2008.  Beginning in April 2007, Electric began to produce large-scaled
forged rolled rings that are up to three meters in diameter for the wind-power
and other industries.  In 2008, the sale of forged rolled rings
accounted for 41.4% of
the Company’s consolidated revenues, and for the nine months ended September 30,
2009, sales of forged rolled rings accounted for 69.5% of its consolidated
revenues.   In 2009, the Company began to produce and sell forged
products through Fulland Wind Energy. Fulland Wind Energy manufactures forged
rolled rings in the Company’s new facilities.  In addition to forged
rolled rings, Electric continues to manufacture electric power auxiliary
apparatuses (including coking equipment). The Company refers to this
segment of its business as the forged rolled rings and electric power equipment
division.





Dyeing,
which was formed on August 17, 1995, produces and sells a variety of high and
low temperature dyeing and finishing machinery.  The Company refers to
this segment as the dyeing division.





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





Management
acknowledges its responsibility for the preparation of the accompanying interim
consolidated financial statements which reflect all adjustments, consisting of
normal recurring adjustments, considered necessary in its opinion for a fair
statement of its consolidated financial position and the results of its
operations for the interim period presented.




6




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


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





These
consolidated financial statements should be read in conjunction with the summary
of significant accounting policies and notes to consolidated financial
statements included in the Company’s Form 10-K annual report for the year ended
December 31, 2008.





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





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





The
Huayang Companies are considered variableinterestentities (“VIE”), and the
Company is the primary beneficiary.  The Company’s relationships with
the Huayang Companies and their shareholders are governed by a series of
contractual arrangements between Green Power and each of the Huayang Companies,
which are the operating companies of the Company in the PRC. Under PRC laws,
each of Green Power, Huayang Dye Machine and Huayang Electrical Power Equipment
is an independent legal entity and none of them is exposed to liabilities
incurred by the other parties. The contractual arrangements constitute valid and
binding obligations of the parties of such agreements. Each of the contractual
arrangements and the rights and obligations of the parties thereto are
enforceable and valid in accordance with the laws of the PRC. The following is a
summary of the contractual arrangements with each of the Huayang
Companies:





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





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





7





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


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





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





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





The
accounts of the Huayang Companies are consolidated in the
accompanying financial statements.  As VIEs,the Huayang Companies’ sales are included in the Company’s
total sales, its income from operations is consolidated with the Company’s, and
the Company’s net income includes all ofthe Huayang
Companies net income. The Company does not have any non-controlling interest
and, accordingly, did not subtract any net income in calculating the net income
attributable to the Company. Because of the contractual arrangements, the
Company had a pecuniary interest inthe Huayang
Companies that requires consolidation of the Company’s andthe Huayang Companies’ financial statements.





Use of
estimates





The
preparation of the financial statements in conformity with accounting principles
generally accepted in the U.S. requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues,
expenses, and the related disclosures at the date of the financial statements
and during the reporting period. Actual results could materially differ from
these estimates. Significant estimates in 2009 and 2008 include the allowance
for doubtful accounts, the allowance for obsolete inventory, the useful life of
property and equipment and intangible assets, assumptions used in assessing
impairment of long-term assets and valuation of deferred tax assets, accruals
for taxes due, the calculation of the value of any beneficial conversion feature
related to convertible debt, and warrants granted upon the conversion of debt to
preferred stock.





Cash and cash
equivalents





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





8




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


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





Fair value of financial
instruments





The
Company adopted new accounting guidance on fair value measurements which
clarifies the definition of fair value, prescribes methods for measuring fair
value, and establishes a fair value hierarchy to classify the inputs used in
measuring fair value as follows:





Level
1-Inputs are unadjusted quoted prices in active markets for identical assets or
liabilities available at the measurement date.




Level
2-Inputs are unadjusted quoted prices for similar assets and liabilities in
active markets, quoted prices for identical or similar assets and liabilities in
markets that are not active, inputs other then quoted prices that are
observable, and inputs derived from or corroborated by observable market
data.




Level
3-Inputs are unobservable inputs which reflect the reporting entity’s own
assumptions on what assumptions the market participants would use in pricing the
asset or liability based on the best available information.





The
carrying amounts reported in the balance sheets for cash, accounts receivable,
loans payable, accounts payable and accrued expenses, customer advances, and
amounts due from related parties approximate their fair market value based on
the short-term maturity of these instruments. The Company did not identify any
assets or liabilities that are required to be presented on the consolidated
balance sheets at fair value in accordance with the new accounting
guidance.





Concentrations of credit
risk





The
Company’s operations are carried out in the PRC. Accordingly, the Company's
business, financial condition and results of operations may be influenced by the
political, economic and legal environment in the PRC, and by the general state
of the PRC's economy. The Company's operations in the PRC are subject to
specific considerations and significant risks not typically associated with
companies in North America. The Company's results may be adversely affected by
changes in governmental policies with respect to laws and regulations,
anti-inflationary measures, currency conversion and remittance abroad, and rates
and methods of taxation, among other things.





Financial
instruments which potentially subject the Company to concentrations of credit
risk consist principally of cash and trade accounts receivable. Substantially
all of the Company’s cash is maintained with state-owned banks within the PRC,
and no deposits are covered by insurance. The Company has not experienced any
losses in such accounts and believes it is not exposed to any risks on its cash
in bank accounts. A significant portion of the Company’s sales are credit sales
which are primarily to customers whose ability to pay is dependent upon the
industry economics prevailing in these areas; however, concentrations of credit
risk with respect to trade accounts receivables is limited due to generally
short payment terms.  The Company also performs ongoing credit
evaluations of its customers to help further reduce credit risk.





At
September 30, 2009 and December 31, 2008, the Company’s cash balances by
geographic area were as follows:





September
      30, 2009
                  
                  
                  December
      31, 2008Country:United
      States
                  
                  $
                  30,261
                  
                  
                  
                  2.6
                  %
                  
                  $
                  832
                  
                  
                  
                  0.3
                  %China
                  
                  
                  1,128,727
                  
                  
                  
                  97.4
                  %
                  
                  
                  327,782
                  
                  
                  
                  99.7
                  %Total
      cash and cash equivalents
                  
                  $
                  1,158,988
                  
                  
                  
                  100.0
                  %
                  
                  $
                  328,614
                  
                  
                  
                  100.0
                  %


9
  CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES
 NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)





Notes
receivable





Notes receivable represents trade accounts receivable due from various
customers where the customers’ bank has guaranteed the payment of the
receivable. This amount is non-interest bearing and is normally paid within
three to six months.   Historically, the Company has experienced
no losses on notes receivable. The Company‘snotesreceivable totaled $87,750 and $269,549 at September 30, 2009
and December 31, 2008, respectively.





Accounts
receivable





Accounts
receivable are presented net of an allowance for doubtful accounts. The Company
maintains allowances for doubtful accounts for estimated losses. The Company
reviews the accounts receivable on a periodic basis and makes general and
specific allowances when there is doubt as to the collectability of individual
balances. In evaluating the collectability of individual receivable balances,
the Company considers many factors, including the age of the balance, customer’s
historical payment history, its current credit-worthiness and current economic
trends. Accounts are written off after exhaustive efforts at collection. At
September 30, 2009 and December 31, 2008, the Company has established, based on
a review of its outstanding balances, an allowance for doubtful accounts in the
amount of $1,009,148 and $874,856, respectively.





Inventories





Inventories,
consisting of raw materials, work in process and finished goods related to the
Company’s products are stated at the lower of cost or market utilizing the
weighted average method. An allowance is established when management determines
that certain inventories may not be saleable. If inventory costs exceed expected
market value due to obsolescence or quantities in excess of expected demand, the
Company will record reserves for the difference between the cost and the market
value. These reserves are recorded based on estimates.  The Company
recorded an inventory reserve of $79,362 and $79,170 at September 30, 2009 and
December 31, 2008, respectively.





Property and
equipment





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





Included
in property and equipment is construction-in-progress which consists of
factories and office buildings under construction and machinery pending
installation and includes the costs of construction, machinery and equipment,
and any interest charges arising from borrowings used to finance these assets
during the period of construction or installation. No provision for depreciation
is made on construction-in-progress until such time as the relevant assets are
completed and ready for their intended use. Property purchased from a related
party is recorded at the cost to the related party and any payment to or on
behalf of the related party in excess of the cost is reflected as a distribution
to related party.





Impairment of long-lived
assets





The
Company reviews long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of the assets may not be fully
recoverable, or at least annually. The Company recognizes an impairment loss
when the sum of expected undiscounted future cash flows is less than the
carrying amount of the asset. The amount of impairment is measured as the
difference between the asset’s estimated fair value and its book value. The
Company did not record any impairment charges for the nine months ended
September 30, 2009 and 2008.




10




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


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





Income
taxes





The
Company is governed by the Income Tax Law of the People’s Republic of China and
the United States.  Income taxes are accounted for using an asset and
liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in the Company's financial statements or tax returns.





Pursuant
to accounting standards related to the accounting for uncertainty in income
taxes, the evaluation of a tax position is a two-step process. The first step is
to determine whether it is more likely than not that a tax position will be
sustained upon examination, including the resolution of any related appeals or
litigation based on the technical merits of that position. The second step is to
measure a tax position that meets the more-likely-than-not threshold to
determine the amount of benefit to be recognized in the financial statements. A
tax position is measured at the largest amount of benefit that is greater than
50% likelihood of being realized upon ultimate settlement. Tax positions that
previously failed to meet the more-likely-than-not recognition threshold should
be recognized in the first subsequent period in which the threshold is met.
Previously recognized tax positions that no longer meet the more-likely-than-not
criteria should be de-recognized in the first subsequent financial reporting
period in which the threshold is no longer met. The accounting standard also
provides guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosures, and
transition.





Revenue
recognition





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




All other
product sales with customer specific acceptance provisions, including the
forged rolled rings, are recognized upon customer acceptance and the delivery of
the parts or service. Revenues related to spare part sales are recognized upon
shipment or delivery based on the trade terms.





Advances from
customers





Advances
from customers at September 30, 2009 and December 31, 2008 amounted to
$65,623 and $45,748, respectively, and consist of prepayments from customers for
merchandise that had not yet been shipped. The Company will recognize the
deposits as revenue as customers take delivery of the goods, in accordance with
its revenue recognition policy.





11




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


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





Stock-based
compensation





Stock
based compensation is accounted for based on the requirements of the Share-Based
Payment topic of the FASB Accounting Standards Codification. This FASB
Accounting Standards Codification requires recognition in the financial
statements of the cost of employee and director services received in exchange
for an award of equity instruments over the period the employee or director is
required to perform the services in exchange for the award (presumptively, the
vesting period). The FASB Accounting Standards Codification also requires
measurement of the cost of employee and director services received in exchange
for an award based on the grant-date fair value of the award.





For
share-based payments to consultants and other third-parties, compensation
expense is determined at the “measurement date.” The expense is recognized over
the vesting period of the award. Until the measurement date is reached, the
total amount of compensation expense remains uncertain. The Company records
compensation expense based on the fair value of the award at the reporting date.
The awards to consultants and other third-parties are then revalued, or the
total compensation is recalculated based on the then current fair value, at each
subsequent reporting date.





Shipping
costs





Shipping
costs are included in selling expenses and totaled $111,776 and $113,367 for the
nine months ended September 30, 2009 and 2008, respectively.





Employee
benefits





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





Advertising





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





Research and
development





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





Foreign currency
translation





The
reporting currency of the Company is the U.S. dollar. The functional currency of
the Company is the local currency, the Chinese Renminbi (“RMB”). Results of
operations and cash flows are translated at average exchange rates during the
period, assets and liabilities are translated at the unified exchange rate at
the end of the period, and equity is translated at historical exchange rates.
Translation adjustments resulting from the process of translating the local
currency financial statements into U.S. dollars are included in determining
comprehensive income.  The cumulative translation adjustment and
effect of exchange rate changes on cash for the nine months ended September 30,
2009 and 2008 was $720 and $165,903, respectively. Transactions denominated in
foreign currencies are translated into the functional currency at the exchange
rates prevailing on the transaction dates. Assets and liabilities denominated in
foreign currencies are translated into the functional currency at the exchange
rates prevailing at the balance sheet date with any transaction gains and losses
that arise from exchange rate fluctuations on transactions denominated in a
currency other than the functional currency are included in the results of
operations as incurred.




12




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


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





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





Asset and
liability accounts at September 30, 2009 and December 31, 2008 were translated
at 6.8376 RMB to $1.00 and at 6.8542 RMB to $1.00, respectively, which were the
exchange rates on the balance sheet dates. Equity accounts were stated at their
historical rate. The average translation rates applied to the statements of
income for the nine months ended September 30, 2009 and 2008 were 6.84251 RMB
and 6.99886 RMB to $1.00, respectively.  Cash flows from the Company’s
operations are calculated based upon the local currencies using the average
translation rate. As a result, amounts related to assets and liabilities
reported on the statement of cash flows will not necessarily agree with changes
in the corresponding balances on the balance sheets.





Reverse stock
split





The
Company effected a one-for-three stock split on September 22,
2009.  All share and per share information has been retroactively
adjusted to reflect the reverse split.





Income (loss) per share
of common stock




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





For
      the Three Months Ended September 30,
                
                
                For
      the Nine Months Ended
                  September
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Net
      income (loss) allocable to common shareholders for basic and diluted net
      income (loss) per common share
                
                $
                2,036,437
                
                
                $
                1,860,862
                
                
                $
                4,463,030
                
                
                $
                (861,877
                )Weighted
      average common shares outstanding – basic
                
                
                15,406,842
                
                
                
                13,454,407
                
                
                
                15,141,927
                
                
                
                12,878,103Effect
      of dilutive securities:Series
      A convertible preferred stock
                
                
                4,819,696
                
                
                
                4,676,063
                
                
                
                4,819,696
                
                
                
                -Warrants
                
                
                3,280,398
                
                
                
                4,265,900
                
                
                
                2,008,069
                
                
                
                -Weighted
      average common shares outstanding– diluted
                
                
                23,506,936
                
                
                
                22,396,370
                
                
                
                21,969,692
                
                
                
                12,878,103Net
      income (loss) per common share  - basic
                
                $
                0.13
                
                
                $
                0.14
                
                
                $
                0.29
                
                
                $
                (0.07
                )Net
      income (loss) per common share  - diluted
                
                $
                0.09
                
                
                $
                0.08
                
                
                $
                0.20
                
                
                $
                (0.07
                )





The
Company's aggregate common stock equivalents at September 30, 2009 and 2008
include the following:





2009
                  
                  
                  2008Warrants
                  
                  
                  5,438,835
                  
                  
                  
                  5,478,978Series
      A preferred stock
                  
                  
                  4,819,696
                  
                  
                  
                  4,676,063Total
                  
                  
                  10,258,531
                  
                  
                  
                  10,155,041


13


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


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





Deemed preferred stock
dividend





When we
issue shares of convertible preferred stock at a price that is, on an “as if
converted” basis, less than the market price of the underlying shares of common
stock, the difference between the value of the underlying shares of common stock
and the purchase price of the convertible preferred stock is treated as a deemed
preferred stock dividend.





