UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)





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





For the
quarterly period ended June 30, 2009





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





For the
transition period from __________ to __________





COMMISSION
FILE NUMBER:  33-16335





CHINA WIND SYSTEMS,
INC.


(Name
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 þ No  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation
S-T (§232.405 of this chapter) during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).


Yes  ̈ No  ̈





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





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





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





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.  46,048,636 shares of common
stock are issued and outstanding as of August 12, 2009.





CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


FORM
10-Q


June
30, 2009





TABLE
OF CONTENTS




Page
                      No.PART
      I. - FINANCIAL INFORMATIONItem
      1.
                    Financial
      Statements
                    3Consolidated
      Balance Sheets as of June 30, 2009 (Unaudited) and December 31,
      2008
                    3Consolidated
      Statements of Income and Comprehensive Income for the Three and Six Months
      Ended June 30, 2009 and 2008 (unaudited)
                    4Consolidated
      Statements of Cash Flows for the Six Months Ended June 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.
                    45Item
      4
                    Controls
      and Procedures.
                    45PART
      II – OTHER INFORMATIONItem
      2.
                    Unregistered
      Sales of Equity Securities and Use of Proceeds.
                    48Item
      6.
                    Exhibits.
                    48






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
 
 June
      30,
                                          
                                          
                                          December
      31,2009
                                          
                                          
                                          2008(Unaudited)
                                          
                                          
                                          (Audited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                                          
                                          $
                                          720,827
                                          
                                          
                                          $
                                          328,614Notes
      receivable
                                          
                                          
                                          401,473
                                          
                                          
                                          
                                          269,549Accounts
      receivable, net of allowance for doubtful accounts (Note
2)
                                          
                                          
                                          6,271,623
                                          
                                          
                                          
                                          4,518,259Inventories,
      net of reserve for obsolete inventory (Note 3)
                                          
                                          
                                          2,516,385
                                          
                                          
                                          
                                          1,892,090Advances
      to suppliers
                                          
                                          
                                          123,919
                                          
                                          
                                          
                                          117,795Due
      from related party (Note 8)
                                          
                                          
                                          -
                                          
                                          
                                          
                                          437,688Prepaid
      value-added taxes on purchases
                                          
                                          
                                          234,089
                                          
                                          
                                          
                                          -Prepaid
      expenses and other
                                          
                                          
                                          72,344
                                          
                                          
                                          
                                          21,744Total
      Current Assets
                                          
                                          
                                          10,340,660
                                          
                                          
                                          
                                          7,585,739PROPERTY
      AND EQUIPMENT - net (Note 4)
                                          
                                          
                                          28,126,754
                                          
                                          
                                          
                                          25,939,596OTHER
      ASSETS:Land
      use rights, net (Note 5)
                                          
                                          
                                          3,768,468
                                          
                                          
                                          
                                          3,806,422Total
      Assets
                                          
                                          $
                                          42,235,882
                                          
                                          
                                          $
                                          37,331,757LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Loans
      payable (Note 7)
                                          
                                          $
                                          1,168,770
                                          
                                          
                                          $
                                          1,021,272Accounts
      payable
                                          
                                          
                                          2,891,880
                                          
                                          
                                          
                                          2,485,137Accrued
      expenses
                                          
                                          
                                          269,991
                                          
                                          
                                          
                                          187,605VAT
      and service taxes payable
                                          
                                          
                                          -
                                          
                                          
                                          
                                          97,341Advances
      from customers
                                          
                                          
                                          471,847
                                          
                                          
                                          
                                          45,748Income
      taxes payable
                                          
                                          
                                          701,168
                                          
                                          
                                          
                                          569,371Total
      Current Liabilities
                                          
                                          
                                          5,503,656
                                          
                                          
                                          
                                          4,406,474LONG-TERM
      LIABILITIES:Loan
      payable - net of current portion and debt discount (Note
7)
                                          
                                          
                                          758,397
                                          
                                          
                                          
                                          -Total
      Liabilities
                                          
                                          
                                          6,262,053
                                          
                                          
                                          
                                          4,406,474RELATED
      PARY TRANSACTIONS (Note 8)Committments
      (Note 11)
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -STOCKHOLDERS'
      EQUITY: (Note 6)Preferred
      stock $0.001 par value; (June 30, 2009 and December 31, 2008 -
      60,000,000 shares authorized, all of whichwere
      designated as series A convertible preferred, 13,626,728 and 14,028,189
      shares issued and outstanding;at June 30,
      2009 and December 31, 2008,
respectively)
                                          
                                          
                                          13,627
                                          
                                          
                                          
                                          14,028Common
      stock ($0.001 par value; 150,000,000 shares authorized;46,039,342 and
      44,895,546 shares issued and outstandingat
      June 30, 2009 and December 31, 2008, respectively)
                                          
                                          
                                          46,039
                                          
                                          
                                          
                                          44,896Additional
      paid-in capital
                                          
                                          
                                          16,147,706
                                          
                                          
                                          
                                          15,571,288Retained
      earnings
                                          
                                          
                                          15,858,198
                                          
                                          
                                          
                                          13,639,641Statutory
      reserve
                                          
                                          
                                          829,239
                                          
                                          
                                          
                                          621,203Other
      comprehensive gain - cumulative foreign currency translation
      adjustment
                                          
                                          
                                          3,079,020
                                          
                                          
                                          
                                          3,034,227Total
      Stockholders' Equity
                                          
                                          
                                          35,973,829
                                          
                                          
                                          
                                          32,925,283Total
      Liabilities and Stockholders' Equity
                                          
                                          $
                                          42,235,882
                                          
                                          
                                          $
                                          37,331,757
 
 See notes
to unaudited consolidated financial statements
 
 3
 
 CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF INCOME
  
 For
      the Three Months Ended
                      
                      
                      For
      the Six Months EndedJune
      30,
                      
                      
                      June
      30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008(Unaudited)
                      
                      
                      (Unaudited)
                      
                      
                      (Unaudited)
                      
                      
                      (Unaudited)NET
      REVENUES
                      
                      $
                      13,584,030
                      
                      
                      $
                      11,182,950
                      
                      
                      $
                      21,444,897
                      
                      
                      $
                      19,630,024COST
      OF SALES
                      
                      
                      10,479,370
                      
                      
                      
                      8,419,505
                      
                      
                      
                      16,743,588
                      
                      
                      
                      14,692,331GROSS
      PROFIT
                      
                      
                      3,104,660
                      
                      
                      
                      2,763,445
                      
                      
                      
                      4,701,309
                      
                      
                      
                      4,937,693OPERATING
      EXPENSES:Depreciation
                      
                      
                      83,393
                      
                      
                      
                      141,568
                      
                      
                      
                      160,923
                      
                      
                      
                      219,588Selling,
      general and administrative
                      
                      
                      509,408
                      
                      
                      
                      589,420
                      
                      
                      
                      1,010,356
                      
                      
                      
                      1,205,988Total
      Operating Expenses
                      
                      
                      592,801
                      
                      
                      
                      730,988
                      
                      
                      
                      1,171,279
                      
                      
                      
                      1,425,576INCOME
      FROM OPERATIONS
                      
                      
                      2,511,859
                      
                      
                      
                      2,032,457
                      
                      
                      
                      3,530,030
                      
                      
                      
                      3,512,117OTHER
      INCOME (EXPENSE):Interest
      income
                      
                      
                      98
                      
                      
                      
                      4,011
                      
                      
                      
                      328
                      
                      
                      
                      9,644Interest
      expense
                      
                      
                      (176,058
                      )
                      
                      
                      (18,753
                      )
                      
                      
                      (199,729
                      )
                      
                      
                      (2,278,447
                      )Foreign
      currency loss
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (11
                      )
                      
                      
                      -Grant
      income
                      
                      
                      146,130
                      
                      
                      
                      -
                      
                      
                      
                      146,130
                      
                      
                      
                      -Debt
      issuance costs
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (12,000
                      )
                      
                      
                      (21,429
                      )Total
      Other Income (Expense)
                      
                      
                      (29,830
                      )
                      
                      
                      (14,742
                      )
                      
                      
                      (65,282
                      )
                      
                      
                      (2,290,232
                      )INCOME
      BEFORE INCOME TAXES
                      
                      
                      2,482,029
                      
                      
                      
                      2,017,715
                      
                      
                      
                      3,464,748
                      
                      
                      
                      1,221,885INCOME
      TAXES
                      
                      
                      701,494
                      
                      
                      
                      606,531
                      
                      
                      
                      1,038,155
                      
                      
                      
                      1,060,562NET
      INCOME
                      
                      
                      1,780,535
                      
                      
                      
                      1,411,184
                      
                      
                      
                      2,426,593
                      
                      
                      
                      161,323DEEMED
      PREFERRED STOCK DIVIDEND
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (2,884,062
                      )NET
      INCOME (LOSS) ALLOCABLE TO COMMON SHAREHOLDERS
                      
                      $
                      1,780,535
                      
                      
                      $
                      1,411,184
                      
                      
                      $
                      2,426,593
                      
                      
                      $
                      (2,722,739
                      )COMPREHENSIVE
      INCOME:NET
      INCOME
                      
                      $
                      1,780,535
                      
                      
                      $
                      1,411,184
                      
                      
                      $
                      2,426,593
                      
                      
                      $
                      161,323OTHER
      COMPREHENSIVE INCOME:Unrealized
      foreign currency translation gain
                      
                      
                      3,253
                      
                      
                      
                      605,039
                      
                      
                      
                      44,793
                      
                      
                      
                      1,612,284COMPREHENSIVE
      INCOME
                      
                      $
                      1,783,788
                      
                      
                      $
                      2,016,223
                      
                      
                      $
                      2,471,386
                      
                      
                      $
                      1,773,607NET
      INCOME (LOSS) PER COMMON SHARE:Basic
                      
                      $
                      0.04
                      
                      
                      $
                      0.04
                      
                      
                      $
                      0.05
                      
                      
                      $
                      (0.07
                      )Diluted
                      
                      $
                      0.03
                      
                      
                      $
                      0.02
                      
                      
                      $
                      0.04
                      
                      
                      $
                      (0.07
                      )WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING:Basic
                      
                      
                      45,241,308
                      
                      
                      
                      38,036,208
                      
                      
                      
                      45,104,303
                      
                      
                      
                      37,760,355Diluted
                      
                      
                      63,768,462
                      
                      
                      
                      65,712,820
                      
                      
                      
                      60,623,311
                      
                      
                      
                      37,760,355
 
 See notes
to unaudited consolidated financial statements
 
 4
 
 CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 
 For
      the Six Months EndedJune
      30,2009
                    
                    
                    2008(Unaudited)
                    
                    
                    (Unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                    
                    $
                    2,426,593
                    
                    
                    $
                    161,323Adjustments
      to reconcile net income from operations to net cashprovided
      by operating activities:Depreciation
                    
                    
                    697,127
                    
                    
                    