Accumulated other
comprehensive income




Comprehensive
income is comprised of net income and all changes to the statements of
stockholders' equity, except those due to investments by stockholders, changes
in paid-in capital and distributions to stockholders. For the Company,
comprehensive income for the three and nine months ended September 30, 2009 and
2008 included net income and unrealized gains from foreign currency translation
adjustments.





Related
parties





Parties
are considered to be related to the Company if the parties that, directly or
indirectly, through one or more intermediaries, control, are controlled by, or
are under common control with the Company. Related parties also include
principal owners of the Company, its management, members of the immediate
families of principal owners of the Company and its management and other parties
with which the Company may deal if one party controls or can significantly
influence the management or operating policies of the other to an extent that
one of the transacting parties might be prevented from fully pursuing its own
separate interests. The Company discloses all related party transactions. All
transactions shall be recorded at fair value of the goods or services exchanged.
Property purchased from a related party is recorded at the cost to the related
party and any payment to or on behalf of the related party in excess of the cost
is reflected as a distribution to related party.





Subsequent events







For
purposes of determining whether a post-balance sheet event should be evaluated
to determine whether it has an effect on the financial statements for the period
ending September 30, 2009, subsequent events were evaluated by the Company as of
November 16, 2009, the date on which the unaudited consolidated financial
statements at and for the quarter ended September 30, 2009, were
issued.







Recent accounting
pronouncements





In June
2009, the FASB issued Accounting Standards Update No. 2009-01, “Generally
Accepted Accounting Principles” (ASC Topic 105) which establishes the FASB
Accounting Standards Codification (“the Codification” or “ASC”) as the official
single source of authoritative U.S. generally accepted accounting principles
(“GAAP”). All existing accounting standards are superseded. All other accounting
guidance not included in the Codification will be considered non-authoritative.
The Codification also includes all relevant Securities and Exchange Commission
(“SEC”) guidance organized using the same topical structure in separate sections
within the Codification.  Following the Codification, the Board will
not issue new standards in the form of Statements, FASB Staff Positions or
Emerging Issues Task Force Abstracts. Instead, it will issue Accounting
Standards Updates (“ASU”) which will serve to update the Codification, provide
background information about the guidance and provide the basis for conclusions
on the changes to the Codification. The Codification is not intended to change
GAAP, but it will change the way GAAP is organized and presented. The
Codification is effective for our third-quarter 2009 financial statements and
the principal impact on our financial statements is limited to disclosures as
all future references to authoritative accounting literature will be referenced
in accordance with the Codification. In order to ease the transition to the
Codification, we are providing the Codification cross-reference alongside the
references to the standards issued and adopted prior to the adoption of the
Codification.





14




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


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





In April
2009, the FASB issued FASB Staff Positions FAS 115-2 and FAS 124-2, “Recognition
and Presentation of Other-Than-Temporary Impairments” (ASC Topic 320-10-65).
This update provides guidance for allocation of charges for other-than-temporary
impairments between earnings and other comprehensive income. It also revises
subsequent accounting for other-than-temporary impairments and expands required
disclosure. The update was effective for interim and annual periods ending after
June 15, 2009. The adoption of FAS 115-2 and FAS 124-2 did not have a material
impact on the results of operations and financial condition.





In April
2009, the FASB issued FSP SFAS 107-1 and APB 28-1, “Interim Disclosures About
Fair Value of Financial Instruments” (ASC Topic 320-10-65). This update requires
fair value disclosures for financial instruments that are not currently
reflected on the balance sheet at fair value on a quarterly basis and is
effective for interim periods ending after June 15, 2009.  The
Company’s financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, accrued expenses and notes payable.  At
September 30, 2009 and December 31, 2008 the carrying value of the Company’s
financial instruments approximated fair value, due to their short term
nature.





In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (ASC Topic 855). This
guidance is intended to establish general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued or available to be issued. It is effective for
interim and annual reporting periods ending after June 15, 2009.  The
adoption of this guidance did not have a material impact on our consolidated
financial statements.  The Company evaluated all events and
transactions that occurred after September 30, 2009 up through November 10,
2009.  During this period no material subsequent events came to our
attention.





In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R)” (ASC Topic 810-10). This updated guidance requires a qualitative approach
to identifying a controlling financial interest in a variable interest entity
(VIE), and requires ongoing assessment of whether an entity is a VIE and whether
an interest in a VIE makes the holder the primary beneficiary of the VIE. It is
effective for annual reporting periods beginning after November 15, 2009. We are
currently evaluating the impact of the pending adoption of SFAS No. 167 on our
consolidated financial statements.





In
October 2009, the FASB issued ASU No. 2009-13, “Multiple-Deliverable Revenue
Arrangements.” This ASU establishes the accounting and reporting guidance for
arrangements including multiple revenue-generating activities. This ASU provides
amendments to the criteria for separating deliverables, measuring and allocating
arrangement consideration to one or more units of accounting. The amendments in
this ASU also establish a selling price hierarchy for determining the selling
price of a deliverable. Significantly enhanced disclosures are also required to
provide information about a vendor’s multiple-deliverable revenue arrangements,
including information about the nature and terms, significant deliverables, and
its performance within arrangements. The amendments also require providing
information about the significant judgments made and changes to those judgments
and about how the application of the relative selling-price method affects the
timing or amount of revenue recognition. The amendments in this ASU are
effective prospectively for revenue arrangements entered into or materially
modified in the fiscal years beginning on or after June 15, 2010. Early
application is permitted. The Company is currently evaluating this new
ASU.





In
October 2009, the FASB issued ASU No. 2009-14, “Certain Revenue Arrangements
That Include Software Elements.” This ASU changes the accounting model for
revenue arrangements that include both tangible products and software elements
that are “essential to the functionality,” and scopes these products out of
current software revenue guidance. The new guidance will include factors to help
companies determine what software elements are considered “essential to the
functionality.” The amendments will now subject software-enabled products to
other revenue guidance and disclosure requirements, such as guidance surrounding
revenue arrangements with multiple-deliverables. The amendments in this ASU are
effective prospectively for revenue arrangements entered into or materially
modified in the fiscal years beginning on or after June 15, 2010. Early
application is permitted. The Company is currently evaluating this new
ASU.


15


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


NOTE 2 –
ACCOUNTS
RECEIVABLE





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





September
      30,
                    2009
                  
                  
                  December
      31,
                    2008Accounts
      receivable
                  
                  $
                  7,013,885
                  
                  
                  $
                  5,393,115Less:
      allowance for doubtful accounts
                  
                  
                  (1,009,148
                  )
                  
                  
                  (874,856
                  )$
                  6,004,737
                  
                  
                  $
                  4,518,259





NOTE 3 -
INVENTORIES





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





September
      30,
                      2009
                    
                    
                    December
      31,
                      2008Raw
      materials
                    
                    $
                    1,551,469
                    
                    
                    $
                    1,054,182Work
      in process
                    
                    
                    546,778
                    
                    
                    
                    254,960Finished
      goods
                    
                    
                    993,109
                    
                    
                    
                    662,1183,091,356
                    
                    
                    
                    1,971,260Less:
      reserve for obsolete inventory
                    
                    
                    (79,362
                    )
                    
                    
                    (79,170
                    )$
                    3,011,994
                    
                    
                    $
                    1,892,090





NOTE 4 -
PROPERTY AND
EQUIPMENT





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





Useful
      Life
                        
                        
                        September
      30,
                          2009
                        
                        
                        December
      31,
                          2008Office
      equipment and furniture
                        
                        5
      Years
                        
                        
                        $
                        109,982
                        
                        
                        $
                        99,561Manufacturing
      equipment
                        
                        5 –
      10 Years
                        
                        
                        
                        17,012,510
                        
                        
                        
                        14,754,250Vehicles
                        
                        5
      Years
                        
                        
                        
                        79,565
                        
                        
                        
                        79,372Construction
      in progress
                        
                        -
                        
                        
                        
                        3,764,850
                        
                        
                        
                        207,605Building
      and building improvements
                        
                        20
      Years
                        
                        
                        
                        15,140,642
                        
                        
                        
                        14,404,41936,107,549
                        
                        
                        
                        29,545,207Less:
      accumulated depreciation
                        
                        
                        
                        
                        
                        
                        (4,853,176
                        )
                        
                        
                        (3,605,611
                        )$
                        31,254,373
                        
                        
                        $
                        25,939,596





For the
nine months ended September 30, 2009 and 2008, depreciation expense
amounted to $1,237,922 and $482,376, respectively, of which $993,946 and
$254,187, respectively, is included in cost of sales.  Upon completion
of the construction in progress, the assets will be classified to their
respective property and equipment category.






NOTE 5 –
LAND USE
RIGHTS





There is
no private ownership of land in China. Land is owned by the government and the
government grants land use rights for specified terms.  In 2008, in
connection with the acquisition of land use rights from a related party, the
Company received the certificate of land use rights from the government. At the
time the Company received the land use rights, $5,617,000 was carried as a
deposit on long-term assets. As a result of the grant of the land use rights,
the Company reclassified this amount as follows: (i) approximately $3,304,000 to
land use rights and (ii) approximately $2,313,000 to distributions to related
parties (see Note 8).  The distribution to relate parties represents
the amount by which the Company’s purchase price for the land uses right exceeds
the cost of the land use rights to the related parties. The Company’s land use
rights have terms of 45 and 50 years and expire on January 1, 2053 and October
30, 2053.  The Company amortizes the land use rights over the term of
the respective land use right. For the nine months ended September 30, 2009 and
2008, amortization of land use rights amounted to $64,794 and $63,346,
respectively.




16




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


NOTE 5 –
LAND USE RIGHTS
(continued)





At
September 30, 2009 and December 31, 2008, land use rights consist of the
following:





Useful
      Life
                      
                      September
      30,2009
                      
                      
                      December
      31,2008Land
      Use Rights
                      
                      45
      - 50 years
                      
                      $
                      3,948,870
                      
                      
                      $
                      3,939,307Less:
      Accumulated Amortization
                      
                      
                      
                      
                      (198,048
                      )
                      
                      
                      (132,885
                      )$
                      3,750,822
                      
                      
                      $
                      3,806,422





Amortization
of land use rights attributable to future periods is as follows:





Twelve
      months ending September 30:2010
                    
                    $
                    86,4542011
                    
                    
                    86,4542012
                    
                    
                    86,4542013
                    
                    
                    86,454Thereafter
                    
                    
                    3,405,006$
                    3,750,822




NOTE 6 –
STOCKHOLDERS’
EQUITY





(a)           Common
stock





On
January 1, 2009, the Company issued 23,333 shares of its common stock for
investor relations services. The Company valued these shares at the fair value
of the common shares on date of grant of $35,000, or $1.50 per share, and
recorded professional fees of $35,000.





On March
3, 2009, the Company issued 76 shares of its common stock for services rendered.
The shares were valued at fair value on the date of grant and the Company
recorded stock-based compensation of $87.





During
the nine months ended September 30, 2009, the Company issued 14,946 shares of
its common stock to its chief financial officer for services rendered pursuant
to an employment agreement.  The shares were valued at fair value on
the dates of grant, and the Company recorded stock-based compensation of
$40,858.





On June
4, 2009, the Company issued 69,260 shares of its common stock to Eos Holdings
upon the exercise of stock warrants for cash proceeds of $83,112.





On June
12, 2009, the Company issued 101,975 shares of its common stock in satisfaction
of debt and accrued interest.  The shares were valued at fair value on
the date of grant of $281,452 or $2.76 per share and, accordingly, the Company
reduced loans payable and accrued expenses by $152,963 and recorded interest
expense of $128,489.





During
the nine months ended September 30, 2009, the Company issued 19,138 shares of
its common stock to its vice president of financial reporting for services
rendered pursuant to an engagement agreement. The shares were valued at fair
value on the dates of grant and the Company recorded stock-based compensation of
$34,500.





On June
18, 2009, the Company issued 24,823 shares of its common stock to a
newly-elected director pursuant to an agreement with the director. The shares
were valued at fair value on the date of grant and the Company recorded
stock-based compensation of $14,583 and prepaid expenses of
$20,417.





17




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


NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(a)           Common stock
(continued)





On August
14, 2009, the Company issued 6,897 shares of its common stock to a newly-elected
director pursuant to an agreement with the director. The shares were valued at
fair value on the date of grant and the Company recorded stock-based
compensation of $3,750 and prepaid expenses of $26,250.





On August
14, 2009, the Company issued 6,667 shares of its common stock to an investor
relations company. The shares were valued at fair value on the date of grant and
the Company recorded professional fees of $29,000.





During
the nine months ended September 30, 2009, the Company issued 223,034 shares of
its common stock upon the conversion of 669,101 shares of series A convertible
preferred stock (“series A preferred stock”).





During
the nine months ended September 30, 2009, the Company issued 7,759 shares of its
common stock upon the cashless exercise of warrants.





(b)  Conversion of Convertible
Notes; Restatement of Certificate of
Incorporation;Beneficial
Conversion Feature and Deemed Dividend





On
November 13, 2007, the Company entered into a securities purchase agreement with
three accredited investors.  Pursuant to the agreement, the Company
issued and sold to the investors, for $5,525,000, the Company’s 3% convertible
subordinated notes (the “3% convertible notes”) in the principal amount of
$5,525,000.  At the time of the financing, the Company did not have
any authorized shares of preferred stock.  On March 28, 2008, upon the
filing of both a restated certificate of incorporation, which created a series
of preferred stock and gave the board of directors broad authority to create one
or more series of preferred stock, and  a statement of designation
that set forth the rights, preferences, privileges and limitations of the
holders of the series A preferred stock, these notes were automatically
converted into an aggregate of (i) 14,787,135 shares of Series A preferred stock
and (ii) warrants to purchase 3,725,501 shares of common stock at $1.74 per
share, 1,862,751 shares of common stock at $2.49 per share, and 688,333 shares
of common stock at $2.76 per share, subject to adjustment.  The
restated certificate of incorporation increased the number of authorized shares
of capital stock from 75,000,000 to 210,000,000 shares, of which (i) 150,000,000
shares are designated as common stock, par value of $.001 per share, and (ii)
60,000,000 shares are designated as preferred stock, par value of $.001 per
share.