                    322,923Amortization
      of debt discount to interest expense
                    
                    
                    16,997
                    
                    
                    
                    2,263,661Amortization
      of debt offering costs
                    
                    
                    -
                    
                    
                    
                    21,429Amortization
      of land use rights
                    
                    
                    43,191
                    
                    
                    
                    66,761Increase
      in allowance for doubtful accounts
                    
                    
                    143,620
                    
                    
                    
                    170,024Interest
      expense related to debt converion
                    
                    
                    128,489
                    
                    
                    
                    -Stock-based
      compensation expense
                    
                    
                    119,612
                    
                    
                    
                    75,000Changes
      in assets and liabilities:Notes
      receivable
                    
                    
                    (131,584
                    )
                    
                    
                    -Accounts
      receivable
                    
                    
                    (1,891,180
                    )
                    
                    
                    (1,860,346
                    )Inventories
                    
                    
                    (621,840
                    )
                    
                    
                    (911,684
                    )Prepaid
      value-added taxes on purchases
                    
                    
                    (234,142
                    )
                    
                    
                    -Prepaid
      and other current assets
                    
                    
                    (50,602
                    )
                    
                    
                    235,398Advances
      to suppliers
                    
                    
                    (5,964
                    )
                    
                    
                    647,106Due
      from related party
                    
                    
                    438,389
                    
                    
                    
                    -Accounts
      payable
                    
                    
                    403,527
                    
                    
                    
                    (137,507
                    )Accrued
      expenses
                    
                    
                    82,146
                    
                    
                    
                    3,085VAT
      and service taxes payable
                    
                    
                    (97,497
                    )
                    
                    
                    (230,670
                    )Income
      taxes payable
                    
                    
                    131,045
                    
                    
                    
                    74,150Advances
      from customers
                    
                    
                    426,134
                    
                    
                    
                    864NET
      CASH PROVIDED BY OPERATING ACTIVITIES
                    
                    
                    2,024,061
                    
                    
                    
                    901,517CASH
      FLOWS FROM INVESTING ACTIVITIES:Decrease
      in due from related parties
                    
                    
                    -
                    
                    
                    
                    98,058Proceeds
      from sale of cost-method investee
                    
                    
                    -
                    
                    
                    
                    35,348Deposit
      on long-term assets - related party
                    
                    
                    -
                    
                    
                    
                    (88,783
                    )Deposit
      on long-term assets
                    
                    
                    -
                    
                    
                    
                    (2,648,096
                    )Purchase
      of property and equipment
                    
                    
                    (2,849,156
                    )
                    
                    
                    (2,126,847
                    )NET
      CASH USED IN INVESTING ACTIVITIES
                    
                    
                    (2,849,156
                    )
                    
                    
                    (4,730,320
                    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from loans payable
                    
                    
                    1,133,612
                    
                    
                    
                    141,390Proceeds
      from exercise of warrants
                    
                    
                    83,111
                    
                    
                    
                    854,340Payments
      on related party advances
                    
                    
                    -
                    
                    
                    
                    (101,905
                    )NET
      CASH PROVIDED BY FINANCING ACTIVITIES
                    
                    
                    1,216,723
                    
                    
                    
                    893,825EFFECT
      OF EXCHANGE RATE ON CASH AND CASH EQUIVALENTS
                    
                    
                    585
                    
                    
                    
                    184,068NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                    
                    
                    392,213
                    
                    
                    
                    (2,750,910
                    )CASH AND
      CASH EQUIVALENTS - beginning of year
                    
                    
                    328,614
                    
                    
                    
                    5,025,434CASH
      AND CASH EQUIVALENTS - end of period
                    
                    $
                    720,827
                    
                    
                    $
                    2,274,524SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid for:Interest
                    
                    $
                    46,443
                    
                    
                    $
                    35,505Income
      taxes
                    
                    $
                    921,760
                    
                    
                    $
                    1,169,603NON-CASH
      INVESTING AND FINANCING ACTIVITIES:Debt
      discount for grant of warrants
                    
                    $
                    92,985
                    
                    
                    $
                    -Deemed
      preferred stock dividend reflected in paid-in capital
                    
                    $
                    -
                    
                    
                    $
                    2,884,062Convertible
      debt converted to series A preferred stock
                    
                    $
                    -
                    
                    
                    $
                    5,525,000Deposit
      on long-term assets-related party reclassified to intangible
      assets
                    
                    $
                    -
                    
                    
                    $
                    5,500,030Series
      A preferred converted to common shares
                    
                    $
                    401
                    
                    
                    $
                    759Common
      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


June 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 manufactures and sells 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 for the wind-power and other industries that are up to three
meters in diameter.  In 2008, the sale of rolled rings accounted for
more than 88% of Electric’s revenue.   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


June 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 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 variable interest entities (“VIE”), and the
Company is the primary beneficiary.  The Company’s relationships with
the Huayang Companies and their shareholders are governed by a series of
contractual arrangements between Green Power 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 (collectively the “Huayang Companies
Shareholders”), Green Power provides guidance and instructions on the
Huayang Companies’ daily operations, financial management and employment issues.
The Huayang Companies Shareholders must designate the candidates recommended by
Green Power as their representatives on the boards of directors of each of the
Huayang Companies. Green Power has the right to appoint senior executives of the
Huayang Companies. In addition, Green Power agrees to guarantee the Huayang
Companies’ performance under any agreements or arrangements relating to the
Huayang Companies’ business arrangements with any third party. The Huayang
Companies, in return, agrees to pledge their accounts receivable and all of
their assets to Green Power. Moreover, 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


June 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 (2) 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 pursuant to Financial Accounting Standards Board Interpretation No.
46 (Revised), “Consolidation of Variable Interest Entities - an Interpretation
of ARB No. 51.” 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 of the Huayang Companies
net income. The Company does not have any non-controlling interest and
accordingly, did not subtract any net income in calculating the net income
attributable to the Company. Because of the contractual arrangements, the
Company had a pecuniary interest in the Huayang Companies that require
consolidation of the Company’s and the Huayang Companies financial
statements.





Use of
estimates





The
preparation of the financial statements in conformity with accounting principles
generally accepted in the U.S. requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues,
expenses, and the related disclosures at the date of the financial statements
and during the reporting period. Actual results could materially differ from
these estimates. Significant estimates in 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.


8




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009




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





Fair value of financial
instruments





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





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




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




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





The
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 SFAS 157.





Cash and cash
equivalents





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





Concentrations of credit
risk





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





Financial
instruments which potentially subject the Company to concentrations of credit
risk consist principally of cash and trade accounts receivable. Substantially
all of the Company’s cash is maintained with state-owned banks within the 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.


9




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009




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





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





June 30, 2009
                  
                  
                  December 31, 2008Country:United
      States
                  
                  $
                  10,324
                  
                  
                  
                  1.4
                  %
                  
                  $
                  832
                  
                  
                  
                  0.3
                  %China
                  
                  
                  710,503
                  
                  
                  
                  98.6
                  %
                  
                  
                  327,782
                  
                  
                  
                  99.7
                  %Total
      cash and cash equivalents
                  
                  $
                  720,827
                  
                  
                  
                  100.0
                  %
                  
                  $
                  328,614
                  
                  
                  
                  100.0
                  %





Notes
receivable





Notes
receivable represents trade accounts receivable due from various customers where
the customers’ bank has guaranteed the payment of the receivable. This amount is
non-interest bearing and is normally paid within three to six months.
Historically, the Company has experienced no losses on notes receivable. The
Company‘s notes receivable totaled $401,473 at June 30, 2009 and $269,549 at
December 31, 2008.





Accounts
receivable





Accounts
receivable are presented net of an allowance for doubtful accounts. The Company
maintains allowances for doubtful accounts for estimated losses. The Company
reviews the accounts receivable on a periodic basis and makes general and
specific allowances when there is doubt as to the collectability of individual
balances. In evaluating the collectability of individual receivable balances,
the Company considers many factors, including the age of the balance, customer’s
historical payment history, its current credit-worthiness and current economic
trends. Accounts are written off after exhaustive efforts at collection. At June
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
$1,019,645 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 $79,278 and $79,170 at June 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.


10




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009




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





Impairment of long-lived
assets





In
accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets,” 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 six months ended June 30,
2009 and 2008.





Income
taxes





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





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





Revenue
recognition





The
Company recognizes revenue when persuasive evidence of an arrangement exists,
delivery has occurred or services have been rendered, the purchase price is
fixed or determinable and collectability is reasonably assured. The Company
accounts for the product sale as a multiple element arrangement. Revenue from
multiple element arrangements is allocated among the separate accounting units
based on the residual method. Under the residual method, the revenue is
allocated to undelivered elements based on fair value of such undelivered
elements and the residual amounts of revenue allocated to delivered elements.
The Company recognizes revenues from the sale of dyeing equipment, forged rolled
rings, and electric equipment upon shipment and transfer of title. The other
elements may include installation and, generally, a one-year warranty. Equipment
installation revenue is valued based on estimated service person hours to
complete installation and is recognized when the labor has been completed
and the equipment has been accepted by the customer, which is generally within a
couple days of the delivery of the equipment. Warranty revenue is valued based
on estimated service person hours to complete a service and generally is
recognized over the contract period.  For the six months ended June
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.


11


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


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





Advances from
customers





Advances
from customers at June 30, 2009 and December 31, 2008 amounted to $471,847
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.





Stock-based
compensation





Stock
based compensation is accounted for under SFAS No. 123R, “Share-Based
Payment.” SFAS No. 123R 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). SFAS No. 123R 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. The Company accounts for non-employee share-based awards in
accordance with EITF No. 96-18, “Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquisition, or in Conjunction with Selling,
Goods or Services.”





Shipping
costs





Shipping
costs are included in selling expenses and totaled $99,704 and $85,340 for the
six months ended June 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, which is approximately 25% of salaries. The costs of these
payments are charged to income in the same period as the related salary costs
and are not material.





Advertising





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





Research and
development





Research
and development costs are expensed as incurred. For the six months ended June
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 six months ended June 30, 2009
and 2008 was $585 and $184,068, 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


June 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 June 30, 2009 and December 31, 2008 were translated at
6.8448 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 six months ended June 30, 2009 and 2008 were 6.84323 RMB and
7.07263 RMB to $1.00, respectively.  In accordance with Statement of
Financial Accounting Standards No. 95, Statement of Cash Flows cash flows from
the Company’s operations is 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.





Income 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:





FortheThreeMonthsEnded
                  June30,
                
                
                FortheSixMonthsEnded
                  June30,2009
                
                
                2008
                
                
                2009
                
                
                2008Net
      income (loss) allocable to common shareholders for basic and diluted net
      income (loss) per common share
                
                $
                1,780,535
                
                
                $
                1,411,184
                
                
                $
                2,426,593
                
                
                $
                (2,722,739
                )Weighted
      average common shares outstanding – basic
                
                
                45,241,308
                
                
                
                38,036,208
                
                
                
                45,104,303
                
                
                
                37,760,355Effect
      of dilutive securities:Series
      A convertible preferred stock
                
                
                13,626,728
                
                
                
                14,028,189
                
                
                
                13,626,728
                
                
                
                -Warrants
                
                
                4,900,426
                
                
                
                13,648,423
                
                
                
                1,892,280
                
                
                
                -Weighted
      average common shares outstanding– diluted
                
                
                63,768,462
                
                
                
                65,712,820
                
                
                
                60,623,311
                
                
                
                37,760,355Net
      income (loss) per common share  - basic
                
                $
                0.04
                
                
                $
                0.04
                
                
                $
                0.05
                
                
                $
                (0.07
                )Net
      income (loss) per common share  - diluted
                
                $
                0.03
                
                
                $
                0.02
                
                
                $
                0.04
                
                
                $
                (0.07
                )





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


2009
                  
                  
                  2008Warrants
                  
                  
                  16,363,221
                  
                  
                  
                  17,756,756Series
      A preferred stock
                  
                  
                  13,626,728
                  
                  
                  
                  14,028,189Total
                  
                  
                  29,989,949
                  
                  
                  
                  31,784,945





Accumulated other
comprehensive income




The
Company follows Statement of Financial Accounting Standards No. 130 (SFAS
130) “Reporting Comprehensive
Income” to recognize the elements of comprehensive income. Comprehensive
income is comprised of net income and all changes to the statements of
stockholders' equity, except those due to investments by stockholders, changes
in paid-in capital and distributions to stockholders. For the Company,
comprehensive income for the three and six months ended June 30, 2009 and 2008
included net income and unrealized gains from foreign currency translation
adjustments.


13




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009




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





Related
parties





Parties
are considered to be related to the Company if the parties that, directly or
indirectly, through one or more intermediaries, control, are controlled by, or
are under common control with the Company. Related parties also include
principal owners of the Company, its management, members of the immediate
families of principal owners of the Company and its management and other parties
with which the Company may deal if one party controls or can significantly
influence the management or operating policies of the other to an extent that
one of the transacting parties might be prevented from fully pursuing its own
separate interests. 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 June 30, 2009, subsequent events were evaluated by the Company as of
August 13, 2009, the date on which the unaudited consolidated financial
statements at and for the quarter ended June 30, 2009, were available to be
issued.





Recent accounting
pronouncements





In
March 2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities”. The new standard is
intended to improve financial reporting about derivative instruments and hedging
activities by requiring enhanced disclosures to enable investors to better
understand their effects on an entity’s financial position, financial
performance, and cash flows. It is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged.  The adoption of SFAS 161 did not have a
material impact on the preparation of our consolidated financial
statements.





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





On June
16, 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating
Securities,” to address the question of whether instruments granted in
share-based payment transactions are participating securities prior to vesting.
The FSP determines that unvested share-based payment awards that contain rights
to dividend payments should be included in earnings per share calculations. The
guidance will be effective for fiscal years beginning after December 15, 2008.
The adoption of FSP EITF 03-6-1 did not have an impact on our consolidated
financial statements.


14


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


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




Recent accounting
pronouncements (continued)





In June
2008, the FASB ratified Emerging Issues Task Force Issue No. 07-5, “Determining Whether an Instrument
(or Embedded Feature) is Indexed to an Entity’s Own
Stock.”  EITF 07-5 mandates a two-step process for evaluating
whether an equity-linked financial instrument or embedded feature is indexed to
the entity’s own stock.  Warrants that a company issues that contain a
strike price adjustment feature, upon the adoption of EITF 07-5, are no longer
being considered indexed to the company’s own stock. Accordingly, adoption of
EITF 07-5 will change the current classification (from equity to liability) and
the related accounting for such warrants outstanding at that date. EITF 07-5 is
effective for fiscal years beginning after December 15, 2008, and interim
periods within those fiscal years. The adoption of EITF 07-5 did not have a
material impact on our consolidated financial statements.





On
October 10, 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active,” which
clarifies the application of SFAS 157 when the market for a financial asset is
inactive. Specifically, FSP 157-3 clarifies how (1) management’s internal
assumptions should be considered in measuring fair value when observable data
are not present, (2) observable market information from an inactive market
should be taken into account, and (3) the use of broker quotes or pricing
services should be considered in assessing the relevance of observable and
unobservable data to measure fair value. The Company is currently evaluating the
impact of adoption of FSP 157-3 on the Company’s consolidated
financial.





In
November 2008, the FASB issued EITF Issue No. 08-7, “Accounting for
Defensive Intangible Assets,” or EITF No. 08-7. EITF No. 08-7
discusses that when an entity acquired in a business combination or an asset
acquisition an intangible asset that it did not intend to actively use,
otherwise known as a defensive asset, the entity historically allocated little
or no value to the defensive asset. However, with the issuance of SFAS
No. 141(R) and SFAS No. 157 the entity must recognize a value for the
defensive asset that reflects the asset’s highest and best use based on market
assumptions. Upon the effective date of both SFAS No. 141(R) and SFAS
No. 157, acquirers will generally assign a greater value to a defensive
asset than would typically have been assigned under SFAS No. 141. EITF
No. 08-7 will be effective for the first annual reporting period beginning
on or after December 15, 2008. EITF No. 08-7 will apply prospectively
to business combinations for which the acquisition date is after fiscal years
beginning on or after December 15, 2008. The adoption of EITF No. 08-7
did not have a material impact on our results of operations or financial
condition.





In April 2009, the FASB issued SFAS
No. 141 (R), “Accounting for Assets Acquired and Liabilities Assumed in a
Business Combination That Arise from Contingencies.” SFAS No. 141
(R) amends and clarifies SFAS No. 141, “Business Combinations,” in
regards to the initial recognition and measurement, subsequent measurement and
accounting, and disclosures of assets and liabilities arising from contingencies
in a business combination. FSP SFAS No. 141 (R) applies to all assets
acquired and liabilities assumed in a business combination that
arise from contingencies that would be within the scope of SFAS No. 5,
“Accounting for Contingencies”, if not acquired or assumed in a business
combination, except for assets or liabilities arising from contingencies that
are subject to specific guidance in SFAS No. 141 (R). FSP SFAS No. 141
(R) will be effective for the first annual reporting period beginning on or
after December 15, 2008. FSP SFAS No. 141(R) will apply prospectively
to business combinations for which the acquisition date is after fiscal years
beginning on or after December 15, 2008. The adoption of SFAS No. 141
(R) did not have a material impact on our results of operations or financial
condition.




In April
2009, the FASB issued FSP FAS 157-4, which provides guidance on how to determine
the fair value of assets and liabilities when the volume and level of activity
for the asset or liability has significantly decreased when compared with normal
market activity for the asset or liability as well as guidance on identifying
circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is
effective for interim and annual periods ending after June 15, 2009. The Company
is currently evaluating the financial impact that FSP FAS. 157-4 will have, but
expects that the financial impact, if any, will not be material on its
Consolidated Financial Statements.


15


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


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




In April
2009, the FASB issued FSP FAS 115-2 and FAS 124-2, which amends the requirements
for the recognition and measurement of other-than-temporary impairments for debt
securities by modifying the current "intent and ability" indicator. Under FSP
FAS 115-2 and FAS 124-2, an other-than-temporary impairment must be recognized
if the Company has the intent to sell the debt security or the Company is more
likely than not will be required to sell the debt security before its
anticipated recovery. In addition, FSP FAS 115-2 and FAS 124-2 requires
impairments related to credit loss, which is the difference between the present
value of the cash flows expected to be collected and the amortized cost basis
for each security, to be recognized in earnings while impairments related to all
other factors to be recognized in other comprehensive income. FSP FAS 115-2 and
FAS 124-2 is effective for interim and annual periods ending after June 15,
2009. The Company is currently evaluating the financial impact that FSP FAS
115-2 and FAS 124-2 will have, but expects that the financial impact, if any,
will not be material on its consolidated financial statements.





In April
2009, the FASB issued FSP 107-1 and 28-1. This FSP amends SFAS 107, to require
disclosures about fair value of financial instruments not measured on the
balance sheet at fair value in interim financial statements as well as in annual
financial statements. Prior to this FSP, fair values for these assets and
liabilities were only disclosed annually. This FSP applies to all financial
instruments within the scope of SFAS 107 and requires all entities to disclose
the method(s) and significant assumptions used to estimate the fair value of
financial instruments. This FSP shall be effective for interim periods ending
after June 15, 2009, with early adoption permitted for periods ending after
March 15, 2009. An entity may early adopt this FSP only if it also elects
to early adopt FSP 157-4 and 115-2 and 124-2. This FSP does not require
disclosures for earlier periods presented for comparative purposes at initial
adoption. In periods after initial adoption, this FSP requires comparative
disclosures only for periods ending after initial adoption. The Company is
currently evaluating the disclosure requirements of this new FSP.




In May
2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS 165).
SFAS 165 establishes general standards for accounting for and disclosure of
events that occur after the balance sheet date but before financial statements
are available to be issued (subsequent events). More specifically, SFAS 165
sets forth the period after the balance sheet date during which management of a
reporting entity should evaluate events or transactions that may occur for
potential recognition in the financial statements, identifies the circumstances
under which an entity should recognize events or transactions occurring after
the balance sheet date in its financial statements and the disclosures that
should be made about events or transactions that occur after the balance sheet
date. SFAS 165 provides largely the same guidance on subsequent events
which previously existed only in auditing literature. The statement was adopted
by the Company in its second quarter and did not have an impact on its
Consolidated Financial Statements.





In June 2009, the FASB issued
SFAS No. 168, The FASB Accounting Standards Codification and Hierarchy
of Generally Accepted Accounting Principles, a replacement of FASB Statement
No. 162 (SFAS 168). SFAS 168 establishes the FASB Standards
Accounting Codification (Codification) as the source of authoritative
U.S. generally accepted accounting principles (GAAP) recognized by the FASB
to be applied to nongovernmental entities and rules and interpretive releases of
the SEC as authoritative GAAP for SEC registrants. The Codification will
supersede all the existing non-SEC accounting and reporting standards upon its
effective date and subsequently, the FASB will not issue new standards in the
form of Statements, FASB Staff Positions or Emerging Issues Task Force
Abstracts. SFAS 168 also replaces FASB StatementNo. 162, The
Hierarchy of Generally Accepted Accounting Principles, given that once in
effect, the Codification will carry the same level of authority. SFAS 168 will
be effective for financial statements issued for reporting periods that end
after September 15, 2009.





In April
2009, the FASB issued Staff Position No. FAS 107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments (FAS 107-1 and APB 28-1),
which requires publicly traded companies to include in their interim financial
reports certain disclosures about the carrying value and fair value of financial
instruments previously required only in annual financial statements and to
disclose changes in significant assumptions used to calculate the fair value of
financial instruments. FAS 107-1 and APB 28-1 is effective for all interim
reporting periods ending after June 15, 2009, with early adoption permitted
for interim reporting periods ending after March 15, 2009. The Company
adopted FAS 107-1 and APB 28-1 in the second quarter of 2009. The adoption did
not have a material impact on the Company’s consolidated financial
statements.