The 3%
convertible notes had a beneficial conversion option. In fiscal 2007, the
Company computed the intrinsic value of the conversion option at $2,610,938
based on a comparison of (a) the proceeds of the convertible debt allocated to
the common stock portion of the conversion option by first allocating the
proceeds received from the convertible debt offering to the debt and the
detachable warrants on a relative fair value basis, and (b) the fair value at
the commitment date of the common stock to be received by the Company upon
conversion. The excess of (b) over (a) is the intrinsic value of the embedded
conversion option of $2,610,938 that has been recognized by the Company as a
discount to the notes and amortized using the straight-line method over the
stated term; with the unamortized portion being recognized in March 2008 upon
the automatic conversion of the notes into shares of series A preferred stock
and warrants.





At
November 13, 2007, the fair value of the warrants used to calculate the
intrinsic value of the conversion option was estimated at $2,884,062 and was
computed using the Black-Scholes option-pricing model based on the assumed
issuance of the warrants on the date the notes were issued. Variables used in
the option-pricing model include risk-free interest rate at the date of grant of
3.84%, an expected warrant life of five years, an expected volatility of
150%, and an expected dividend rate of 0%. As the series A preferred stock does
not require redemption by the Company or have a finite life, upon issuance of
the warrants on March 28, 2008, a one-time preferred stock deemed dividend of
$2,884,062 was recognized immediately as a non-cash charge on March 28, 2008.
The non-cash, deemed dividend did not have an effect on net earnings or cash
flows for the nine months ended September 30, 2009. The estimated fair market
value of the warrants of $2,884,062 has been recorded as additional paid-in
capital and a reduction to retained earnings.





18




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


NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





For the
nine months ended September 30, 2008, amortization of debt issue costs was
$21,429 and included any remaining balance of debt issue costs that was expensed
upon conversion of the convertible notes to the series A preferred stock and
warrants.  The amortization of debt discounts for the nine months
ended September 30, 2009 and 2008 was $32,495 and $2,263,661, respectively,
which has been included in interest expense on the accompanying statements of
income.   For the nine months ended September 30, 2008,
amortization of debt discounts included any remaining balance of the debt
discount that was expensed upon conversion of the convertible debt to the series
A preferred stock, which occurred on March 28, 2008.





On March
28, 2008, the Company concluded that the preferred stock and warrants associated
with the November 13, 2007 financing did not meet the definition of a derivative
financial instrument.  Derivative financial instruments, as defined in
the Account Standards Codification, consist of financial instruments or other
contracts that contain all three of the following characteristics: i) the
financial instrument has a notional amount and one or more underlying, e.g.
interest rate, security price or other variable, ii) require no initial net
investment and iii) permits net settlement. Derivative financial instruments may
be free-standing or embedded in other financial instruments. In order for the
net settlement requirement to be met, the contract must meet one of the three
tests listed in the accounting standards.   The accounting
standards define net settlement.  In order for the net settlement
requirement to be met, the contract must meet one of the three tests listed in
the accounting standards.


Since
there is no net settlement provision in the contract and no market mechanism
that facilitates net settlement that would cause the contract to meet the
certain criteria in the accounting standards, the Company analyzed the
accounting standard which provides that a contract that requires delivery of the
assets associated with the underlying has the characteristic of net settlement
if those assets are readily convertible to cash.





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





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





On March
28, 2008, in connection with the conversion of the convertible notes and
warrants, the Company issued to the investors warrants to purchase a total of
more than 18,800,000 shares of common stock.  On that date there were
approximately 37,400,000 shares of common stock outstanding and the public float
of the common stock was not significant.  Thus, the warrants, at the time
of issuance, represented more than 50% of the outstanding common
stock.





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





(c)           Series A Preferred
Stock





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





·
            There
      are 60,000,000 authorized shares of series A preferred
      stock.




·
            No
      dividends shall be payable with respect to the series A preferred stock.
      No dividends shall be declared or payable with respect to the common stock
      while the series A preferred stock is outstanding. The Company shall not
      redeem or purchase any shares of Common Stock or any other class or series
      of capital stock which is junior to or on parity with the series A
      preferred stock while the series A preferred stock is
      outstanding.




19




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


NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(c)           Series A Preferred Stock
(continued)





·
            The
      holders of the series A preferred stock have no voting rights except as
      required by law. However, so long as any shares of series A preferred
      stock are outstanding, the Company shall not, without the affirmative
      approval of the holders of 75% of the shares of the series A preferred
      stock then outstanding, (a) alter or change adversely the powers,
      preferences or rights given to the series A preferred stock or alter or
      amend the statement of designations relating to the series A preferred
      stock, (b) authorize or create any class of stock ranking as to dividends
      or distribution of assets upon a liquidation senior to or pari passu with
      the series A preferred stock, or any of preferred stock possessing greater
      voting rights or the right to convert at a more favorable price than the
      series A preferred stock, (c) amend its certificate of incorporation or
      other charter documents in breach of any of the provisions of the
      certificate of designation, (d) increase the authorized number of shares
      of series A preferred stock or the number of authorized shares of
      preferred stock, or (e) enter into any agreement with respect to the
      foregoing.




·
            Upon
      any liquidation, dissolution or winding-up of the Company, whether
      voluntary or involuntary, the holders of the series A preferred stock have
      a liquidation preference of $0.374 per
  share.




·
            Each
      share of series A preferred stock is convertible (subject to the 4.9%
      limitations described below) into one-third share of common stock, subject
      to adjustment at any time.




·
            All
      of the outstanding shares of series A preferred stock shall be
      automatically converted into common stock upon the close of business on
      the business day immediately preceding the date fixed for consummation of
      any transaction resulting in a change of control of the Company, as
      defined in the statement of
designation.




·
            The
      holders may not convert the series A preferred stock to the extent that
      such conversion would result in the holder and its affiliates beneficially
      owning more than 4.9% of the Company’s common stock.  This
      provision may not be waived or
amended.




(d)           November 2007 Securities
Purchase Agreement





Pursuant
to the securities purchase agreement relating to the Company’s November 2007
private placement, as amended:




·
            The
      Company agreed to have appointed such number of independent directors that
      would result in a majority of its directors being independent directors,
      that the audit committee would be composed solely of not less than three
      independent directors and the compensation committee would have at least
      three directors, a majority of which shall be independent
      directors.  The Company is presently in compliance with this
      covenant.  If the Company does not meet these requirements for a
      period of 60 days for an excused reason, as defined in the securities
      purchase agreement, or 75 days for a reason which is not an excused
      reason, the Company would be required to pay liquidated
      damages.




·
            The
      Company agreed to have a qualified chief financial officer.  If
      the Company cannot hire a qualified chief financial officer promptly upon
      the resignation or termination of employment of a former chief financial
      officer, the Company may engage an accountant or accounting firm to
      perform the duties of the chief financial officer.  In no event
      shall the Company either (i) fail to file an annual, three months or other
      report in a timely manner because of the absence of a qualified chief
      financial officer, or (ii) not have a person who can make the statements
      and sign the certifications required to be filed in an annual or three
      monthly report under the Securities Exchange Act of
  1934.




·
            Liquidated
      damages for failure to comply with the preceding two covenants are
      computed in an amount equal to 12% per annum of the purchase price, up to
      a maximum of 12% of the purchase price, which is $663,000, which is
      payable in cash or series A preferred stock, at the election of the
      investors.  If payment is made in shares of series A preferred
      stock, each share is valued at $0.374 per
share.




20




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


NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(d)           November 2007 Securities
Purchase Agreement (continued)





·
            The
      Company and the investors entered into a registration rights agreement
      pursuant to which the Company agreed to file, by January 12, 2008, a
      registration statement covering the common stock issuable upon conversion
      of the series A preferred stock and exercise of the warrants and to have
      the registration statement declared effective by June 11,
      2008.  The registration rights agreement provides for additional
      demand registration rights in the event that the investors are not able to
      register all of the shares in the initial registration statement. The
      Company filed its registration on February 14, 2008 and it was declared
      effective on June 13, 2008. No liquidated damages were incurred and
      accordingly, no liability was
recorded.





·
            Until
      the earlier of November 13, 2010 or such time as the investors cease to
      own at least 5% of the total number of shares that were issued or are
      issuable upon conversion of the series A preferred stock that were issued
      upon conversion of the 3% convertible subordinated notes issued in
      November 2007, the Investors have a right of first refusal on future
      financings.




·
            Until
      the earlier of November 13, 2011 or such time as the Investors shall have
      sold all of the underlying shares of common stock, the Company is
      restricted from issuing convertible debt or preferred
    stock.




·
            Until
      the earlier of November 13, 2010 or such time as the Investors have sold
      90% of the underlying shares of common stock, the Company’s debt cannot
      exceed twice the preceding four quarters earnings before interest, taxes,
      depreciation and amortization.




·
            The
      Company’s officers and directors agreed, with certain limited exceptions,
      not to publicly sell shares of common stock for 27 months or such earlier
      date as all of the convertible securities and warrants have been converted
      or exercised and the underlying shares of common stock have been
      sold.  This 27 month period will expire on February 13,
      2010.




·
            In
      connection with the securities purchase agreement, the Company paid
      $30,000 to an investor as reimbursement for due diligence expenses, which
      is treated as a debt discount and was amortized over the life of the
      convertible notes. Other fees incurred in connection with the debt
      issuance include $25,000 of legal fees, which were treated as a deferred
      debt issue costs and are being amortized to debt issue cost expense over
      the life of the notes. The unamortized portion of this debt discount on
      March 28, 2008, the date on which the convertible notes were automatically
      converted, was recognized at that
time.





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





(e)  September 2009 Sale of
Series A Preferred Stock




On
September 15, 2009, the Company sold 1,100,000 shares of series A preferred
stock to an investor for $1,100,000.  The effective price per share of
common stock issuable upon conversion of the series A preferred stock was $3.00
per share, which was less than the market price on the date of the
sale.  We recognized a deemed preferred stock dividend of $462,000,
representing the difference between the fair market value of the 1,100,000
shares of series A preferred stock, determined on an “as if converted” basis and
the consideration we received for the series A preferred stock
($1,100,000).





21


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


NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(f)           March 2009 Issuance of Notes
and Warrants




On March
23, 2009, Company sold to two investors, for $250,000, its 18-month, 15% notes
in the aggregate principal amount of $250,000 and five-year warrants to purchase
145,833 shares at an exercise price of $1.20 per share.  These
warrants were treated as a discount on the secured notes and were valued at
$92,985 to be amortized over the 18-month note term. The fair value of this
warrants was estimated on the date of grant using the Black-Scholes
option-pricing model in accordance with SFAS 123R using the following
weighted-average assumptions: expected dividend yield of 0%; expected volatility
of 137.51%; risk-free interest rate of 1.69% and an expected holding period of
five years.  For the nine months ended September 30, 2009,
amortization of this debt discount amounted to $32,495.  The exercise
price of these warrants was less than the exercise price of outstanding warrants
which have provision for an adjustment in the exercise price in the event of a
sale of stock or the issuance of warrants or convertible securities with an
exercise price or conversion price which is less than the exercise price of the
warrants.  As a result, the exercise price of outstanding warrants to
purchase 3,077,475 shares was reduced from $1.701 to $1.698.  Our
financial statements were not affected by this change.





Pursuant
to the related purchase agreements, our chief executive officer placed 510,417
shares of common stock into escrow.  The note holders have the right
to take these shares, valued at $0.60 per share if the Company does not pay the
interest on or principal of the notes before such failure becomes an event of
default.  Pursuant to the loan documents, in the event of that Leo
Wang ceases to be employed by the Company as its chief financial officer, the
holders of not less than $126,000 principal amount of the notes shall have the
right, on not less than 60 days’ notice, to declare the notes in
default.  If Mr. Wang ceases to be employed by the Company as a result
of his death, disability or a termination for cause, then the Company shall have
60 days to replace Mr. Wang with a chief financial officer acceptable to
investors. The debt discount of $91,485 represents the value of the warrants
issued in connection with this note





Warrant
activity for the nine months ended September 30, 2009 is summarized as
follows:





Number
      of Warrants
                    
                    
                    Weighted
      Average Exercise PriceBalance
      at beginning of period
                    
                    
                    5,377,834
                    
                    
                    $
                    1.50Granted
                    
                    
                    145,833
                    
                    
                    
                    1.20Exercised
                    
                    
                    (84,832
                    )
                    
                    
                    1.29Balance
      at end of period
                    
                    
                    5,438,835
                    
                    
                    $
                    1.49Warrants
      exercisable at end of period
                    
                    
                    5,438,835
                    
                    
                    $
                    1.49




The
following table summarizes the shares of the Company's common stock issuable
upon exercise of warrants outstanding at September 30, 2009:




Warrants
      Outstanding
                              
                              
                              Warrants
      ExercisableRange
      of
                                Exercise
      Price
                              
                              
                              Number
      Outstanding at September 30, 2009
                              
                              
                              Weighted
      Average Remaining Contractual Life (Years)
                              
                              
                              Weighted
      Average Exercise Price
                              
                              
                              Number
                                Exercisable
      at
                                September
      30, 2009
                              
                              
                              Weighted
      Average Exercise Price$
      1.50
                              
                              
                              
                              133,333
                              
                              
                              
                              3.12
                              
                              
                              $
                              1.50
                              
                              
                              
                              133,333
                              
                              
                              $
                              1.501.70
                              
                              
                              
                              3,061,903
                              
                              
                              
                              3.12
                              
                              
                              
                              1.70
                              
                              
                              
                              3,061,903
                              
                              
                              
                              1.701.20
                              
                              
                              
                              2,243,599
                              
                              
                              
                              3.21
                              
                              
                              
                              1.20
                              
                              
                              
                              2,243,599
                              
                              
                              
                              1.205,438,835
                              
                              
                              
                              
                              
                              
                              $
                              1.49
                              
                              
                              
                              5,438,835
                              
                              
                              $
                              1.49




22




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


NOTE 7 –
LOANS
PAYABLE





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





September
      30, 2009
                  
                  
                  December
      31, 2008Loan
      payable to Bank of Communications, due on December 16, 2009 with annual
      interest at September 30, 2009 of 6.05% secured by assets of the
      Company.
                  