16


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


NOTE 2 –
ACCOUNTS
RECEIVABLE





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





June 30, 2009
                  
                  
                  December 31, 2008Accounts
      receivable
                  
                  $
                  7,291,268
                  
                  
                  $
                  5,393,115Less:
      allowance for doubtful accounts
                  
                  
                  (1,019,645
                  )
                  
                  
                  (874,856
                  )$
                  6,271,623
                  
                  
                  $
                  4,518,259





NOTE 3 -
INVENTORIES





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





June 30, 2009
                  
                  
                  December 31, 2008Raw
      materials
                  
                  $
                  1,151,608
                  
                  
                  $
                  1,054,182Work
      in process
                  
                  
                  463,210
                  
                  
                  
                  254,960Finished
      goods
                  
                  
                  980,845
                  
                  
                  
                  662,1182,595,663
                  
                  
                  
                  1,971,260Less:
      Reserve for obsolete inventory
                  
                  
                  (79,278
                  )
                  
                  
                  (79,170
                  )$
                  2,516,385
                  
                  
                  $
                  1,892,090





NOTE 4 -
PROPERTY AND
EQUIPMENT





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





Useful Life
                    
                    
                    June 30, 2009
                    
                    
                    December 31, 2008Office
      equipment and furniture
                    
                    5
      Years
                    
                    
                    $
                    107,439
                    
                    
                    $
                    99,561Manufacturing
      equipment
                    
                    5 –
      10 Years
                    
                    
                    
                    14,979,119
                    
                    
                    
                    14,754,250Vehicles
                    
                    5
      Years
                    
                    
                    
                    79,481
                    
                    
                    
                    79,372Construction
      in progress
                    
                    -
                    
                    
                    
                    2,143,529
                    
                    
                    
                    207,605Building
      and building improvements
                    
                    20
      Years
                    
                    
                    
                    15,124,716
                    
                    
                    
                    14,404,41932,434,284
                    
                    
                    
                    29,545,207Less:
      accumulated depreciation
                    
                    
                    
                    
                    
                    
                    (4,307,530
                    )
                    
                    
                    (3,605,611
                    )$
                    28,126,754
                    
                    
                    $
                    25,939,596





For the
six months ended June 30, 2009 and 2008, depreciation expense amounted to
$697,127 and $322,923, respectively, of which $536,204 and $103,335,
respectively, is included in cost of sales.  Upon completion of the
construction in progress, the assets will be classified to its respective
property and equipment category.




NOTE 5 –
LAND USE
RIGHTS





There is
no private ownership of land in China. Land is owned by the government and the
government grants land use rights for specified terms.  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 six months ended June 30, 2009 and 2008,
amortization of land use rights amounted to $43,191 and $66,761,
respectively.


17


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


NOTE 5 –
LAND USE RIGHTS
(continued)





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


Useful Life
                    
                    June 30, 2009
                    
                    
                    December 31, 2008Land
      Use Rights
                    45
      - 50 years
                    
                    $
                    3,944,716
                    
                    
                    $
                    3,939,307Less:
      Accumulated Amortization
                    
                    
                    
                    (176,248
                    )
                    
                    
                    (132,885
                    )$
                    3,768,468
                    
                    
                    $
                    3,806,422





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





Period
      ending June 30:2010
                  
                  $
                  86,3632011
                  
                  
                  86,3632012
                  
                  
                  86,3632013
                  
                  
                  86,363Thereafter
                  
                  
                  3,423,016$
                  3,768,468




NOTE 6 –
STOCKHOLDERS’
EQUITY





(a)           Common
stock





On
January 1, 2009, the Company issued 70,000 shares of its common stock for
investor relation services. The Company valued these shares at the fair
value of the common shares on date of grant of $35,000, or $0.50 per share, and
recorded professional fees of $35,000.





On March
3, 2009, the Company issued 232 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 six months ended June 30, 2009, the Company issued 30,948 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
date of grant, and the Company recorded stock-based compensation of
$21,274





On June
4, 2009, the Company issued 207,780 shares of its common stock to Eos Holdings
upon the exercise of stock warrants for cash proceeds of $83,112.





On June
5, 2009, the Company issued 401,461 shares of its common stock to Eos Holdings
upon the conversion of 401,461 shares of series A preferred stock.





On June
12, 2009, the Company issued 305,926 shares of its common stock in satisfaction
of debt and accrued interest of $152,963.  The shares were valued at
fair value on the date of grant of $281,461 or $.92 per share, and accordingly,
the Company reduced loans payable and accrued expenses by $152,963 and recorded
interest expense of $128,489.





On June
17, 2009, the Company issued 52,980 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 date of grant and the
Company recorded stock-based compensation of $26,167 and prepaid expenses of
$2,083.





On June
18, 2009, the Company issued 74,469 shares of its common stock to its
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 recorder
stock-based compensation of $5,833 and prepaid expenses of
$29,167.


18




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009




NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





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





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 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
11,176,504 shares of common stock at $0.58 per share, 5,588,252 shares of common
stock at $0.83 per share, and 2,065,000 shares at $0.92 per share, 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.





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(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.




·
            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
      $.374 per share.




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


19




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009




NOTE 6 –
STOCKHOLDERS’
EQUITY





·
            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)           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 $.374 per
share.




·
            The
      Company and the investors entered into a registration rights agreement
      pursuant to which the Company agreed to file, by January 12, 2008, a
      registration statement covering the common stock issuable upon conversion
      of the series A preferred stock and exercise of the warrants and to have
      the registration statement declared effective by June 11,
      2008.  The 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, pursuant to FASB Staff Position, or FSP, EITF 00-19-2, Accounting for Registration
      Payment Arrangements, no liability was
  recorded.





·
            The
      Investors have a right of first refusal on future
    financings.




·
            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 March 13,
      2010.


20


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009




NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





·
            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)          Warrants




On March
23, 2009, in connection with the Company’s sale to two investors of its
18-month, 15% notes in the aggregate principal amount of $250,000, the Company
issued five-year warrants to purchase 437,500 shares at an exercise price of
$0.40 per share. These warrants were treated as a discount on the secured notes
and were valued at $92,985 to be amortized over the 18-month note term. The fair
value of this warrant 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 six months ended June 20, 2009, amortization of this debt
discount amounted to $16,997. As a result of the issuance of these warrants, the
exercise price of warrants to purchase 9,232,424 shares was reduced from $0.567
to $0.566. Our financial statements were not affected by this
change.





Warrant
activity for the six months ended June 30, 2009 is summarized as
follows:


Number of
                    Warrants
                  
                  
                  Weighted
                    Average
                    Exercise PriceBalance
      at beginning of period
                  
                  
                  16,133,501
                  
                  
                  $
                  0.50Granted
                  
                  
                  437,500
                  
                  
                  
                  0.40Exercised
                  
                  
                  (207,780
                  )
                  
                  
                  0.40Balance
      at end of period
                  
                  
                  16,363,221
                  
                  
                  $
                  0.50Warrants
      exercisable at end of period
                  
                  
                  16,363,221
                  
                  
                  $
                  0.50





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


Warrants Outstanding
                          
                          
                          Warrants ExercisableRange of
                            Exercise
                            Price
                          
                          Number
                            Outstanding at
                            June 30, 2009
                          
                          
                          Weighted
                            Average
                            Remaining
                            Contractual
                            Life (Years)
                          
                          
                          Weighted
                            Average
                            Exercise
                            Price
                          
                          
                          Number
                            Exercisable at
                            June 30, 2009
                          
                          
                          Weighted
                            Average
                            Exercise
                            Price$
                          0.50
                          
                          
                          400,000
                          
                          
                          
                          3.38
                          
                          
                          $
                          0.50
                          
                          
                          
                          400,000
                          
                          
                          $
                          0.500.566
                          
                          
                          9,232,424
                          
                          
                          
                          3.38
                          
                          
                          
                          0.566
                          
                          
                          
                          9,232,424
                          
                          
                          
                          0.5660.40
                          
                          
                          6,730,797
                          
                          
                          
                          3.46
                          
                          
                          
                          0.40
                          
                          
                          
                          6,730,797
                          
                          
                          
                          0.4016,363,221
                          
                          
                          
                          
                          
                          
                          $
                          0.50
                          
                          
                          
                          16,363,221
                          
                          
                          $
                          0.50


21


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(f)           Beneficial Conversion
FeatureandDeemedDividend





In
November 2007, the Company evaluated the application of EITF 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios,” and EITF 00-27, “Application of Issue No. 98-5 to
Certain Convertible Instruments” and concluded that the convertible notes
had a beneficial conversion option. In fiscal 2007, pursuant to EITF 00-27,
Issue 15, the Company computed the intrinsic value of the conversion option at
$2,610,938 based on a comparison of (a) the proceeds of the convertible debt
allocated to the common stock portion of the conversion option by first
allocating the proceeds received from the convertible debt offering to the debt
and the detachable warrants on a relative fair value basis, and (b) the fair
value at the commitment date of the common stock to be received by the Company
upon conversion. The excess of (b) over (a) is the intrinsic value of the
embedded conversion option of $2,610,938 that has been recognized by the Company
as a discount to the notes and amortized using the straight-line method over the
stated term; with the unamortized portion being recognized upon the conversion
of the notes.





The
Company filed the restated certificate of incorporation on March 28,
2008.   Upon filing of the restated certificate of incorporation,
the note was automatically converted into 14,787,135 shares of series A
preferred stock and warrants to purchase 18,829,756 shares of the common stock.
As a result of the automatic conversion of the note into shares of series A
preferred stock and warrants, as described above, the Company recognized the
value of the warrants and any remaining debt discount upon conversion of the
note.





At
November 13, 2007, the fair value of the warrants used to calculate the
intrinsic value of the conversion option was estimated at $2,884,062 and was
computed using the Black-Scholes option-pricing model based on the assumed
issuance of the warrants on the date the notes were issued. Variables used in
the option-pricing model include (1) risk-free interest rate at the date of
grant (3.84%), (2) expected warrant life of 5 years, (3) expected
volatility of 150%, and (4) 0% expected dividend. As the series A preferred
stock does not require redemption by the Company or have a finite life, upon
issuance of the warrants on March 28, 2008, a one-time preferred stock deemed
dividend of $2,884,062 was recognized immediately as a non-cash charge on March
28, 2008. The non-cash, deemed dividend did not have an effect on net earnings
or cash flows for the six months ended June 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.





For the
six months ended June 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 six months ended
June 30, 2009 and 2008 was $16,997 and $2,263,661, respectively, which has been
included in interest expense on the accompanying statements of
income.   For the six months ended March 31, 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 evaluated the application of Financial Accounting Standard
No. 133, Accounting for Derivative Financial Instruments and Hedging Activities
(FAS 133) and 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
FAS 133, consist of financial instruments or other contracts that contain all
three of the following characteristics: i) the financial instrument has a
notional amount and one or more underlying, e.g. interest rate, security price
or other variable, ii) require no initial net investment and iii) permits net
settlement. Derivative financial instruments may be free-standing or embedded in
other financial instruments. Paragraph 9 of FAS 133 defines net
settlement.  In order for the net settlement requirement to be met, the
contract must meet one of the three tests listed in paragraph
9.


22


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





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





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





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





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





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





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


23


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009





NOTE 7 –
LOANS
PAYABLE





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





June 30, 2009
                  
                  
                  December 31, 2008Loan
      payable to Bank of Communications, due on December 16, 2009 with annual
      interest at June 16, 2009 of 6.05% secured by assets of the
      Company.
                  
                  $
                  292,193
                  
                  
                  $
                  291,792Loan
      payable to Bank of Communications, due on December 10, 2009 with annual
      interest at June 10, 2009 of 6.05% secured by assets of the
      Company.
                  
                  
                  438,289
                  
                  
                  
                  437,688Loan
      payable to Industrial and Commercial Bank of China, due on December 16,
      2009 with annual interest at June 30, 2009 of 6.42% secured by assets of
      the Company.
                  
                  
                  292,193
                  
                  
                  
                  291,792Loan
      payable to Industrial and Commercial Bank of China, due on November 18,
      2009 with annual interest at June 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.
                  
                  
                  146,096
                  
                  
                  
                  -Loan
      payable to Agricultural  and Commercial Bank, due on May 25,
      2013 with annual interest at June 30, 2009 of 5.7525% secured by assets of
      the Company
                  
                  
                  584,384
                  
                  
                  
                  -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
                  
                  
                  2,003,155
                  
                  
                  
                  1,021,272Less:
      current portion of loans payable
                  
                  
                  (1,168,770
                  )
                  
                  
                  (1,021,272
                  )Long-term
      loans payable
                  
                  
                  834,385
                  
                  
                  
                  -Less:
      debt discount (a)
                  
                  
                  (75,988
                  )
                  
                  
                  -Long-term
      loans payable – net
                  
                  $
                  758,397
                  
                  
                  $
                  -





(a)
            In
      March 2009, the Company sold to two investors its 18-month, 15% notes in
      the aggregate principal amount of $250,000 and warrants to purchase
      437,500 shares at an exercise price of $0.40 per share for a total of
      $250,000. Pursuant to the related purchase agreements, our chief executive
      officer placed 1,531,250 shares of common stock into escrow. The note
      holders have the right to take these shares, valued at $0.20 per share, if
      the Company does not pay the interest on or principal of the notes before
      such failure becomes an event of default. Pursuant to the loan documents,
      in the event of that Leo Wang ceases to be employed by the Company as its
      chief financial officer, the holders of not less than $126,000 principal
      amount of the notes, shall have the right, on not less than 60 days’
      notice, to declare the notes in default. If Mr. Wang ceases to be employed
      by the Company as a result of his death, disability or a termination for
      cause, than the Company shall have 60 days to replace Mr. Wang with a
      chief financial officer acceptable to investors. The debt discount of
      $91,485 represents the value of the warrants issued in connection with
      this note (See Note 6(e)).


24


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009





NOTE 8 –
RELATED PARTY
TRANSACTIONS





Due
from related party





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





Name
                  
                  Relationship
                  
                  June 30,
                    2009
                  
                  
                  December 31,
                    2008Wuxi
      Anyida 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
9,196,341RMB, 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 under Statement of Financial Accounting
Standards No. 109, ‘‘Accounting for Income Taxes’’ (‘‘SFAS 109’’). SFAS 109
requires the recognition of deferred tax assets and liabilities for both the
expected impact of differences between the financial statements and the tax
basis of assets and liabilities, and for the expected future tax benefit to be
derived from tax losses and tax credit carryforwards.  SFAS 109
additionally requires the establishment of a valuation allowance to reflect the
likelihood of realization of deferred tax assets. Realization of deferred tax
assets, including those related to the U.S. net operating loss carryforwards,
are dependent upon future earnings, if any, of which the timing and amount are
uncertain. Accordingly, the net deferred tax asset related to the U.S. net
operating loss carryforward has been fully offset by a valuation allowance. The
Company is governed by the Income Tax Law of the People’s Republic of China and
the United States. In 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 are subject to these
statutory rates.


25


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 30,
2009





NOTE 10 -
SEGMENT INFORMATION





The
following information is presented in accordance with SFAS No. 131, Disclosure
about Segments of an Enterprise and Related Information.  For the
three and six months ended June 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 six months ended June 30, 2009
and 2008 is as follows:


For the Three Months Ended June 30,
                                                          
                                                          
                                                          For the Six Months Ended June 30,2009
                                                          
                                                          
                                                          2008
                                                          
                                                          
                                                          2009
                                                          
                                                          
                                                          2008Revenues:Dyeing
      and finishing equipment
                                                          
                                                          $
                                                          3,797,008
                                                          
                                                          
                                                          $
                                                          6,514,153
                                                          
                                                          
                                                          $
                                                          7,326,449
                                                          
                                                          
                                                          $
                                                          11,167,291Forged
      rolled rings and electric power equipment
                                                          
                                                          
                                                          9,787,022
                                                          
                                                          
                                                          
                                                          4,668,797
                                                          
                                                          
                                                          
                                                          14,118,448
                                                          
                                                          
                                                          
                                                          8,462,73313,584,030
                                                          
                                                          
                                                          
                                                          11,182,950
                                                          
                                                          
                                                          
                                                          21,444,897
                                                          
                                                          
                                                          
                                                          19,630,024Depreciation:Dyeing
      and finishing equipment
                                                          
                                                          
                                                          103,585
                                                          
                                                          
                                                          
                                                          106,508
                                                          
                                                          
                                                          
                                                          203,692
                                                          
                                                          
                                                          
                                                          204,346Forged
      rolled rings and electric power equipment
                                                          
                                                          
                                                          418,429
                                                          
                                                          
                                                          
                                                          57,353
                                                          
                                                          
                                                          
                                                          493,435
                                                          
                                                          
                                                          
                                                          118,577522,014
                                                          
                                                          
                                                          
                                                          163,861
                                                          
                                                          
                                                          
                                                          697,127
                                                          
                                                          
                                                          
                                                          322,923Interest
      expense:Dyeing
      and finishing equipment
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -Forged
      rolled rings and electric power equipment
                                                          
                                                          
                                                          22,875
                                                          
                                                          
                                                          
                                                          18,753
                                                          
                                                          
                                                          
                                                          44,139
                                                          
                                                          
                                                          
                                                          35,505Other
      (a)
                                                          
                                                          
                                                          153,183
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          155,590
                                                          
                                                          
                                                          
                                                          2,242,942176,058
                                                          
                                                          
                                                          
                                                          18,753
                                                          
                                                          
                                                          
                                                          199,729
                                                          
                                                          
                                                          
                                                          2,278,447Net
      income (loss):Dyeing
      and finishing equipment
                                                          
                                                          
                                                          427,088
                                                          
                                                          
                                                          
                                                          1,086,989
                                                          
                                                          
                                                          
                                                          891,591
                                                          
                                                          
                                                          
                                                          1,791,375Forged
      rolled rings and electric power equipment
                                                          
                                                          
                                                          1,647,318
                                                          
                                                          
                                                          
                                                          488,913
                                                          
                                                          
                                                          
                                                          2,071,354
                                                          
                                                          
                                                          
                                                          1,129,862Other
      (a)
                                                          
                                                          
                                                          (293,871
                                                          )
                                                          
                                                          
                                                          (164,718
                                                          )
                                                          
                                                          
                                                          (536,352
                                                          )
                                                          
                                                          
                                                          (2,759,914
                                                          )1,780,535
                                                          
                                                          
                                                          
                                                          1,411,184
                                                          
                                                          
                                                          
                                                          2,426,593
                                                          
                                                          
                                                          
                                                          161,323Identifiablelong-lived tangible
      assets at June 30, 2009 and December 31, 2008 by segment:Dyeing
      and finishing equipment
                                                          
                                                          $
                                                          4,364,151
                                                          
                                                          
                                                          $
                                                          10,057,047Forged
      rolled rings and electric power equipment
                                                          
                                                          
                                                          23,762,603
                                                          
                                                          
                                                          
                                                          15,882,549Other
      (a)
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -$
                                                          28,126,754
                                                          
                                                          
                                                          $
                                                          25,939,596Identifiable
      long-lived tangible assets at June 30, 2009 and December 31, 2008 by
      geographical location:China
                                                          
                                                          $
                                                          28,126,754
                                                          
                                                          
                                                          $
                                                          25,939,596United
      States
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -$
                                                          28,126,754
                                                          
                                                          
                                                          $
                                                          25,939,596




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




26


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


June 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
six months ended June 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
                
                
                -
                
                
                
                206,816
                
                
                
                1,220
                
                
                
                208,036Balance
      – June 30, 2009
                
                $
                72,407
                
                
                $
                755,612
                
                
                $
                1,220
                
                
                $
                829,239





NOTE 12 –
GRANT
INCOME





The
Company received RMB 1 million ($146,130) in a grant from the Economic and Trade
Bureau of Huishan District, Wuxi City on June 18, 2009.  The Company
will use the grant for working capital purposes to increase production of forged
products.





NOTE 13 –
SUBSEQUENT
EVENTS





On July
1, 2009, the Company issued 9,294 shares of common stock in connection with
cashless exercise of warrants to purchase 23,358 shares of common
stock.





On August
7, 2009, the Company borrowed $80,000 from Barron Partners LP, for which it
issued its 18-month 12% promissory note in the principal amount of
$80,000.  Payment of the Company’s obligations of the note are secured
by a pledge of and conversion right with respect to 188,800 shares of the
Company’s common stock owned by Yunxia Ren, a major stockholder of the Company
and the daughter-in-law of the Company’s chief executive officer.  The
pledge and conversion right enables Barron to convert any or all of the
principal amount of the note or interest into pledged shares, at a conversion
price of $.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.  The Company has the right to prepay the note at any time
without premium or penalty.





On August
12, 2009, the board of directors and holders of a majority of the outstanding
shares of common stock approved a one-for-three reverse split, which will become
effective after notice is given to stockholders and an amendment to the
Company’s certificate of incorporation is filed with the Secretary of State of
Delaware.





Pursuant
to the agreement relating to the November 2007 private placement, the Company
agreed that a majority of the members of the Company’s board of directors would
be independent directors.  The Company was not in compliance with this
covenant for a period of 35 days beyond the applicable grace
period.  The agreement provides for liquidated damage to the holders
of the series A preferred stock in the event the Company is not in
compliance.  The sole holder of the Company’s series A preferred stock
waived compliance with this covenant as long as the Company met the independent
director requirement by August 20, 2009.  On August 13, 2009, the
Company elected a third independent director, which brought the Company into
compliance with the independent director requirement.