                  $
                  292,500
                  
                  
                  $
                  291,792Loan
      payable to Bank of Communications, due on December 10, 2009 with annual
      interest at September 30, 2009 of 6.05% secured by assets of the
      Company.
                  
                  
                  438,750
                  
                  
                  
                  437,688Loan
      payable to Industrial and Commercial Bank of China, due on December 16,
      2009 with annual interest at September 30, 2009 of 6.42% secured by assets
      of the Company.
                  
                  
                  292,500
                  
                  
                  
                  291,792Loan
      payable to Industrial and Commercial Bank of China, due on November 18,
      2009 with annual interest at September 30, 2009 of 6.1065% the rate being
      adjusted quarterly based on People’s Bank of China’s base rate plus 1.5%
      secured by assets of the Company.
                  
                  
                  146,250
                  
                  
                  
                  -Loan
      payable to Agricultural  and Commercial Bank, due on May 25,
      2013 with annual interest at September 30, 2009 of 5.7525% secured by
      assets of the Company.
                  
                  
                  585,002
                  
                  
                  
                  -Principal
      amount of loan payable to an investor, due on
                    February
      7, 2011.
                  
                  
                  80,000
                  
                  
                  
                  -Principal
      amount of loan payable to investors, due on September 23, 2010, with
      interest of 15% per annum (see (a) below).
                  
                  
                  250,000
                  
                  
                  
                  -Total
      loans payable
                  
                  
                  2,085,002
                  
                  
                  
                  1,021,272Less:
      long-term portion of loans payable
                  
                  
                  (665,001
                  )
                  
                  
                  -Current
      portion of  loans payable
                  
                  
                  1,420,001
                  
                  
                  
                  -Less:
      debt discount (a)
                  
                  
                  (60,490
                  )
                  
                  
                  -Current
      portion of  loans payable – net
                  
                  $
                  1,359,511
                  
                  
                  $
                  1,021,272





(a)
              In
      March 2009, the Company sold to two investors its 18-month, 15% notes in
      the aggregate principal amount of $250,000 and warrants to purchase
      145,833 shares at an exercise price of $1.20 per share for a total of
      $250,000. The debt discount represents the unamortized value of the
      warrants issued in the transaction.  (See Note
      6(f)).




23




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


NOTE 8 –
RELATED PARTY
TRANSACTIONS





Due
from related party





At
September 30, 2009 and December 31, 2008, the following was due from related
parties:





Name
                
                Relationship
                
                
                September
      30,
                  2009
                
                
                December
      31,
                  2008Wuxi
      Aoyida Machinery Co. Ltd
                
                Company
      owned by sibling of CEO (1)
                
                
                $
                -
                
                
                $
                437,688$
                -
                
                
                $
                437,688





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





Purchase
of assets from related party





In July
2007, the Company agreed to acquire property from Boiler for an aggregate price
of 89,282,500 RMB, or approximately $12,207,000. The Company had previously been
a 33% owner of Boiler and, in 2007, the Company sold its interest in Boiler to a
related party.  The original purchase price was reduced by 9,196,341
RMB, or approximately $1,257,000, which represents the Company’s 33% interest in
the appreciation in property prior to the sale of the Company’s interest in
Boiler, resulting in a net purchase price of 80,086,159 RMB, or approximately
$10,950,000. The property consists of an approximately 100,000 square foot
factory, land use rights, employee housing facilities and other leasehold
improvements. The purchase price was fully paid by December 31,
2008.  Prior to payment of the purchase price, the Company treated its
payments as deposits on long-term assets, which amounted to
$11,538,000.  During 2008, the Company received the certificate of
land use rights but as of December 31, 2008 had not received the completed title
to the buildings until March 2009. During 2008, upon the receipt of the land use
rights and the full payment of the purchase price, the Company reclassified
approximately $3,304,000, representing Boiler’s cost of the land use rights, to
land use rights (See Note 5), reclassified approximately $5,517,000, which
represents Boiler’s cost of constructing the factory and related leasehold
improvements and employee housing facilities, to property and equipment, and
reclassified approximately $2,717,000, which represents the excess of amounts
paid by the Company for the land use rights and factory facilities over the
original cost of the land use rights and factory facilities acquired, to a
distribution to related parties. The difference between the total payments,
$11,538,000, and the purchase price of $10,950,000 is treated as a foreign
currency translation adjustment.





NOTE 9 –
INCOME
TAXES





The
Company accounts for income taxes pursuant to the accounting standards that
requires the recognition of deferred tax assets and liabilities for both the
expected impact of differences between the financial statements and the tax
basis of assets and liabilities, and for the expected future tax benefit to be
derived from tax losses and tax credit carryforwards.  Additionally,
the accounting standards require the establishment of a valuation allowance to
reflect the likelihood of realization of deferred tax assets. Realization of
deferred tax assets, including those related to the U.S. net operating loss
carryforwards, are dependent upon future earnings, if any, of which the timing
and amount are uncertain. Accordingly, the net deferred tax asset related to the
U.S. net operating loss carryforward has been fully offset by a valuation
allowance. The Company is governed by the Income Tax Law of the People’s
Republic of China and the United States. In 2009 and 2008, under the Income Tax
Laws of PRC, Chinese companies are generally subject to an income tax at an
effective rate of 25% on income reported in the statutory
financial statements after appropriate tax adjustments. The Company’s VIE,
Dyeing and Electric and Fulland Wind Energy are subject to these statutory
rates.




24




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES
 NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
  NOTE 10 -
SEGMENT
INFORMATION





For the
three and nine months ended September 30, 2009 and 2008, the Company operated in
two reportable business segments - (1) the manufacture of dyeing and finishing
equipment and (2) the manufacture of forged rolled rings and other components
for the wind power and other industries and electric power auxiliary apparatuses
(including coking equipment). The Company's reportable segments are strategic
business units that offer different products. They are managed separately based
on the fundamental differences in their operations.  All of the
Company’s operations are conducted in the PRC. Information with respect to these
reportable business segments for the three and nine months ended September 30,
2009 and 2008 is as follows:




Three
      Months Ended September 30,
                                  
                                  
                                  Nine
      Months Ended September 30,2009
                                  
                                  
                                  2008
                                  
                                  
                                  2009
                                  
                                  
                                  2008Revenues:Dyeing
      and finishing equipment
                                  
                                  $
                                  4,983,302
                                  
                                  
                                  $
                                  5,958,627
                                  
                                  
                                  $
                                  12,309,750
                                  
                                  
                                  $
                                  17,125,918Forged
      rolled rings and electric power equipment
                                  
                                  
                                  11,148,968
                                  
                                  
                                  
                                  5,811,535
                                  
                                  
                                  
                                  25,267,417
                                  
                                  
                                  
                                  14,274,26816,132,270
                                  
                                  
                                  
                                  11,770,162
                                  
                                  
                                  
                                  37,577,167
                                  
                                  
                                  
                                  31,400,186Depreciation:Dyeing
      and finishing equipment
                                  
                                  
                                  104,335
                                  
                                  
                                  
                                  89,316
                                  
                                  
                                  
                                  308,027
                                  
                                  
                                  
                                  293,662Forged
      rolled rings and electric power equipment
                                  
                                  
                                  436,460
                                  
                                  
                                  
                                  70,137
                                  
                                  
                                  
                                  929,895
                                  
                                  
                                  
                                  188,714540,795
                                  
                                  
                                  
                                  159,453
                                  
                                  
                                  
                                  1,237,922
                                  
                                  
                                  
                                  482,376Interest
      expense:Dyeing
      and finishing equipment
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Forged
      rolled rings and electric power equipment
                                  
                                  
                                  27,965
                                  
                                  
                                  
                                  20,427
                                  
                                  
                                  
                                  72,104
                                  
                                  
                                  
                                  55,932Other
      (a)
                                  
                                  
                                  26,286
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  181,876
                                  
                                  
                                  
                                  2,242,94254,251
                                  
                                  
                                  
                                  20,427
                                  
                                  
                                  
                                  253,980
                                  
                                  
                                  
                                  2,298,874Net
      income (loss):Dyeing
      and finishing equipment
                                  
                                  
                                  705,206
                                  
                                  
                                  
                                  988,906
                                  
                                  
                                  
                                  1,596,797
                                  
                                  
                                  
                                  2,780,281Forged
      rolled rings and electric power equipment
                                  
                                  
                                  2,032,910
                                  
                                  
                                  
                                  1,039,993
                                  
                                  
                                  
                                  4,104,264
                                  
                                  
                                  
                                  2,169,854Other
      (a)
                                  
                                  
                                  (239,679
                                  )
                                  
                                  
                                  (168,037
                                  )
                                  
                                  
                                  (776,031
                                  )
                                  
                                  
                                  (2,927,950
                                  )2,498,437
                                  
                                  
                                  
                                  1,860,862
                                  
                                  
                                  
                                  4,925,030
                                  
                                  
                                  
                                  2,022,185
  Identifiablelong-lived tangible
      assets at September 30, 2009 and
                            
                            September 30,
                              2009
                            
                            
                            December 31,
                              2008December
      31, 2008 by segment:Dyeing
      and finishing equipment
                            
                            $
                            5,012,448
                            
                            
                            $
                            10,057,047Forged
      rolled rings and electric power equipment
                            
                            
                            26,241,925
                            
                            
                            
                            15,882,549Other
      (a)
                            
                            
                            -
                            
                            
                            
                            -$
                            31,254,373
                            
                            
                            $
                            25,939,596


Identifiable
      long-lived tangible assets at September 30, 2009 andDecember
      31, 2008 by geographical location:China
                                    
                                    $
                                    31,254,373
                                    
                                    
                                    $
                                    25,939,596United
      States
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -$
                                    31,254,373
                                    
                                    
                                    $
                                    25,939,596




(a)
            The
      Company does not allocate any general and administrative expenses of its
      U.S. activities to its reportable segments, because these activities are
      managed at a corporate level. Additionally, other identifiable long-lived
      tangible assets represents assets located in the United States and Hong
      Kong and are not allocated to reportable
  segments.




25




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


NOTE 11 –
STATUTORY
RESERVES





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





For the
nine months ended September 30, 2009, statutory reserve activity is as
follows:





Dyeing
                  
                  
                  Electric
                  
                  
                  Wuxi
      Fulland
                  
                  
                  TotalBalance
      – December 31, 2008
                  
                  $
                  72,407
                  
                  
                  $
                  548,796
                  
                  
                  $
                  -
                  
                  
                  $
                  621,203Additional
      to statutory reserves
                  
                  
                  -
                  
                  
                  
                  398,285
                  
                  
                  
                  11,683
                  
                  
                  
                  409,968Balance
      – September 30, 2009
                  
                  $
                  72,407
                  
                  
                  $
                  947,081
                  
                  
                  $
                  11,683
                  
                  
                  $
                  1,031,171





NOTE 12 –
GRANT
INCOME





The
Company received RMB 1 million ($146,145) in a grant from the Economic and Trade
Bureau of Huishan District, Wuxi City on June 18, 2009.  The Company
used the grant for working capital purposes to increase production of forged
products.





NOTE 13 –
SUBSEQUENT
EVENTS





On
October 22, 2009, the Company sold 2,400,000 shares of series A preferred stock
to investors for $2,400,000.  The price of the common stock was $3.00
per share.  As  a result, the Company will recognize a
deemed preferred stock dividend equal to the difference between the fair market
value of the 2,400,000 shares of series A preferred stock, determined on an “as
if converted” basis and the $2,400,000 consideration we received for the series
A preferred stock.





26




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





Overview





Our
revenues are derived from two unrelated businesses:  (1) the
manufacture and sale of forged rolled rings and other components for the wind
power and other industries and electric power auxiliary apparatuses and (2) the
manufacture and sale of dyeing and finishing equipment. We market products from
these two segments with independent marketing groups to different customer
bases.  We operate through a wholly-owned subsidiary and two
affiliated companies, which are variable interest entities.  The
variable interest entities are Wuxi Huayang Electrical Power Equipment Co., Ltd.
(“Electrical”) and Wuxi Huayang Dyeing Machinery Co., Ltd. (“Dyeing”), which are
collectively referred to as the “Huayang Companies.”  The wholly-owned
subsidiary is Wuxi Fulland Wind Energy Equipment Co., Ltd. (“Fulland
Wind”).  Fulland Wind manufactures forged rolled rings in our new
facilities, and our rolled ring business is being increasingly operated through
Fulland Wind.





Substantially
all of sales are made to companies in China.  Prior to 2009, the
dyeing and finishing equipment business has been the principal source of our
revenue and operating income.  Commencing in 2008, we began to
emphasize our forged rolled rings and electrical power equipment segment,
principally the high precision forged rolled rings for the wind power and other
industries.  We have also manufactured specialty electrical power
equipment for operators of coal-fired electricity generation
plants.  Although this portion of our business accounted for
approximately 5.5% of our revenue in the nine months ended September 30, 2008,
we did not generate any revenue from these products during the nine months ended
September 30, 2009, and we cannot assure you that we will generate significant,
if any, revenue from these products in the future, especially since we are
devoting an increasing percentage of our capacity to the development and
marketing of forged rolled rings for the wind power and other
industries.  As the wind power industry continues to grow, we expect
the shortage of key components, such as gearboxes and bearings, to
continue.  As a result, we expect to see continued demand for our
forged products coming from the wind power and other industries.  As
China continues to promote renewable energy and environmental sustainability
while seeking to expand its economy,





Our
growth in our forged rolled rings business has been accompanied by a decline in
revenue from dyeing and finishing equipment in both the three and nine months
ended September 30, 2009, compared with the comparable periods during 2008. Our
dyeing and finishing equipment business is dependent upon the continued growth
of the textile industry in the PRC. To the extent that growth in this industry
stagnates in the PRC, whether as a result of export restrictions from countries
such as the United States, who are major importers of Chinese-made textiles, or
shifts in international manufacturing to countries which may have a lower cost
than the PRC, or overexpansion of the Chinese textile industry, we will have
more difficulty in selling these products in the PRC, and we may have difficulty
exporting our equipment. Further, it is harder for us to collect our outstanding
accounts receivable due to the tough economy. We deliberately slowed down our
dyeing machine production in fiscal 2009.  Additionally, the export
market can also be subject to protectionist measures imposed by importing
countries seeking to protect their own industries in a time of a declining
demand for products.  As a result, we are experiencing a significant
decline in this segment of our business, and we cannot predict when, if at all,
business in this segment will improve.  If we are not able to generate
sufficient business, we may discontinue this phase of our operations and
concentrate on our forged rings and electrical power equipment
segment.





The
following table sets forth information as to revenue of our dyeing and finishing
equipment, forged rolled rings and electrical power equipment in dollars and as
a percent of revenue (dollars in thousands):




Three months ended September
      30,
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    Nine months
      ended September
      30,2009
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2008
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2009
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    2008Dollars
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    Dollars
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    Dollars
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    Dollars
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    %Dyeing
      and finishing equipment
                                                                                                                    
                                                                                                                    $
                                                                                                                    4,983
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    30.5
                                                                                                                    %
                                                                                                                    
                                                                                                                    $
                                                                                                                    5,959
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    50.6
                                                                                                                    %
                                                                                                                    
                                                                                                                    $
                                                                                                                    12,310
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    32.8
                                                                                                                    %
                                                                                                                    
                                                                                                                    $
                                                                                                                    17,126
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    54.5
                                                                                                                    %Forged
      rolled rings – wind power industry
                                                                                                                    
                                                                                                                    
                                                                                                                    6,877
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    42.9
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    2,494
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    21.2
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    13,243
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    35.2
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    5,125
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    16.3
                                                                                                                    %Forged
      rolled rings – other industries
                                                                                                                    
                                                                                                                    
                                                                                                                    4,272
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    26.6
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    2,764
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    23.5
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    12,024
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    32.0
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    7,420
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    23.7
                                                                                                                    %Electrical
      equipment
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    553
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    4.7
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    -
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    1,730
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    5.5
                                                                                                                    %Total
                                                                                                                    
                                                                                                                    $
                                                                                                                    16,132
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    100.0
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    11,770
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    100.0
                                                                                                                    %
                                                                                                                    
                                                                                                                    $
                                                                                                                    37,577
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    100.0
                                                                                                                    %
                                                                                                                    
                                                                                                                    
                                                                                                                    31,401
                                                                                                                    
                                                                                                                    
                                                                                                                    
                                                                                                                    100.0
                                                                                                                    %




27




The
forged rolled rings segment became a more significant percentage of total
revenues, as we have expanded our manufacturing facilities to enable us to
manufacture forged rolled rings with a larger diameter in order to meet the
perceived needs of the wind power industry.





In 2007,
we purchased property from an affiliated company for a net price of
approximately $10,950,000. The property consists of an approximately 100,000
square foot factory, land use rights, employee housing facilities and other
leasehold improvements.  We are using this new facility to manufacture
forged rolled rings and other components for use in the wind power and other
industries.  With our expanded facilities designed to accommodate the
manufacture of rolled rings with larger diameters, we plan to develop products
designed to meet the needs of the wind power industry. Wind power accounts for
an insignificant percentage of the power generated in the PRC, and our ability
to market to this segment is dependent upon both the growth of the acceptance of
wind power as an energy source in the PRC and the acceptance of our
products.





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





A major
element of our cost of sales is raw materials, principally steel and other
metals. These metals are subject to price fluctuations, and recently these
fluctuations have been significant.  In times of increasing prices, we
need to try to fix the price at which we purchase raw materials in order to
avoid increases in costs which we cannot recoup through increases in sales
prices.  Similarly, in times of decreasing prices, we may have
purchased metals at prices which are high in terms of the price at which we can
sell our products, which also can impair our margins.





We have
required cash for our business, particularly for our expanded plant facilities.
In September and October we issued shares of series A preferred stock at a price
which, on an as-converted basis, was at a discount from the market price of the
common stock on the date of the sale.  These sales generate a deemed
preferred stock dividend equal to the difference between the value of the
underlying common stock on the date of sale and the sales
proceeds.  Although this deemed preferred stock dividend affects the
net income allocable to common stockholders, it does not affect our cash
position.





Critical
Accounting Policies and Estimates





Our
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. We
continually evaluate our estimates, including those related to bad debts,
inventories, recovery of long-lived assets, income taxes, and the valuation of
equity transactions. We base our estimates on historical experience and on
various other assumptions that we believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Any future changes to these estimates and assumptions could cause
a material change to our reported amounts of revenues, expenses, assets and
liabilities. Actual results may differ from these estimates under different
assumptions or conditions. We believe the following critical accounting policies
affect our more significant judgments and estimates used in the preparation of
the financial statements.





Variable
Interest Entities





Pursuant
to Financial Accounting Standards Board accounting standards, we are required to
include in our consolidated financial statements the financial statements of
variable interest entities (“VIEs”).  The accounting standards require
a VIE to be consolidated by a company if that company is subject to a majority
of the risk of loss for the VIE or is entitled to receive a majority of the
VIE’s residual returns. VIEs are those entities in which we, through contractual
arrangements, bear the risk of, and enjoy the rewards normally associated with
ownership of the entity, and therefore we are the primary beneficiary of the
entity.





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




28




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





Accounts
receivable





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





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





Inventories





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





Property
and equipment





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





Useful
      LifeBuilding
      and building improvements
                  
                  20
                  
                  YearsManufacturing
      equipment
                  
                  5 –
      10
                  
                  YearsOffice
      equipment and furniture
                  
                  5
                  
                  YearsVehicle
                  
                  5
                  
                  Years




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





29




Included
in property and equipment is construction-in-progress which consists of
factories and office buildings under construction and machinery pending
installation and includes the costs of construction, machinery and equipment,
and any interest charges arising from borrowings used to finance these assets
during the period of construction or installation. No provision for depreciation
is made on construction-in-progress until such time as the relevant assets are
completed and ready for their intended use.





We
examine the possibility of decreases in the value of fixed assets when events or
changes in circumstances reflect the fact that their recorded value may not be
recoverable. We recognize an impairment loss when the sum of expected
undiscounted future cash flows is less than the carrying amount of the asset.
The amount of impairment is measured as the difference between the asset’s
estimated fair value and its book value.





Land
use rights





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





Revenue
recognition





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





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





Warranty
revenue is valued based on estimated service person hours to complete a service
and generally is recognized over the contract period. For the nine months
ended September 30, 2009 and 2008, amounts allocated to warranty revenues were
not material. Based on historical experience, warranty service calls and any
related labor costs have been minimal.




All other
product sales, including the forging of parts, with customer specific acceptance
provisions, are recognized upon customer acceptance and the delivery of the
parts or service. Revenues related to spare part sales are recognized upon
shipment or delivery based on the trade terms.





Research
and development





Research
and development costs are expensed as incurred, and are included in general and
administrative expenses. These costs primarily consist of cost of material used
and salaries paid for the development of our products and fees paid to third
parties. We had no research and development expenses during the nine months
ended September 30, 2009 and 2008.





Income
taxes





We are
governed by the Income Tax Law of the PRC. Income taxes are accounted for
pursuant to accounting standards, which is an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in our financial
statements or tax returns. The charge for taxes is based on the results for the
year as adjusted for items, which are non-assessable or disallowed. It is
calculated using tax rates that have been enacted or substantively enacted by
the balance sheet date.




30




Deferred
tax is accounted for using the balance sheet liability method in respect of
temporary differences arising from differences between the carrying amount of
assets and liabilities in the financial statements and the corresponding tax
basis used in the computation of assessable tax profit. In principle, deferred
tax liabilities are recognized for all taxable temporary differences, and
deferred tax assets are recognized to the extent that it is probably that
taxable profit will be available against which deductible temporary differences
can be utilized.





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





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





Deemed
Preferred Stock Dividend





When we
issue shares of convertible preferred stock at a price that is, on an “as if
converted” basis, less than the market price of the underlying shares of common
stock, the difference between the value of the underlying shares of common stock
and the purchase price of the convertible preferred stock is treated as a deemed
preferred stock dividend.





Recent
accounting pronouncements





In June
2009, the FASB issued Accounting Standards Update No. 2009-01, “Generally
Accepted Accounting Principles” (ASC Topic 105) which establishes the FASB
Accounting Standards Codification (“the Codification” or “ASC”) as the official
single source of authoritative U.S. generally accepted accounting principles
(“GAAP”). All existing accounting standards are superseded. All other accounting
guidance not included in the Codification will be considered non-authoritative.
The Codification also includes all relevant Securities and Exchange Commission
(“SEC”) guidance organized using the same topical structure in separate sections
within the Codification.  Following the Codification, the Board will
not issue new standards in the form of Statements, FASB Staff Positions or
Emerging Issues Task Force Abstracts. Instead, it will issue Accounting
Standards Updates (“ASU”) which will serve to update the Codification, provide
background information about the guidance and provide the basis for conclusions
on the changes to the Codification. The Codification is not intended to change
GAAP, but it will change the way GAAP is organized and presented. The
Codification is effective for our third-quarter 2009 financial statements and
the principal impact on our financial statements is limited to disclosures as
all future references to authoritative accounting literature will be referenced
in accordance with the Codification. In order to ease the transition to the
Codification, we are providing the Codification cross-reference alongside the
references to the standards issued and adopted prior to the adoption of the
Codification.





In April
2009, the FASB issued FASB Staff Positions FAS 115-2 and FAS 124-2, “Recognition
and Presentation of Other-Than-Temporary Impairments” (ASC Topic 320-10-65).
This update provides guidance for allocation of charges for other-than-temporary
impairments between earnings and other comprehensive income. It also revises
subsequent accounting for other-than-temporary impairments and expands required
disclosure. The update was effective for interim and annual periods ending after
June 15, 2009. The adoption of FAS 115-2 and FAS 124-2 did not have a material
impact on the results of operations and financial condition.





In April
2009, the FASB issued FSP SFAS 107-1 and APB 28-1, “Interim Disclosures About
Fair Value of Financial Instruments” (ASC Topic 320-10-65). This update requires
fair value disclosures for financial instruments that are not currently
reflected on the balance sheet at fair value on a quarterly basis and is
effective for interim periods ending after June 15, 2009.  The
Company’s financial instruments include cash and cash equivalents, accounts
receivable, accounts payable, accrued expenses and notes payable.  At
September 30, 2009 and December 31, 2008 the carrying value of the Companies
financial instruments approximated fair value, due to their short term
nature.





In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (ASC Topic 855). This
guidance is intended to establish general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued or available to be issued. It is effective for
interim and annual reporting periods ending after June 15, 2009.  The
adoption of this guidance did not have a material impact on our consolidated
financial statements.  The Company evaluated all events and
transactions that occurred after September 30, 2009 up through November 10,
2009.  During this period no material subsequent events came to our
attention.





31




In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R)” (ASC Topic 810-10). This updated guidance requires a qualitative approach
to identifying a controlling financial interest in a variable interest entity
(VIE), and requires ongoing assessment of whether an entity is a VIE and whether
an interest in a VIE makes the holder the primary beneficiary of the VIE. It is
effective for annual reporting periods beginning after November 15, 2009. We are
currently evaluating the impact of the pending adoption of SFAS No. 167 on our
consolidated financial statements.





In
October 2009, the FASB issued ASU No. 2009-13, “Multiple-Deliverable Revenue
Arrangements.” This ASU establishes the accounting and reporting guidance for
arrangements including multiple revenue-generating activities. This ASU provides
amendments to the criteria for separating deliverables, measuring and allocating
arrangement consideration to one or more units of accounting. The amendments in
this ASU also establish a selling price hierarchy for determining the selling
price of a deliverable. Significantly enhanced disclosures are also required to
provide information about a vendor’s multiple-deliverable revenue arrangements,
including information about the nature and terms, significant deliverables, and
its performance within arrangements. The amendments also require providing
information about the significant judgments made and changes to those judgments
and about how the application of the relative selling-price method affects the
timing or amount of revenue recognition. The amendments in this ASU are
effective prospectively for revenue arrangements entered into or materially
modified in the fiscal years beginning on or after June 15, 2010. Early
application is permitted. The Company is currently evaluating this new
ASU.





In
October 2009, the FASB issued ASU No. 2009-14, “Certain Revenue Arrangements
That Include Software Elements.” This ASU changes the accounting model for
revenue arrangements that include both tangible products and software elements
that are “essential to the functionality,” and scopes these products out of
current software revenue guidance. The new guidance will include factors to help
companies determine what software elements are considered “essential to the
functionality.” The amendments will now subject software-enabled products to
other revenue guidance and disclosure requirements, such as guidance surrounding
revenue arrangements with multiple-deliverables. The amendments in this ASU are
effective prospectively for revenue arrangements entered into or materially
modified in the fiscal years beginning on or after June 15, 2010. Early
application is permitted. The Company is currently evaluating this new
ASU.





Currency
Exchange Rates





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





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





Our
financial statements are expressed in U.S. dollars but the functional
currency of our operating subsidiary and affiliates is RMB.  To the extent
we hold assets denominated in U.S. dollars, any appreciation of the RMB
against the U.S. dollar could result in a charge in our statement of
operations and a reduction in the value of our U.S. dollar denominated
assets. On the other hand, a decline in the value of RMB against the
U.S. dollar could reduce the U.S. dollar equivalent amounts of our
financial results, which may have a material adverse effect on the price of our
stock.