27


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 two affiliated companies, which are
variable interest entities, and a wholly-owned subsidiairy.  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 Energy manufactures forged rolled rings in our new facilities, and our
rolled ring business is being increasingly operated through Fulland Wind
Energy.





Historically,
the dyeing and finishing equipment business has been the principal source of our
revenue and operating income, accounting for 34.2% of revenue for the six months
ended June 30, 2009 and 56.9% of revenues for the six months ended June 30,
2008.  Substantially all of our sales of these products are made to
companies in the PRC. 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, as the textile
industry seeks to lower costs by purchasing equipment that uses the most
technological developments to improve productivity, reduce costs and have less
adverse environmental impact, if we are not able to offer products utilizing the
most current technology, our ability to market our products will suffer. The
Chinese textile industry has been severely impacted by the worldwide economic
downturn, which has resulted in a substantial decline in
exports.  Additionally, the export market can also be subject to
protectionist measures imposed by importing countries seeking to protect their
own industries in a time of a declining demand for
products.    As a result, we 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.





In our
forged rolled rings and electrical power equipment segment, we manufacture high
precision forged rolled rings for the wind power industry and other industries.
Additionally, we also manufacture specialty equipment used in the production of
coal generated electricity. Revenue from our forged rolled rings and electrical
power equipment segment accounted for 65.8% of revenues for the six months ended
June 30, 2009, and 43.1% of revenues for the six months ended June 30,
2008.





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, we expect to
gradually move away from the auxiliary electric power equipment business (which
generated about 5.5% of our revenue in 2008) and focus more on the forging
business, particularly for the wind power industry.





The
following table sets forth information as to revenue of our forged rolled rings
and electrical power equipment segment in dollars and as a percent of
revenue:





Three months ended June 30,
                
                
                Six months ended June 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Dollars
                
                
                %
                
                
                Dollars
                
                
                %
                
                
                Dollars
                
                
                %
                
                
                Dollars
                
                
                %Forged
      rolled rings - wind power industry
                
                $
                3,642,540
                
                
                
                37.2
                %
                
                
                1,669,459
                
                
                
                35.7
                %
                
                $
                6,366,671
                
                
                
                45.1
                %
                
                $
                2,630,749
                
                
                
                31.1
                %Forged
      rolled rings – other industries
                
                
                6,144,482
                
                
                
                62.8
                %
                
                
                2,412,286
                
                
                
                51.7
                %
                
                
                7,751,777
                
                
                
                54.9
                %
                
                
                4,655,262
                
                
                
                55.0
                %Electrical
      equipment
                
                
                -
                
                
                
                -
                
                
                
                587,052
                
                
                
                12.6
                %
                
                
                -
                
                
                
                -
                
                
                
                1,176,722
                
                
                
                13.9
                %Total
                
                $
                9,787,022
                
                
                
                100
                %
                
                
                4,668,797
                
                
                
                100
                %
                
                $
                14,118,448
                
                
                
                100
                %
                
                
                8,462,733
                
                
                
                100
                %




28





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.





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





Our
products are sold for use by manufacturers of industrial
equipment.  Because of the recent decline in oil prices and the
general international economic trends, the demand for products used in
manufacturing in general 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.





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


29





Variable
Interest Entities





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





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





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





Accounts
receivable





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





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





Inventories





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


30


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:





UsefulLifeBuilding
      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.





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.





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





Land
use rights





There is
no private ownership of land in the PRC. All land in the PRC is owned by the
government and cannot be sold to any individual or company. The government
grants a land use right that permits the holder of the land use right to use the
land for a specified period. Our land use rights were granted 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.


31





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 a
close to the date of delivery of the equipment.





Warranty
revenue is valued based on estimated service person hours to complete a service
and generally is recognized over the contract period. For the six months ended
June 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 six months ended
June 30, 2009 and 2008.





Income
taxes





We are
governed by the Income Tax Law of the PRC. Income taxes are accounted for under
Statement of Financial Accounting Standards No. 109, “Accounting for Income
Taxes,” which is an asset and liability approach that requires the recognition
of deferred tax assets and liabilities for the expected future tax consequences
of events that have been recognized in our financial statements or tax returns.
The charge for taxes is based on the results for the year as adjusted for items,
which are non-assessable or disallowed. It is calculated using tax rates that
have been enacted or substantively enacted by the balance sheet
date.




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





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





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





We
adopted FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes”
(“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit
only if it is “more likely than not” that the tax position would be sustained in
a tax examination, with a tax examination being presumed to occur. The amount
recognized is the largest amount of tax benefit that is greater than 50% likely
of being realized on examination. For tax positions not meeting the “more likely
than not” test, no tax benefit is recorded. The adoption had no affect on our
financial statements.


32


Recent
accounting pronouncements





In
March 2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities”. The new standard is
intended to improve financial reporting about derivative instruments and hedging
activities by requiring enhanced disclosures to enable investors to better
understand their effects on an entity’s financial position, financial
performance, and cash flows. It is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged.  The adoption of SFAS 161 did not have a
material impact on the preparation of our consolidated financial
statements.





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





On June
16, 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating
Securities,” to address the question of whether instruments granted in
share-based payment transactions are participating securities prior to vesting.
The FSP determines that unvested share-based payment awards that contain rights
to dividend payments should be included in earnings per share calculations. The
guidance will be effective for fiscal years beginning after December 15, 2008.
The adoption of FSP EITF 03-6-1 did not have an impact on our consolidated
financial statements.





In June
2008, the FASB ratified Emerging Issues Task Force Issue No. 07-5, “Determining Whether an Instrument
(or Embedded Feature) is Indexed to an Entity’s Own
Stock.”  EITF 07-5 mandates a two-step process for evaluating
whether an equity-linked financial instrument or embedded feature is indexed to
the entity’s own stock.  Warrants that a company issues that contain a
strike price adjustment feature, upon the adoption of EITF 07-5, are no longer
being considered indexed to the company’s own stock. Accordingly, adoption of
EITF 07-5 will change the current classification (from equity to liability) and
the related accounting for such warrants outstanding at that date. EITF 07-5 is
effective for fiscal years beginning after December 15, 2008, and interim
periods within those fiscal years. The adoption of EITF 07-5 did not have a
material impact on our consolidated financial statements.





On
October 10, 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active,” which
clarifies the application of SFAS 157 when the market for a financial asset is
inactive. Specifically, FSP 157-3 clarifies how (1) management’s internal
assumptions should be considered in measuring fair value when observable data
are not present, (2) observable market information from an inactive market
should be taken into account, and (3) the use of broker quotes or pricing
services should be considered in assessing the relevance of observable and
unobservable data to measure fair value. The Company is currently evaluating the
impact of adoption of FSP 157-3 on the Company’s consolidated
financial.




In
November 2008, the FASB issued EITF Issue No. 08-7, “Accounting for
Defensive Intangible Assets,” or EITF No. 08-7. EITF No. 08-7
discusses that when an entity acquired in a business combination or an asset
acquisition an intangible asset that it did not intend to actively use,
otherwise known as a defensive asset, the entity historically allocated little
or no value to the defensive asset. However, with the issuance of SFAS
No. 141(R) and SFAS No. 157 the entity must recognize a value for the
defensive asset that reflects the asset’s highest and best use based on market
assumptions. Upon the effective date of both SFAS No. 141(R) and SFAS
No. 157, acquirers will generally assign a greater value to a defensive
asset than would typically have been assigned under SFAS No. 141. EITF
No. 08-7 will be effective for the first annual reporting period beginning
on or after December 15, 2008. EITF No. 08-7 will apply prospectively
to business combinations for which the acquisition date is after fiscal years
beginning on or after December 15, 2008. The adoption of EITF No. 08-7
did not have a material impact on our results of operations or financial
condition.


33


In April
2009, the FASB issued SFAS No. 141 (R), “Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies,”.  SFAS No. 141 (R) amends and clarifies SFAS
No. 141, “Business Combinations,” in regards to the initial recognition and
measurement, subsequent measurement and accounting, and disclosures of assets
and liabilities arising from contingencies in a business combination. SFAS
No. 141 (R) applies to all assets acquired and liabilities assumed in
a business combination that arise from contingencies that would be within the
scope of SFAS No. 5, “Accounting for Contingencies”, if not acquired or
assumed in a business combination, except for assets or liabilities arising from
contingencies that are subject to specific guidance in SFAS No. 141 (R).
SFAS No. 141 (R) will be effective for the first annual reporting
period beginning on or after December 15, 2008. SFAS No. 141(R) will
apply prospectively to business combinations for which the acquisition date is
after fiscal years beginning on or after December 15, 2008. The adoption of
SFAS No. 141 (R) did not have a material impact on our results of
operations or financial condition.




In April
2009, the FASB issued FSP FAS 157-4, which provides guidance on how to determine
the fair value of assets and liabilities when the volume and level of activity
for the asset or liability has significantly decreased when compared with normal
market activity for the asset or liability as well as guidance on identifying
circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is
effective for interim and annual periods ending after June 15, 2009. The Company
is currently evaluating the financial impact that FSP FAS. 157-4 will have, but
expects that the financial impact, if any, will not be material on its
Consolidated Financial Statements.




In April
2009, the FASB issued FSP FAS 115-2 and FAS 124-2, which amends the requirements
for the recognition and measurement of other-than-temporary impairments for debt
securities by modifying the current "intent and ability" indicator. Under FSP
FAS 115-2 and FAS 124-2, an other-than-temporary impairment must be recognized
if the Company has the intent to sell the debt security or the Company is more
likely than not will be required to sell the debt security before its
anticipated recovery. In addition, FSP FAS 115-2 and FAS 124-2 requires
impairments related to credit loss, which is the difference between the present
value of the cash flows expected to be collected and the amortized cost basis
for each security, to be recognized in earnings while impairments related to all
other factors to be recognized in other comprehensive income. FSP FAS 115-2 and
FAS 124-2 is effective for interim and annual periods ending after June 15,
2009. The Company is currently evaluating the financial impact that FSP FAS
115-2 and FAS 124-2 will have, but expects that the financial impact, if any,
will not be material on its Consolidated Financial Statements.




In April
2009, the FASB issued FSP 107-1 and 28-1. This FSP amends SFAS 107, to require
disclosures about fair value of financial instruments not measured on the
balance sheet at fair value in interim financial statements as well as in annual
financial statements. Prior to this FSP, fair values for these assets and
liabilities were only disclosed annually. This FSP applies to all financial
instruments within the scope of SFAS 107 and requires all entities to disclose
the method(s) and significant assumptions used to estimate the fair value of
financial instruments. This FSP shall be effective for interim periods ending
after June 15, 2009, with early adoption permitted for periods ending after
March 15, 2009. An entity may early adopt this FSP only if it also elects
to early adopt FSP 157-4 and 115-2 and 124-2. This FSP does not require
disclosures for earlier periods presented for comparative purposes at initial
adoption. In periods after initial adoption, this FSP requires comparative
disclosures only for periods ending after initial adoption. The Company is
currently evaluating the disclosure requirements of this new FSP.




In May
2009, the FASB issued SFAS No. 165, Subsequent Events (SFAS 165).
SFAS 165 establishes general standards for accounting for and disclosure of
events that occur after the balance sheet date but before financial statements
are available to be issued (subsequent events). More specifically, SFAS 165
sets forth the period after the balance sheet date during which management of a
reporting entity should evaluate events or transactions that may occur for
potential recognition in the financial statements, identifies the circumstances
under which an entity should recognize events or transactions occurring after
the balance sheet date in its financial statements and the disclosures that
should be made about events or transactions that occur after the balance sheet
date. SFAS 165 provides largely the same guidance on subsequent events
which previously existed only in auditing literature. The statement was adopted
by the Company in its second quarter and did not have an impact on our
consolidated financial statements.


34


In June
2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162 (SFAS 168). SFAS 168
establishes the FASB Standards Accounting Codification (Codification) as the
source of authoritative U.S. generally accepted accounting principles
(GAAP) recognized by the FASB to be applied to nongovernmental entities and
rules and interpretive releases of the SEC as authoritative GAAP for SEC
registrants. The Codification will supersede all the existing non-SEC accounting
and reporting standards upon its effective date and subsequently, the FASB will
not issue new standards in the form of Statements, FASB Staff Positions or
Emerging Issues Task Force Abstracts. SFAS 168 also replaces FASB Statement
No. 162, The Hierarchy of Generally Accepted Accounting Principles, given
that once in effect, the Codification will carry the same level of authority.
SFAS 168 will be effective for financial statements issued for reporting periods
that end after September 15, 2009.




In April
2009, the FASB issued Staff Position No. FAS 107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments (FAS 107-1 and APB 28-1),
which requires publicly traded companies to include in their interim financial
reports certain disclosures about the carrying value and fair value of financial
instruments previously required only in annual financial statements and to
disclose changes in significant assumptions used to calculate the fair value of
financial instruments. FAS 107-1 and APB 28-1 is effective for all interim
reporting periods ending after June 15, 2009, with early adoption permitted
for interim reporting periods ending after March 15, 2009. We adopted FAS
107-1 and APB 28-1 in the second quarter of 2009. The adoption did not have a
material impact on our consolidated financial statements.





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. The value of your
investment in our stock will be affected by the foreign exchange rate between
U.S. dollars and RMB. To the extent we hold assets denominated in
U.S. dollars, any appreciation of the RMB against the U.S. dollar
could result in a change to our statement of operations and a reduction in the
value of our U.S. dollar denominated assets. On the other hand, a decline
in the value of RMB against the U.S. dollar could reduce the
U.S. dollar equivalent amounts of our financial results, which may have a
material adverse effect on the price of our stock.





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):


35





Three Months Ended June 30,
                      
                      
                      Six Months Ended June 30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008($)
                      
                      
                      (%)
                      
                      
                      ($)
                      
                      
                      (%)
                      
                      
                      ($)
                      
                      
                      (%)
                      
                      
                      ($)
                      
                      
                      (%)Net
      Revenues
                      
                      
                      13,584
                      
                      
                      
                      100.0
                      %
                      
                      
                      11,183
                      
                      
                      
                      100.0
                      %
                      
                      
                      21,445
                      
                      
                      
                      100.0
                      %
                      
                      
                      19,630
                      
                      
                      
                      100.0
                      %Cost
      of Revenues
                      
                      
                      10,479
                      
                      
                      
                      77.1
                      %
                      
                      
                      8,420
                      
                      
                      
                      75.3
                      %
                      
                      
                      16,744
                      
                      
                      
                      78.1
                      %
                      
                      
                      14,692
                      
                      
                      
                      74.8
                      %Gross
      Profit
                      
                      
                      3,105
                      
                      
                      
                      22.9
                      %
                      
                      
                      2,763
                      
                      
                      
                      24.7
                      %
                      
                      
                      4,701
                      
                      
                      
                      21.9
                      %
                      
                      
                      4,938
                      
                      
                      
                      25.2
                      %Operating
      Expenses
                      
                      
                      593
                      
                      
                      
                      4.4
                      %
                      
                      
                      731
                      
                      
                      
                      6.5
                      %
                      
                      
                      1,171
                      
                      
                      
                      5.5
                      %
                      
                      
                      1,426
                      
                      
                      
                      7.3
                      %Income
      from Operations
                      
                      
                      2,512
                      
                      
                      
                      18.5
                      %
                      
                      
                      2,032
                      
                      
                      
                      18.1
                      %
                      
                      
                      3,530
                      
                      
                      
                      16.5
                      %
                      
                      
                      3,512
                      
                      
                      
                      17.9
                      %Other
      Income (Expenses)
                      
                      
                      (30
                      )
                      
                      
                      (0.2
                      )%
                      
                      
                      (15
                      )
                      
                      
                      (0.1
                      )%
                      
                      
                      (65
                      )
                      
                      
                      (0.3
                      )%
                      
                      
                      (2,290
                      )
                      
                      
                      (11.7
                      )%Income
      Before Provision for Income Taxes
                      
                      
                      2,482
                      
                      
                      
                      18.3
                      %
                      
                      
                      2,018
                      
                      
                      
                      18.0
                      %
                      
                      
                      3,464
                      
                      
                      
                      16.2
                      %
                      
                      
                      1,222
                      
                      
                      
                      6.2
                      %Provision
      for Income Taxes
                      
                      
                      701
                      
                      
                      
                      5.2
                      %
                      
                      
                      607
                      
                      
                      
                      5.4
                      %
                      
                      
                      1,038
                      
                      
                      
                      4.8
                      %
                      
                      
                      1,061
                      
                      
                      
                      5.4
                      %Net
      Income
                      
                      
                      1,781
                      
                      
                      
                      13.1
                      %
                      
                      
                      1,411
                      
                      
                      
                      12.6
                      %
                      
                      
                      2,427
                      
                      
                      
                      11.3
                      %
                      
                      
                      161
                      
                      
                      
                      0.8
                      %Other
      Comprehensive Income:Foreign
      Currency Translation Adjustment
                      
                      
                      3
                      
                      
                      
                      0.0
                      %
                      
                      
                      605
                      
                      
                      
                      5.4
                      %
                      
                      
                      45
                      
                      
                      
                      0.2
                      %
                      
                      
                      1,612
                      
                      
                      
                      8.2
                      %Comprehensive
      Income
                      
                      
                      1,784
                      
                      
                      
                      13.1
                      %
                      
                      
                      2,016
                      
                      
                      
                      18.0
                      %
                      
                      
                      2,472
                      
                      
                      
                      11.5
                      %
                      
                      
                      1,773
                      
                      
                      
                      9.0
                      %




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





For the Three Months Ended June 30,
                        
                        
                        For the Six Months Ended June 30,2009
                        
                        
                        2008
                        
                        
                        2009
                        
                        
                        2008Dyeing and finishing
    equipment:Revenue
                        
                        $
                        3,797
                        
                        
                        $
                        6,514
                        
                        
                        $
                        7,326
                        
                        
                        $
                        11,167Cost
      of sales
                        
                        
                        2,959
                        
                        
                        
                        4,827
                        
                        
                        
                        5,737
                        
                        
                        
                        8,266Gross
      profit
                        
                        
                        838
                        
                        
                        
                        1,687
                        
                        
                        
                        1,590
                        
                        
                        
                        2,901Gross
      margin
                        
                        
                        22.1
                        %
                        
                        
                        25.9
                        %
                        
                        
                        21.7
                        %
                        
                        
                        26.0
                        %Forged rolled rings and electric power
      equipmentRevenue
                        
                        $
                        9,787
                        
                        
                        $
                        4,669
                        
                        
                        $
                        14,118
                        
                        
                        $
                        8,463Cost
      of sales
                        
                        
                        7,521
                        
                        
                        
                        3,592
                        
                        
                        
                        11,007
                        
                        
                        
                        6,426Gross
      profit
                        
                        
                        2,266
                        
                        
                        
                        1,077
                        
                        
                        
                        3,112
                        
                        
                        
                        2,037Gross
      margin
                        
                        
                        23.2
                        %
                        
                        
                        23.1
                        %
                        
                        
                        22.0
                        %
                        
                        
                        24.1
                        %





Six
Months Ended June 30, 2009 and 2008





Revenues. For the six months
ended June 30, 2009, we had revenues of $21,445,000, as compared to revenues of
$19,630,000 for the six months ended June 30, 2008, an increase of $1,815,000,
or approximately 9.2%. The increase in total revenue was attributable to
increases in revenue from forged rolled rings offset by a decrease in Dyeing
revenues and is summarized as follows (dollars in thousands):


For the Six
                    Months
                    Ended June 30,
                    2009
                  
                  
                  For the Six
                    Months
                    Ended June 30,
                    2008
                  
                  
                  Increase/
                    (Decrease)
                  
                  
                  Percentage
                    ChangeDyeing
      and finishing equipment
                  
                  $
                  7,326
                  
                  
                  $
                  11,167
                  
                  
                  $
                  (3,841
                  )
                  
                  
                  (34.4
                  )
      %Forged
      rolled rings - wind power industry
                  
                  
                  6,367
                  
                  
                  
                  2,631
                  
                  
                  
                  3,736
                  
                  
                  
                  142.0
                  %Forged
      rolled rings - other industries
                  
                  
                  7,752
                  
                  
                  
                  4,655
                  
                  
                  
                  3,097
                  
                  
                  
                  66.5
                  %Electrical
      equipment
                  
                  
                  -
                  
                  
                  
                  1,177
                  
                  
                  
                  (1,177
                  )
                  
                  
                  (100
                  )
      %Total
      net revenues
                  
                  $
                  21,445
                  
                  
                  $
                  19,630
                  
                  
                  $
                  1,815
                  
                  
                  
                  9.2
                  %


36


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 for the wind power industry amounted to $6,366,671
and revenues from other forging operations amounted to
$7,751,777.  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 142% in the six months ended June 30, 2009 compared to the six
months ended June 30, 2008.We experienced a 66.5% 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 six months ended June 30, 2009 increased $2,052,000 or 13%,
from $14,692,000 for the six months ended June 30, 2008 to $16,744,000 for
the six months ended June 30, 2009. Cost of goods sold for Dyeing was
$5,737,000 for the six months ended June 30, 2009, as compared to $8,266,000 for
the six months ended June 30, 2008. Cost of sales related to the manufacture of
forged rolled rings and other components and the electric power generating
equipment was $11,007,000 for the six months ended June 30, 2009 as compared to
$6,426,000 for the six months ended June 30, 2008.