32




RESULTS
OF OPERATIONS





The
following table sets forth the results of our operations for the periods
indicated as a percentage of net revenues (dollars in thousands):








Three Months Ended September
      30,
                
                
                Nine Months Ended September
    30,2009
                
                
                2008
                
                
                2009
                
                
                2008($)
                
                
                (%)
                
                
                ($)
                
                
                (%)
                
                
                ($)
                
                
                (%)
                
                
                ($)
                
                
                (%)Net
      Revenues
                
                $
                16,132
                
                
                
                100.0
                %
                
                $
                11,770
                
                
                
                100.0
                %
                
                $
                37,577
                
                
                
                100.0
                %
                
                $
                31,400
                
                
                
                100.0
                %Cost
      of Revenues
                
                
                12,243
                
                
                
                75.9
                %
                
                
                8,816
                
                
                
                74.9
                %
                
                
                28,986
                
                
                
                77.1
                %
                
                
                23,509
                
                
                
                74.8
                %Gross
      Profit
                
                
                3,889
                
                
                
                24.1
                %
                
                
                2,954
                
                
                
                25.1
                %
                
                
                8,591
                
                
                
                22.9
                %
                
                
                7,891
                
                
                
                25.2
                %Operating
      Expenses
                
                
                470
                
                
                
                2.9
                %
                
                
                484
                
                
                
                4.1
                %
                
                
                1,641
                
                
                
                4.4
                %
                
                
                1,909
                
                
                
                6.1
                %Income
      from Operations
                
                
                3,420
                
                
                
                21.2
                %
                
                
                2,470
                
                
                
                21.0
                %
                
                
                6,950
                
                
                
                18.5
                %
                
                
                5,982
                
                
                
                19.1
                %Other
      Income (Expenses)
                
                
                (59
                )
                
                
                (0.4
                )%
                
                
                (18
                )
                
                
                (0.2
                )%
                
                
                (124
                )
                
                
                (0.3
                )%
                
                
                (2,309
                )
                
                
                (7.4
                )%Income
      Before Provision for Income Taxes
                
                
                3,360
                
                
                
                20.8
                %
                
                
                2,452
                
                
                
                20.8
                %
                
                
                6,825
                
                
                
                18.2
                %
                
                
                3,673
                
                
                
                11.7
                %Provision
      for Income Taxes
                
                
                862
                
                
                
                5.3
                %
                
                
                591
                
                
                
                5.0
                %
                
                
                1,900
                
                
                
                5.1
                %
                
                
                1,651
                
                
                
                5.3
                %Net
      Income
                
                
                2,498
                
                
                
                15.5
                %
                
                
                1,861
                
                
                
                15.8
                %
                
                
                4,925
                
                
                
                13.1
                %
                
                
                2,022
                
                
                
                6.4
                %Deemed
      preferred stock dividend
                
                
                (462
                )
                
                
                (2.9
                %)
                
                
                --
                
                
                
                --
                
                
                
                (462
                )
                
                
                (1.3
                )%
                
                
                (2,884
                )
                
                
                (9.2
                )%Net
      income (loss) allocable to common shareholders
                
                
                2,036
                
                
                
                12.6
                %
                
                
                1,861
                
                
                
                15.8
                %
                
                
                4,463
                
                
                
                11.9
                %
                
                
                (862
                )
                
                
                (2.7
                )%Other
      Comprehensive Income:Foreign
      Currency Translation Adjustment
                
                
                40
                
                
                
                0.2
                %
                
                
                67
                
                
                
                0.6
                %
                
                
                84
                
                
                
                0.2
                %
                
                
                1,680
                
                
                
                5.4
                %Comprehensive
      Income
                
                
                2,538
                
                
                
                15.7
                %
                
                
                1,928
                
                
                
                16.4
                %
                
                
                5,009
                
                
                
                13.3
                %
                
                
                3,702
                
                
                
                11.8
                %





The
following table sets forth information as to the gross margin for our two lines
of business for the three and nine months ended September 30, 2009 and 2008
(dollars in thousands).





For
      the Three Months Ended September 30,
                                
                                
                                For
      the Nine Months Ended September 30,2009
                                
                                
                                2008
                                
                                
                                2009
                                
                                
                                2008Dyeing and finishing
    equipment:Revenue
                                
                                $
                                4,983
                                
                                
                                $
                                5,959
                                
                                
                                $
                                12,310
                                
                                
                                $
                                17,126Cost
      of sales
                                
                                
                                3,897
                                
                                
                                
                                4,389
                                
                                
                                
                                9,634
                                
                                
                                
                                12,656Gross
      profit
                                
                                
                                1,086
                                
                                
                                
                                1,570
                                
                                
                                
                                2,676
                                
                                
                                
                                4,470Gross
      margin
                                
                                
                                21.7
                                %
                                
                                
                                26.3
                                %
                                
                                
                                21.7
                                %
                                
                                
                                26.1
                                %Forged rolled rings and electric power
      equipment:Revenue
                                
                                $
                                11,149
                                
                                
                                $
                                5,811
                                
                                
                                $
                                25,267
                                
                                
                                $
                                14,274Cost
      of sales
                                
                                
                                8,345
                                
                                
                                
                                4,427
                                
                                
                                
                                19,352
                                
                                
                                
                                10,853Gross
      profit
                                
                                
                                2,804
                                
                                
                                
                                1,384
                                
                                
                                
                                5,915
                                
                                
                                
                                3,421Gross
      margin
                                
                                
                                25.1
                                %
                                
                                
                                23.8
                                %
                                
                                
                                23.4
                                %
                                
                                
                                24.0
                                %





33




Nine
Months Ended September 30, 2009 and 2008





Revenues. For the nine months
ended September 30, 2009, we had revenues of $37,577,000, as compared to
revenues of $31,400,000 for the nine months ended September 30, 2008, an
increase of $6,177,000, or approximately 19.7%. The increase in total revenue
was attributable to increases in revenue from forged rolled rings offset by a
decrease in Dyeing revenues and the absence of any revenue from electrical
equipment, and is summarized as follows (dollars in thousands):




For
      the
                              Nine
      MonthsEnded
                              September
      30, 2009
                            
                            
                            For
      the
                              Nine
      MonthsEnded
                              September
      30, 2008
                            
                            
                            Increase/
                              (Decrease)
                            
                            
                            Percentage
                              ChangeDyeing
      and finishing equipment
                            
                            $
                            12,310
                            
                            
                            $
                            17,126
                            
                            
                            $
                            (4,816
                            )
                            
                            
                            (28.1
                            )
      %Forged
      rolled rings - wind power industry
                            
                            
                            13,243
                            
                            
                            
                            5,125
                            
                            
                            
                            8,118
                            
                            
                            
                            158.4
                            %Forged
      rolled rings - other industries
                            
                            
                            12,024
                            
                            
                            
                            7,419
                            
                            
                            
                            4,605
                            
                            
                            
                            62.1
                            %Electrical
      equipment
                            
                            
                            -
                            
                            
                            
                            1,730
                            
                            
                            
                            (1,730
                            )
                            
                            
                            (100
                            )
      %Total
      net revenues
                            
                            $
                            37,577
                            
                            
                            $
                            31,400
                            
                            
                            $
                            6,177
                            
                            
                            
                            19.7
                            %




The
decrease in revenues from the sale of dyeing and finishing equipment reflects
the impact that the global recession had on the textile industry in
China.  We have experienced, and we are continuing to experience, a
decline in orders for our textile dyeing machines, and domestic competition has
required us to lower our selling prices to compete with other companies in China
that sell similar products.




Revenues
from forging of rolled rings totaled $25,267,000, with revenues from the wind
power industry amounting to $13,243,000 and revenues from other forging
operations amounting to $12,024,000.  Due to the deliberate shift in
focus of our sales effort to the wind segment, we increased sales of forged
rolled rings to the wind power industry by 158.4% for the nine months ended
September 30, 2009 compared to the nine months ended September 30, 2008. We
experienced a 62.1% increase in forging revenues from other industries such as
the railway, heavy machinery manufacturing, petrochemical, metallurgical, sea
port machinery, and defense and radar industry.  We had no sales of
electrical equipment in the nine months ended September 30, 2009.




Cost of sales. Cost of sales
for the nine months ended September 30, 2009 increased $5,477,000 or 23.3%, from
$23,509,000 for the nine months ended September 30, 2008 to $28,986,000 for the
nine months ended September 30, 2009. Cost of goods sold for Dyeing was
$9,634,000 for the nine months ended September 30, 2009, as compared to
$12,656,000 for the nine months ended September 30, 2008. Cost of sales related
to the manufacture of forged rolled rings and other components and the electric
power generating equipment was $19,352,000 for the nine months ended September
30, 2009, which related only to forged rolled rings, as compared to $10,853,000
for the nine months ended September 30, 2008.





Gross profit and gross
margin. Our gross profit was $8,591,000 for the nine months ended
September 30, 2009, as compared to $7,891,000 for the nine months ended
September 30, 2008, representing gross margins of 22.9% and 25.2%, respectively.
Gross profit for Dyeing was $2,676,000 for the nine months ended September 30,
2009 as compared to $4,470,000 for the nine months ended September 30, 2008,
representing gross margins of approximately 21.7% and 26.1%, respectively. The
decrease in our gross margin for Dyeing was attributable to an increase in the
cost of raw materials, such as steel and other metals, which could not be passed
on to our customers during that period as well as a reduction of our sales price
due to stronger competition resulting from the downturn in the textile industry
in China.  Gross profit from forged rolled rings and electric power
equipment segment were $5,915,000 for the nine months ended September 30, 2009
as compared to $3,421,000 for the nine months ended September 30, 2008,
representing gross margins of approximately 23.4% and 24.0%, respectively. The
slight decrease in our gross margin was mainly attributed to operational
inefficiencies as we operated at low production levels, manufactured sample
units for customers, and incurred significant start-up costs in addition to the
normal fixed-costs associated with operating our new forging
facilities.  Some of the costs incurred during the nine months ended
September 30, 2009 related to costs of test production runs, utilities to
power our new production ovens, and payroll costs. We believe that our gross
margins will improve to the extent that we are able to utilize our factory more
efficiently.





34





Depreciation. For the nine
months ended September 30, 2009, our depreciation was $1,238,000, of which
$994,000 is included in cost of sales and $244,000 is included in operating
expenses, as compared with the nine months ended September 30, 2008, with
depreciation expense of $482,000, of which $254,000 is included in cost of sales
and $228,000 is included in operating expenses. The overall increase in
depreciation is attributable to an increase in our equipment, primarily relating
to our forged rolled rings. Additionally, beginning in the second quarter of
2009, our new facility was placed in service and we began to generate revenues
and, accordingly, we began to depreciate the property and equipment associated
with the new facility.





Selling, general and administrative
expenses. Selling, general and administrative expenses totaled $1,397,000
for the nine months ended September 30, 2009, as compared to $1,681,000 for the
nine months ended September 30, 2008, a decrease of $284,000, or approximately
16.9%. Selling, general and administrative expenses consisted of the following
(dollars in thousands):





Nine
      Months Ended
                            September
      30, 2009
                          
                          
                          Nine
      Months Ended
                            September
      30, 2008Professional
      fees
                          
                          $
                          319
                          
                          
                          $
                          399Payroll
      and related benefits
                          
                          
                          335
                          
                          
                          
                          334Travel
                          
                          
                          115
                          
                          
                          
                          175Bad
      debt expense
                          
                          
                          132
                          
                          
                          
                          172Other
                          
                          
                          496
                          
                          
                          
                          601$
                          1,397
                          
                          
                          $
                          1,681




·
            Professional
      fees decreased for the nine months ended September 30, 2009 by $80,000, or
      20.1%, as compared to the same period in 2008. The decrease is primarily
      attributed to a decrease in legal expense of approximately $110,000
      related to the filing of a registration statement in the 2008 period
      covering stock issuable upon exercise of warrants offset by an increase in
      Edgar filing fee of approximately
$30,000.




·
            Payroll
      and related benefits increased for the nine months ended September 30,
      2009 by $1,000, or 0.3%, as compared to the same period in 2008. For the
      nine months ended September 30, 2009, we had an increase in compensation
      and related benefits of approximately $27,000 in our forged rolled rings
      operations resulting from the expansion of our rolled rings operations
      offset by a decrease in compensation and related benefits of approximately
      $1,000 in our dyeing operations and net decrease in compensation for our
      unallocated overhead of approximately $25,000 which primarily attributed
      to a decrease in our board of directors’
  compensation.




·
            Travel
      expense for the nine months ended September 30, 2009 decreased by $60,000,
      or 34.3%, as compared to the same period in 2008. The decrease is related
      to a decrease in travel by sales personnel and
  engineers.




·
            Bad
      debt expense decreased for the nine months ended September 30, 2009 by
      $40,000, or 23.2%. Based on our periodic review of accounts receivable
      balances, we adjusted the allowance for doubtful accounts after
      considering management’s evaluation of the collectability of individual
      receivable balances, including the analysis of subsequent collections, the
      customers’ collection history, and recent economic
  events.




·
            Other
      selling, general and administrative expenses decreased by $105,000, or
      17.5%, for the nine months ended September 30, 2009 as compared with the
      same period in 2008. The decrease was primarily attributed to the decrease
      in shipping fee paid for our customers and stricter control on our
      expenditures.




Income from operations.For
the nine months ended September 30, 2009, income from operations was $6,950,000
as compared to $5,982,000 for the nine months ended September 30, 2008, an
increase of $968,000 or 16.2%.





Other income (expenses). For
the nine months ended September 30, 2009, other expenses amounted to $124,000 as
compared to other expenses of $2,309,000 for the nine months ended September 30,
2008. For the nine months ended September 30, 2009, other income (expense)
included:





·
            interest
      expense of $254,000, consisting of non-cash interest expense of $32,000
      from the amortization of debt discount arising from our March 2009
      financing, $128,000 from the issuance of common stock as payment of a note
      and interest, and interest expense of $94,000 incurred on our outstanding
      loans;




35




·
            Grant
      income of $146,000 from the Economic and Trade Bureau of Huishan District,
      Wuxi City.  We  used the grant for working capital
      purposes to increase production of forged
  products;




·
            amortization
      of debt issuance costs of $14,000;
and




·
            nominal
      foreign currency losses and interest
income.




For the
nine months ended September 30, 2008, other income (expense)
included:




·
            interest
      expense of $2,299,000, consisting of non-cash interest expense of
      $2,264,000 from the amortization of the balance of debt discount arising
      from the valuation of the beneficial conversion features recorded in
      connection with our November 2007 private placement offset by the reversal
      of accrued interest of $21,000 and interest expense of $56,000 incurred on
      our outstanding loans;




·
            amortization
      of debt issuance costs of $22,000,
and




·
            interest
      income of $12,000.




Income tax expense. Income
tax expense increased $249,000 or approximately 15.1%, for the nine months ended
September 30, 2009 as compared to the comparable period in 2008 primarily as a
result of the increase in taxable income generated by our operating
entities.





Deemed Preferred Stock
Dividend.   In September 2009, we sold 1,100,000 shares of
series A preferred stock for $1,100,000.  Each share of series A
preferred stock is convertible into one-third of a share of common
stock.  The effective price per share of common stock issuable upon
conversion of the series A preferred stock was $3.00 per share, which was less
than the market price on the date of the sale.  We recognized a deemed
preferred stock dividend equal to the difference between the fair market value
of the 1,100,000 shares of series A preferred stock, determined on an “as if
converted” basis and the consideration we received for the series A preferred
stock ($1,100,000), which was $462,000.





In the
nine months ended September 30, 2008, we incurred a deemed preferred stock
dividend of resulted from the automatic conversion in March 2008 of our 3%
convertible subordinated notes into shares of series A preferred stock and
warrants.  The amount of the deemed preferred stock dividend,
$2,884,000, reflected the value of the warrants that were issued upon such
conversion.





Net income.As
a result of the foregoing, our net income for the nine months ended September
30, 2009 was $4,925,000.  As a result of the deemed preferred stock
dividend, our net income allocable to common shareholders was $4,463,000, or
$0.29 per share (basic) or $0.20 (diluted).  Net income for the
nine months ended September 30, 2008 was $2,022,000.   As a
result of the deemed preferred stock dividend, we sustained a net loss allocable
to common shareholders of $862,000, or $(0.07) per share (basic and
diluted).




Foreign currency translation gain.The functional currency of our subsidiaries operating in the PRC is the
RMB. The financial statements of our subsidiaries are translated to U.S. dollars
using period end rates of exchange for assets and liabilities, and average rates
of exchange (for the period) for revenues, costs, and expenses. Net gains and
losses resulting from foreign exchange transactions are included in the
consolidated statements of operations. As a result of these translations, which
are a non-cash adjustment, we reported a foreign currency translation gain of
$84,000 for the nine months ended September 30, 2009 as compared to $1,680,000
for comparable period in 2008. This non-cash gain had the effect of increasing
our reported comprehensive income.




Comprehensive income.As a
result of our foreign currency translation gains, we had comprehensive income
for the nine months ended September 30, 2009 of $5,009,000, compared with
$3,702,000 for the nine months ended September 30, 2008.





36




Three
Months Ended September 30, 2009 and 2008





Revenues. For the three
months ended September 30, 2009, we had revenues of $16,132,000, as compared to
revenues of $11,770,000 for the three months ended September 30, 2008, an
increase of $4,362,000 or approximately 37.1%.  The increase in total
revenue was attributable to increases in revenue from forged rolled rings offset
by a decrease in Dyeing revenues and the absence of any revenues from electrical
equipment in the three months ended September 30, 2009, and is summarized as
follows (dollars in thousands):




For
      the Three Months Ended September 30, 2009
                            
                            
                            For
      the Three Months Ended September 30, 2008
                            
                            
                            Increase
                              (Decrease)
                            
                            
                            Percentage
      ChangeDyeing
      and finishing equipment
                            
                            $
                            4,984
                            
                            
                            $
                            5,959
                            
                            
                            $
                            (975
                            )
                            
                            
                            (16.4
                            )
      %Forged
      rolled rings - wind power industry
                            
                            
                            6,876
                            
                            
                            
                            2,494
                            
                            
                            
                            4,382
                            
                            
                            
                            175.7
                            %Forged
      rolled rings - other industries
                            
                            
                            4,272
                            
                            
                            
                            2,764
                            
                            
                            
                            1,508
                            
                            
                            
                            54.5
                            %Electrical
      equipment
                            
                            
                            -
                            
                            
                            
                            553
                            
                            
                            
                            (553
                            )
                            
                            
                            (100.0
                            )
      %Total
      net revenues
                            
                            $
                            16,132
                            
                            
                            $
                            11,770
                            
                            
                            $
                            4,362
                            
                            
                            
                            37.0
                            %





The
decrease in revenues from the sale of dyeing and finishing equipment was
attributable to decreased sales of our equipment to the textile industry due to
the impact that the global recession had on the textile industry in
China.  We have experienced, and we are continuing to experience, a
decline in orders for our textile dyeing machines and domestic competition have
required us to lower our selling prices to compete with other companies in China
that sell similar products.




Revenues
from forging of rolled rings totaled $11,148,000 for the three months ended
September 30, 2009, with revenues from the wind power industry amounting to
$6,876,000 and revenues from other forging operations amounting to
$4,272,000.  Due to our shift in focus of our sales effort to the wind
segment, we increased sales of forged rolled rings to the wind power industry by
175.7% in the three months ended September 30, 2009 compared to the three months
ended September 30, 2008.We experienced a 54.5% increase in forging revenues
from other industries such as the railway, heavy machinery manufacturing,
petrochemical, metallurgical, sea port machinery, and defense and radar
industry.




Cost of sales. Cost of sales
for the three months ended September 30, 2009 increased $3,426,000 or 38.9%,
from $8,816,000 for the three months ended September 30, 2008 to $12,242,000 for
the three months ended September 30, 2009. Cost of goods sold for
Dyeing was $3,897,000 for the three months ended September 30, 2009, as
compared to $4,389,000 for the three months ended September 30, 2008. Cost of
sales related to electric power generating equipment and the manufacture of
forged rolled rings and other components was $8,345,000 for the three months
ended September 30, 2009 as compared to $4,427,000 for the three months ended
September 30, 2008.





Gross profit and gross
margin. Our gross profit was $3,889,000 for the three months ended
September 30, 2009 as compared to $2,954,000 for the three months ended
September 30, 2008, representing gross margins of 24.1% and 25.1%, respectively.
Gross profit for Dyeing was $1,087,000 for the three months ended September 30,
2009 as compared to $1,570,000 for the three months ended September 30, 2008,
representing gross margins of approximately 21.7% and 26.3%, respectively. The
decrease in our gross margin for Dyeing was attributable to an increase in the
cost of raw materials, such as steel and other metals, which could not be passed
on to our customers during that period as well as a reduction of our sales price
due to stronger competition resulting from the downturn in the textile industry
in China. Gross profit related to the forged rolled rings and electric power
equipment was $2,804,000 for the three months ended September 30, 2009 as
compared to $1,384,000 for the three months ended September 30, 2008,
representing a gross margin of 25.1% and 23.8%, respectively. The increase in
our gross margin for the forged rolled rings and electric power equipment was
attributed to the our ability to manufacture in our facility more products for
which we outsourced and paid fees to third party previously. Additionally, we
are improving our efficiency at our new manufacturing facility and we expect
gross margins to improve over time.





37




Depreciation.Depreciation
amounted to $541,000 for the three months ended September 30, 2009, of which
$458,000 is included in cost of sales and $83,000 is included in operating
expenses.  For the three months ended September 30, 2008, our
depreciation was $159,000, of which $89,000 is included in cost of sales and
$70,000 is included in operating expenses. The overall increase in depreciation
is attributable to an increase in property and equipment. Additionally, during
the third quarter of 2009, our new facility was placed in service and we began
to generate revenues and, accordingly, we began to depreciate the property and
equipment associated with the new facility.





Selling, general and administrative
expenses. Selling, general and administrative expenses totaled $387,000
for the three months ended September 30, 2009, as compared to $414,000 for the
three months ended September 30, 2008, a decrease of $27,000 or approximately
6.6%. Selling, general and administrative expenses consisted of the following
(dollars in thousands):


Three
      Months Ended
                              September
      30, 2009
                            
                            
                            Three
      Months Ended
                              September
      30, 2008Professional
      fees
                            
                            $
                            110
                            
                            
                            $
                            18Payroll
      and related benefits
                            
                            
                            120
                            
                            
                            
                            112Travel
                            
                            
                            47
                            
                            
                            
                            73Bad
      debt (recovery) expense
                            
                            
                            (12
                            )
                            
                            
                            2Other
                            
                            
                            121
                            
                            
                            
                            209$
                            386
                            
                            
                            $
                            414





·
            Professional
      fees increased by $92,000, or 511.1%, for the three months ended September
      30, 2009, as compared to the same period in 2008. The increase resulted
      from an increase is expenses relating to investor presentations and
      conferences during the third quarter of fiscal
  2009.




·
            Payroll
      and related benefits increased for the three months ended September 30,
      2009 by $8,000, or 7.1%, as compared to the same period in 2008. The
      slight increase was primarily attributed to the increase in compensation
      and related benefits in our forging segment resulting from the expansion
      of our forging operation.




·
            Travel
      expenses for the three months ended September 30, 2009 decreased by
      $26,000, or 35.6%, as compared to the same period in 2008. The slight
      decrease is related to a decrease in travel by our sales personnel and
      engineers.




·
            For
      the three months ended September 30, 2009, we had bad debt recovery of
      $12,000 as compared to bad debt expense of $2,000 for the three months
      ended September 30, 2008. Based on our periodic review of accounts
      receivable balances, we adjusted the allowance for doubtful accounts after
      considering management’s evaluation of the collectability of individual
      receivable balances, including the analysis of subsequent collections, the
      customers’ collection history, and recent economic
  events.




·
            Other
      selling, general and administrative expenses decreased by $88,000, or
      42.1%, for the three months ended September 30, 2009 as compared with the
      same period in 2008. The decrease was primarily attributed to a decrease
      in local taxes paid to local government due to decreased tax rate as well
      as cost cutting measures.




Income from operations.For
the three months ended September 30, 2009, income from operations was $3,420,000
as compared to $2,470,000 for the three months ended September 30, 2008, an
increase of $950,000 or 38.5%.





38




Other income (expenses). For
the three months ended September 30, 2009, other expense amounted to $59,000 as
compared to other expenses of $18,000 for the three months ended September 30,
2008. For the three months ended September 30, 2009, other income (expense)
included:




·
            interest
      expense of $54,000, consisting of non-cash interest expense of $15,000
      from the amortization of debt discount arising from our March 2009
      financing and interest expense of $39,000 incurred on our outstanding
      loans;




·
            loss
      from foreign currency exchange rate of
$3,000;




·
            debt
      issuance costs of $2,000 and




·
            nominal
      interest income.




For the
three months ended September 30, 2008, other expenses represented interest
expense of $20,000; and, interest income of $2,000.




Income tax expense. Income
tax expense increased $271,000 or approximately 45.9%, for the three months
ended September 30, 2009 as compared to the same period in 2008 primarily as a
result of the increase in taxable income generated by our operating
entities.




Deemed preferred stock
dividend.   In September 2009, we sold 1,100,000 shares of
series A preferred stock for $1,100,000.  Each share of series A
preferred stock is convertible into one-third of a share of common
stock.  The effective price per share of common stock issuable upon
conversion of the series A preferred stock was $3.00 per share, which was less
than the market price on the date of the sale.  We recognized a deemed
preferred stock dividend equal to the difference between the fair market value
of the 1,100,000 shares of series A preferred stock, determined on an “as if
converted” basis and the consideration we received for the series A preferred
stock ($1,100,000), which was $462,000.  We had no comparable item in
the three months ended September 30, 2008.





Net income.For
the three months ended September 30, 2009, we recorded net income of
$2,498,000.  As a result of the deemed preferred stock dividend, our
net income allocable to common shareholders was $2,036,000, or $0.13 per share
(basic) and $0.09 per share (diluted).  For the three months ended
September 30, 2008, we had net income of $1,861,000, or $0.14 per share (basic)
and $0.08 per share (diluted).  Since we had no deemed preferred stock
dividend, all of our net income allocable to common sharesholders.





Foreign currency translation gain.The functional currency of our subsidiaries operating in the PRC is the
Chinese Yuan or Renminbi (“RMB”). The financial statements of our subsidiaries
are translated to U.S. dollars using period end rates of exchange for assets and
liabilities, and average rates of exchange (for the period) for revenues, costs,
and expenses. Net gains and losses resulting from foreign exchange transactions
are included in the consolidated statements of operations. As a result of these
translations, which are a non cash adjustment, we reported a foreign currency
translation gain of $40,000 for the three months ended September 30, 2009 as
compared to $67,000 for comparable period in 2008. This non-cash gain had the
effect of increasing our reported comprehensive income.





Comprehensive income.For the
three months ended September 30, 2009, comprehensive income was $2,538,000, as
compared with comprehensive income of $1,928,000 for the three months ended
September 30, 2008.





Liquidity
and Capital Resources





Liquidity
is the ability of a company to generate funds to support its current and future
operations, satisfy its obligations and otherwise operate on an ongoing
basis.  At September 30, 2009 and December 31, 2008, we had cash
balances of $1,159,000 and $329,000, respectively. These funds are located in
financial institutions located as follows (dollars in thousands):





September
      30, 2009
                    
                    
                    December
      31, 2008Country:United
      States
                    
                    $
                    30
                    
                    
                    
                    2.6
                    %
                    
                    $
                    1
                    
                    
                    
                    0.3
                    %China
                    
                    
                    1,129
                    
                    
                    
                    97.4
                    %
                    
                    
                    328
                    
                    
                    
                    99.7
                    %Total
      cash and cash equivalents
                    
                    $
                    1,159
                    
                    
                    
                    100.0
                    %
                    
                    $
                    329
                    
                    
                    
                    100.0
                    %




39




The
following table sets forth information as to the principal changes in the
components of our working capital from December 31, 2008 to September 30, 2009
(dollars in thousands):





September
      30,
                      
                      
                      December
      31,
                      
                      
                      
                      
                      
                      PercentCategory
                      
                      2009
                      
                      
                      2008
                      
                      
                      Change
                      
                      
                      ChangeCurrent assets:Cash
      and cash equivalents
                      
                      
                      1,159
                      
                      
                      
                      329
                      
                      
                      
                      830
                      
                      
                      
                      252.7
                      %Notes
      receivable
                      
                      
                      88
                      
                      
                      
                      270
                      
                      
                      
                      (182
                      )
                      
                      
                      (67.4
                      %)Accounts
      receivable, net of allowance for doubtful accounts
                      
                      
                      6,005
                      
                      
                      
                      4,518
                      
                      
                      
                      1,487
                      
                      
                      
                      32.9
                      %Inventories,
      net of reserve for obsolete inventory
                      
                      
                      3,012
                      
                      
                      
                      1,892
                      
                      
                      
                      1,120
                      
                      
                      
                      59.2
                      %Advances
      to suppliers
                      
                      
                      270
                      
                      
                      
                      118
                      
                      
                      
                      152
                      
                      
                      
                      129.5
                      %Due
      from related party
                      
                      
                      -
                      
                      
                      
                      437
                      
                      
                      
                      (437
                      )
                      
                      
                      (100.0
                      )%Prepaid
      value-added taxes on purchases
                      
                      
                      312
                      
                      
                      
                      -
                      
                      
                      
                      312
                      
                      
                      
                      N/APrepaid
      expenses and other
                      
                      
                      121
                      
                      
                      
                      22
                      
                      
                      
                      99
                      
                      
                      
                      454.3
                      %Current liabilities:Loans
      payable
                      
                      
                      1,359
                      
                      
                      
                      1,021
                      
                      
                      
                      338
                      
                      
                      
                      33.1
                      %Accounts
      payable
                      
                      
                      2,654
                      
                      
                      
                      2,485
                      
                      
                      
                      169
                      
                      
                      
                      6.8
                      %Accrued
      expenses
                      
                      
                      454
                      
                      
                      
                      188
                      
                      
                      
                      266
                      
                      
                      
                      142.2
                      %VAT
      and service taxes payable
                      
                      
                      216
                      
                      
                      
                      97
                      
                      
                      
                      119
                      
                      
                      
                      122.2
                      %Advances
      from customers
                      
                      
                      66
                      
                      
                      
                      46
                      
                      
                      
                      20
                      
                      
                      
                      43.4
                      %Income
      taxes payable
                      
                      
                      863
                      
                      
                      
                      569
                      
                      
                      
                      294
                      
                      
                      
                      51.5
                      %Working capital:Total
      current assets
                      
                      
                      10,967
                      
                      
                      
                      7,586
                      
                      
                      
                      3,381
                      
                      
                      
                      44.6
                      %Total
      current liabilities
                      
                      
                      5,612
                      
                      
                      
                      4,406
                      
                      
                      
                      1,206
                      
                      
                      
                      27.4
                      %Working
      capital
                      
                      
                      5,355
                      
                      
                      
                      3,180
                      
                      
                      
                      2,175
                      
                      
                      
                      68.4
                      %





Our
working capital increased by $2,175,000, to $5,354,000 at September 30, 2009
from $3,180,000 at December 31, 2008. This increase in working capital resulted
from an increase in accounts receivable and inventory and the sale of series A
preferred stock in September 2009, from which we received gross proceeds of
$1,100,000.  At September 30, 2009, our accounts receivable were
$6,005,000, of which $2,186,000 originated from our Dyeing segment and
$3,819,000 originated from our forged rolled rings segment.   We
believe that our collection remains strong and that our reserves for bad debts
reflect the risk of nonpayment by our customers. However, the worldwide economic
downturn may affect our customers’ ability to pay, particularly in the Dyeing
segment.





Net cash
flow provided by operating activities was $4,921,000 for the nine months ended
September 30, 2009 as compared to net cash flow provided by operating activities
of $5,040,000 for the nine months ended September 30 2008, a decrease of
$119,000. Net cash flow provided by operating activities for the nine months
ended September 30, 2009 was mainly due to net income of $4,925,000, the
add-back of non-cash items of depreciation of $1,238,000, the amortization of
debt discount of $32,000, the amortization of land use rights of $65,000, an
increase in our allowance for bad debt of $132,000, the add-back of interest
expense of $128,000 resulting from the issuance of common stock for the payment
of interest on a note, and stock-based compensation of $158,000, a decrease in
notes receivable of $182,000, a decrease in due from related party of $438,000,
an increase in accounts payable of $163,000, an increase in accrued expense of
$266,000, an increase in VAT and service taxes payable of $119,000, an increase
in income taxes payable of $292,000 and an increase in advances from customers
of $20,000 offset by an increase in accounts receivable of $1,607,000, an
increase in inventories of $1,115,000, an increase in prepaid value-added taxes
on purchase of $312,000, an increase in prepaid and other current assets of
$52,000 and an increase in advances to suppliers of $152,000. Net cash flow
provided by operating activities for the nine months ended September 30, 2008
was mainly due to net income of $2,022,000, the add-back of non-cash items of
depreciation and amortization of $482,000, the amortization of debt discount of
$2,264,000, the amortization of deferred debt costs of $21,000, the increase in
our allowance for bad debt of $172,000, non-cash rent expense associated with
prepaid land use rights of $63,000, and the add-back of stock-based compensation
of $75,000, the decrease in prepaid and other assets of $281,000 and advances to
suppliers of $727,000 and an increase in accounts payable of $1,190,000 offset
by an increase in accounts receivable of $1,778,000, inventories of $124,000,
and the payment of VAT and service taxes of $390,000.





40




Net cash
flow used in investing activities was $6,486,000 for the nine months ended
September 30, 2009 and compared to net cash used in investing activities of
$11,538,000 for the nine months ended September 30, 2008. Net cash flow used in
investing activities for the nine months ended September 30, 2009 was primarily
due to the purchase of property and equipment of $6,486,000 and was related to
the acquisition of additional equipment for our new facility. For the nine
months ended September 30, 2008, used $11,629,000 for the purchase or our plant
facility and $90,000 for the deposit on factory equipments.  These
expenditures were offset by the repayment of amounts due from related parties of
$146,000 and from the sale of a business in which we had a cost-method
investment.





Net cash
flow provided by financing activities was $2,395,000 for the nine months ended
September 30, 2009 as compared to net cash provided by financing activities of
$2,051,000 for the nine months ended September 30, 2008. For the nine months
ended September 30, 2009, we received proceeds from loans of $1,214,000,
proceeds from the exercise of warrants of $83,000 and proceeds from sale of
preferred stock of $1,098,000. For the nine months ended September 30, 2008, we
received proceeds from short-term bank loans of $143,000, and proceeds from the
exercise of warrants of $2,012,000 offset by the repayment of related party
advances of $103,000. The transactions in which we sold stock and notes are
discussed below.





In 2008,
we received $2,188,000 from the exercise of warrants to purchase 1,032,085
shares of common stock.  During the nine months ended September 30,
2009, we received $83,000 from the exercise of warrants to purchase 69,260
shares of common stock.





In March
2009, we sold to two investors our 18-month, 15% notes in the aggregate
principal amount of $250,000 and warrants to purchase 437,500 shares of common
stock at an exercise price of $0.40 per share.  Pursuant to the
related purchase agreements, our chief executive officer placed 510,417 shares
of common stock into escrow.  The note holders have the right to take
these shares, valued at $0.60 per share, in payment of the interest or
principal, as the case may be, if we do not pay the interest on or principal of
the note before it becomes an event of default.  Pursuant to the loan
documents, in the event of that Leo Wang ceases to be employed by us as our
chief financial officer the holders of not less than $126,000 principal amount
of the notes, shall have the right, on not less than 60 days’ notice, to declare
the notes in default.  If Mr. Wang ceases to be employed by us as a
result of his death, disability or a termination for cause, than we shall have
60 days to replace Mr. Wang with a chief financial officer acceptable to
investors.





In August
2009, we borrowed $80,000 from Barron Partners LP for which we issued our
18-month 12% promissory note in the principal amount of $80,000. Payment of our
obligations of the note are secured by a pledge of and conversion right with
respect to 62,933 shares of common stock owned by Yunxia Ren, the
daughter-in-law of our chief executive officer and a major stockholder. The
pledge and conversion right enables Barron to convert any or the entire
principal amount of the note or interest into pledged shares, at a conversion
price of $1.50 per share upon any default in payment of principal or interest.
The number of pledged shares to be delivered shall be determined by dividing the
principal amount or interest of the note being converted by the conversion
price. The pledged shares shall be held in escrow.





In
September 2009, we sold 1,100,000 shares of series A preferred stock, to Barron
for $1,100,000.





On
October 22, 2009, we sold 2,400,000 shares of series A preferred stock to a
Barron and other investors for $2,400,000.





In
addition to the loans described in the preceding paragraph, during the nine
months ended September 30, 2009, we received several bank and third-party loans
for aggregate proceeds of approximately $1,214,000.





41




Contractual
Obligations and Off-Balance Sheet Arrangements




Contractual
Obligations




The
following tables summarize our contractual obligations as of September 30,
2009 (dollars in thousands).




PaymentsDue by
      PeriodTotal
                            
                            Less than 1
      year
                            
                            1-3
Years
                            
                            3-5
                              Years
                            
                            5 Years
                              +Contractual Obligations :Bank
      indebtedness (1)
                            
                            $
                            1,755
                            
                            
                            $
                            1,170
                            
                            
                            $
                            -
                            
                            
                            $
                            585
                            
                            
                            $
                            -Loans
      payable
                            
                            
                            330
                            
                            
                            
                            250
                            
                            
                            
                            80
                            
                            
                            
                            -
                            
                            
                            
                            -Total
      Contractual Obligations:
                            
                            $
                            2,085
                            
                            
                            $
                            1,420
                            
                            
                            $
                            80
                            
                            
                            $
                            585
                            
                            
                            $
                            -




(1)
            Bank
      indebtedness consists of short term and long term bank
    loans.




Off-balance
Sheet Arrangements




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





Foreign
Currency Exchange Rate Risk





We
produce and sell almost all of our products in China. Thus, most of our revenues
and operating results may be impacted by exchange rate fluctuations between RMB
and US dollars.  For the nine months ended September 30, 2009, we had
unrealized foreign currency translation gain of $84,000, because of the change
in the exchange rate.





ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





Not
required for smaller reporting companies.





ITEM 4.  CONTROLS AND PROCEDURES





Our
management, including Jianhua Wu, our chief executive officer, and Leo Wang, our
chief financial officer, evaluated the effectiveness of the design and operation
of our disclosure controls and procedures as of September 30, 2009.





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





Management
conducted its evaluation of disclosure controls and procedures under the
supervision of our chief executive officer and our chief financial officer.
Based on that evaluation, our management, including Messrs. Wu and Wang,
concluded that because of the significant deficiencies in internal control over
financial reporting described below, our disclosure controls and procedures were
not effective as of September 30, 2009.





42




Management’s
Report on Internal Control over Financial Reporting




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act.  Our management is also required to
assess and report on the effectiveness of our internal control over financial
reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002
(“Section 404”).   Management assessed the effectiveness of our
internal control over financial reporting as of December 31, 2008.  In
making this assessment, we used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control – Integrated Framework.  During our assessment of the
effectiveness of internal control over financial reporting as of
December 31, 2008, management identified significant deficiencies related
to (i) the U.S. GAAP expertise of our internal accounting staff, (ii) our
internal audit functions and (iii) a lack of segregation of duties within
accounting functions.  However, management believes that these
deficiencies do not amount to a material weakness. Therefore, our internal
control over financial reporting were effective as of September 30,
2009.





We became
a reporting company in November 2007.  We began preparing to be in
compliance with the internal control obligations, including Section 404, for our
fiscal year ending December 31, 2007.  During most of 2007 our
internal accounting staff was primarily engaged in ensuring compliance with PRC
accounting and reporting requirements for our operating affiliates and was not
required to meet or apply U.S. GAAP requirements.  As a result, with the
exception of certain additional persons hired at the end of 2007 to address
these deficiencies, including the hiring of our chief financial officer, our
current internal accounting department responsible for financial reporting of
the Company, on a consolidated basis, is relatively new to U.S. GAAP and the
related internal control procedures required of U.S. public companies. Although
our accounting staff is professional and experienced in accounting requirements
and procedures generally accepted in the PRC, management has determined that
they require additional training and assistance in U.S. GAAP matters.
 Management has determined that our internal audit function is also
significantly deficient due to insufficient qualified personnel to perform
internal audit functions.





In order
to correct the foregoing deficiencies, we have taken the following remediation
measures:




·
            In
      late 2007, we engaged Adam Wasserman, a senior financial executive from
      the U.S. to serve as our chief financial officer on a part-time basis.
        In December 2008, we hired Leo Wang as our chief financial officer
      on a full-time basis and Mr. Wasserman became our vice president of
      financial reporting.  Mr. Wasserman has extensive experience in
      internal control and U.S. GAAP reporting compliance, and, together with
      our chief executive and chief financial officers oversees and manages our
      financial reporting process and required training of the accounting
      staff.




·
            We
      have committed to the establishment of effective internal audit functions,
      however, due to the scarcity of qualified candidates with extensive
      experience in U.S. GAAP reporting and accounting in the region, we were
      not able to hire sufficient internal audit resources before end of 2008.
      However, we will increase our search for qualified candidates with
      assistance from recruiters and through
  referrals.




·
            We
      elected two independent directors and they, along with a third
      independent director, serve on our audit committee.  We have
      also adopted a charter for our audit
committee.




·
            Due
      to our size and nature, segregation of all conflicting duties may not
      always be possible and may not be economically
      feasible.  However, to the extent possible, we will implement
      procedures to assure that the initiation of transactions, the custody of
      assets and the recording of transactions will be performed by separate
      individuals.




We
believe that the foregoing steps will remediate the deficiency identified above,
and we will continue to monitor the effectiveness of these steps and make any
changes that our management deems appropriate.





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





43




Our
management is not aware of any material weaknesses in our internal control over
financial reporting, and nothing has come to the attention of management that
causes them to believe that any material inaccuracies or errors exist in our
financial statement as of September 30, 2009.  The reportable
conditions and other areas of our internal control over financial reporting
identified by us as needing improvement have not resulted in a material
restatement of our financial statements. We are not aware of any instance where
such reportable conditions or other identified areas of weakness have resulted
in a material misstatement of omission in any report we have filed with or
submitted to the SEC. Since management has concluded that no errors or
restatements have occurred and believes that controls were in place during the
2008 quarters that would detect or prevent a material misstatement in our
consolidated financial statements, management has concluded that that there was
not a material weakness in controls.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies and procedures may deteriorate.





Changes
in Internal Controls over Financial Reporting




There
were no changes in our internal controls over financial reporting during the
period covered by this report that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.





PART II -
OTHER INFORMATION





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





On August
1, 2009, we issued 1,478 shares of common stock to our vice president of
financial reporting for services rendered pursuant to an engagement agreement.
The shares were valued at fair value on the date of grant and we recorded
stock-based compensation of $6,250.





On August
14, 2009, we issued 6,897 shares of common stock to a newly-elected director
pursuant to an agreement with the director. The shares were valued at fair value
on the date of grant and we recorded stock-based compensation of $3,750 and
prepaid expenses of $26,250.





On August
14, 2009, we issued 6,667 shares of common stock to an investor relations
company. The shares were valued at fair value on the date of grant and we
recorded professional fees of $29,000.





On August
4, 2009, we issued 89,213 shares of common stock upon the conversion of 267,640
shares of series A preferred stock.





On July
1, 2009, we issued 3,098 shares of common stock for cashless exercise of
outstanding warrants.





On
September 9, 2009, we issued 1,487 shares of common stock for cashless exercise
of outstanding warrants.





These
issuances were exempt from registration under the Securities Act in reliance on
an exemption provided by Section 4(2) of that Act.  Each person to
whom the shares were issued acquired the shares for investment and not with a
view to the sale or distribution and received information concerning us, our
business and our financial condition, and the stock certificates bear an
investment legend.  No brokerage fees were paid in connection with any
of these stock issuances.





ITEM 6.    EXHIBITS





31.1           Rule
13a-14(a)/15d-14(a) certification of Chief Executive Officer


31.2           Rule
13a-14(a)/15d-14(a) certificate of Principal Financial Officer


32.1           Section
1350 certification of Chief Executive Officer and Chief Financial
Officer




44





SIGNATURES





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






CHINA WIND SYSTEMS,
      INC.Date:
      November 16, 2009
                  By:
                  /s/
      Jianhua WuJianhua
      Wu, Chief Executive Officer





Date:
      November 16, 2009
                      By:
                      /s/
      Leo WangLeo
      Wang, Chief Financial Officer




45