Gross profit and gross
margin. Our gross profit was $4,701,000 for the six months ended June 30,
2009, as compared to $4,938,000 for the six months ended June 30, 2008,
representing gross margins of 21.9% and 25.2%, respectively. Gross profit for
Dyeing was $1,590,000  for the six months ended June 30, 2009 as
compared to $2,901,000 for the six months ended June 30, 2008, representing
gross margins of approximately 21.7% and 26.0%, 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 $3,112,000
for the six months ended June 30, 2009 as compared to $2,037,000 for the six
months ended June 30, 2008, representing gross margins of approximately 22.0%
and 24.1%, respectively. The decrease in our gross margin for forging was
attributable to an increase in the cost of raw materials, such as steel and
other metals, which could not be passed on to our customers, and operational
inefficiencies as we operated at low production levels, as we manufactured
sample units for customers, but incurred significant start-up costs in addition
to the normal fixed-costs associated with operating our new forging
facilities.  Some of the costs incurred in the first half fiscal
year 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.


.


Depreciation. For the six
months ended June 30, 2009 and 2008, depreciation expense amounted to $697,000
and $323,000, of which $536,000 and $103,000 is included in cost of sales and
$161,000 and $220,000 is included in operating expenses, respectively. The
overall increase in depreciation is attributable to an increase in our
equipment. Additionally, during the second quarter of 2009, our new facility was
placed in services 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 $1,010,000
for the six months ended June 30, 2009, as compared to $1,206,000 for the six
months ended June 30, 2008, a decrease of $196,000, or approximately 16.2%.
Selling, general and administrative expenses consisted of the following (dollars
in thousands):





Six Months
                    Ended
                    June 30, 2009
                  
                  
                  Six Months
                    Ended
                    June 30, 2008Professional
      fees
                  
                  $
                  209
                  
                  
                  $
                  381Payroll
      and related benefits
                  
                  
                  215
                  
                  
                  
                  223Travel
                  
                  
                  68
                  
                  
                  
                  102Bad
      debt expense
                  
                  
                  144
                  
                  
                  
                  170Other
                  
                  
                  375
                  
                  
                  
                  331$
                  1,010
                  
                  
                  $
                  1,206




37





•
            Professional
      fees decreased for the six months ended June 30, 2009 by $172,000, or
      45.2%, as compared to the same period in 2008. For the six months ended in
      June 30, 2008, we incurred additional legal expense of approximately
      $110,000 related to the filing of a registration statement covering stock
      issuable upon exercise of warrants and additional consultation expenses
      related to our Electric subsidiary for an electric power
      substation.




•
            Bad
      debt expense decreased for the six months ended June 30, 2009 by $26,000,
      or 15.5%. 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.




•
            Payroll and
      related benefits decreased for the six months ended June 30, 2009 by
      $7,000, or 3.2%, as compared to the same period in 2008. For the six
      months ended June 30, 2009, we had an increase in compensation and related
      benefits of approximately $12,000 in our forged rolled rings operations
      resulting from the expansion of our rolled rings operations, and net
      decrease in compensation for our unallocated overhead of approximately
      $19,000 which primarily attributed to decrease in our board
      directors’ compensation.




•
            Travel
      expense for the six months ended June 30, 2009 decreased by $34,000, or
      33.4%, as compared to the same period in 2008. The decrease is related to
      a decrease in travel by sales personnel and engineers as well as decreased
      travel for investor road shows.




•
            Other
      selling, general and administrative expenses increased by $44,000, or
      13.3%, for the six months ended June 30, 2009 as compared with the same
      period in 2008. The increase was primarily attributed to the increase in
      shipping fee paid for our customers which was paid by our customers in the
      comparable period of 2008.




Income from operations.For
the six months ended June 30, 2009, income from operations was $3,530,000 as
compared to $3,512,000 for the six months ended June 30, 2008, an increase of
$18,000 or 0.5%.





Other income (expenses). For
the six months ended June 30, 2009, other expenses amounted to $65,000 as
compared to other expenses of $2,290,000 for the six months ended June 30, 2008.
For the six months ended June 30, 2009, other income (expense)
included:





•
            interest
      expense of $200,000, consisting of non-cash interest expense of $17,000
      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 $54,000 incurred on our outstanding
      loans;




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




•
            amortization
      of debt issuance costs of $12,000;
and




•
            nominal
      foreign currency losses and interest
income.




For the
six months ended June 30, 2008, other income (expense) included:




•
            interest
      expense of $2,278,000, 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 $36 incurred on our
      outstanding loans;




•
            amortization
      of debt issuance costs of $21,000,
and




•
            interest
      income of $10.




38





Income tax expense. Income
tax expense decreased $22,407 or approximately 2.1%, for the six months ended
June 30, 2009 as compared to the comparable period in 2008 although income
before income tax increased from $1,222,000 for the six months ended June 30,
2008 to $3,465,000 for the six months ended June 30, 2009, primarily because the
non-cash interest expense arising from the $2,278,000 and expenses incurred and
paid in the United States are not deductible in computing taxable income in the
PRC.




Net income.As a
result of the factors described above, our net income for the six months ended
June 30, 2009 was $2,427,000, or $0.05 per share (basic) and $0.04 per
share (diluted).  For the six months ended June 30, 2008, we had a net
income of $161,000.   The conversion of our convertible
notes into shares of series A preferred stock and warrants in the first quarter
year of 2008 resulted in a deemed preferred stock dividend of $2,884,000,
representing the value of the warrants issued to the investors.  As a
result, the net loss attributable to common stock for the six months ended June
30, 2008 was $2,723,000, 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
$45,000 for the six months ended June 30, 2009 as compared to $1,612,000 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 six months ended June 30, 2009 of $2,471,000, compared
with  $1,774,000 for the six months ended June 30, 2008.





Non-GAAP
Information





We
believe that net income, as adjusted for certain unusual non-cash expenses,
which is a non-GAAP performance measure, it is reasonable means of understanding
our business in view of the significant non-cash charges which we believe do not
relate to the operation of our business.  We use this non-GAAP
information internally for or planning purposes and for evaluating our ability
to fund our capital expenditures and expand our business.





In
presenting non-GAAP information, we do not adjust for such non-cash items as
equity-based compensation or the cost of financings (other than those derived
from the unique circumstances relating to the November 2007 financing), since
those expenses are normal operating expenses, even though non-cash, and they
reflect normal costs incurred in the operation of our business.  We
believe, however, that the expenses that are derived from the November 2007
private placement, which was completed contemporaneously with the reverse
merger, do not provide any real understanding of our operations on an ongoing
basis.  The expensing of non-cash charges relating to the November
2007 financing limits the comparability of our operations to prior years.
 We’ve excluded non-cash interest charges and non-cash deemed preferred
dividend depreciation derived from the November 2007 financing from this measure
of profitability because removing such charges assists management in
assessing, and you in evaluating, our overall profitability.





In
connection with our November 2007 private placement, we issued 3% convertible
notes to the investors in the principal amount of the
$5,525,000.  Because of the favorable conversion terms, the debt was
deemed to be issued at a discount of $2,611,000.  Upon the conversion
of the debt into equity in March 2008, the unamortized debt discount of
$2,264,000 was fully amortized and treated as additional interest, and the
relative fair value of the warrants granted in March 2008 related to our
November 2007 private placement of $2,884,000 was classified as a deemed
dividend to the holders of the series A preferred stock. The amortization of the
debt discount and the deemed dividend are non-cash events which do not affect
our operations.  The following table shows the relationship between
net income (loss) allocable to common shareholders and net income, as adjusted,
for the six months ended June 30, 2009 and 2008 (dollars in
thousands).




39




Six
      Months Ended
                      June
      30,2009
                    
                    
                    2008Net
      income (loss) allocable to common shareholders
                    
                    $
                    2,427
                    
                    
                    $
                    (2,723
                    )Add
      back of:Deemed
      dividend to preferred stockholders
                    
                    
                    -
                    
                    
                    
                    2,884Non-cash
      interest from amortization of debt discount
                    
                    
                    17
                    
                    
                    
                    2,264Amortization
      of debt issuance costs
                    
                    
                    -
                    
                    
                    
                    21Reversal
      of accrued interest
                    
                    
                    -
                    
                    
                    
                    (21
                    )Net
      income, as adjusted
                    
                    $
                    2,444
                    
                    
                    $
                    2,426





For the
reasons discussed above, our net income, as adjusted, increased from $2,427,000
or $0.05 per share (basic) and $0.04 (diluted), for the six months ended June
30, 2008 to $2,444,000, or $0.05 per share (basic) and $0.04 per share
(diluted), for the six months ended June 30, 2008.




There are
material limitations associated with non-GAAP financial measures because these
non-GAAP measures exclude charges that have an effect on our reported results
and, therefore, should not be relied upon as the sole financial measures to
evaluate our financial results.  Because the interest expense that was
excluded and deemed preferred stock dividend comprised a significant portion of
our operating results, these items are evaluated separately by
management. We do not consider net income, as adjusted, to be substitutes
for performance measures calculated in accordance with GAAP.  Instead, we
believe that net income, as adjusted, is a useful performance measure which
should be considered in addition to those measures reported in accordance with
GAAP.  In addition, the non-GAAP financial measures indicated herein may be
different from, and therefore may not be comparable to, similar measures used by
other companies.  We believe these non-GAAP financial measures provide
important supplemental information to management and investors.  Investors
may benefit from referring to these non-GAAP financial measures in assessing our
performance and when planning, forecasting and analyzing future periods and may
also facilitate comparisons to our historical performance. These non-GAAP
financial measures reflects an additional way of viewing aspects of our
operations that, when viewed with the GAAP results and the accompanying
reconciliation to corresponding GAAP financial measures, provide an
understanding of factors and trends affecting our business and results of
operations.  In addition, at conferences we are asked for this
information, and, since it appears that investors with whom we meet consider
this information important, we believe that it is appropriate to include it in
this report.




Three
Months Ended June 30, 2009 and 2008





Revenues. For the three
months ended June 30, 2009, we had revenues of $13,584,000, as compared to
revenues of $11,183,000 for the three months ended June 30, 2008, an increase of
$2,401,000 or approximately 21.5%.  The increase in total revenue was
attributable to increases in revenue from forged rolled rings offset by a
decrease in Dyeing revenues and is summarized as follows (dollars in
thousands):




For
      the Three
                        Months
      Ended
                        June
      30, 2009
                      
                      
                      For
      the Three
                        Months
      Ended
                        June
      30, 2008
                      
                      
                      Increase
                        (Decrease)
                      
                      
                      Percentage
                        ChangeDyeing
      and finishing equipment
                      
                      $
                      3,797
                      
                      
                      $
                      6,514
                      
                      
                      $
                      (2,717
                      )
                      
                      
                      (41.7
                      )%Forged
      rolled rings - wind power industry
                      
                      
                      3,643
                      
                      
                      
                      1,670
                      
                      
                      
                      1,973
                      
                      
                      
                      118.2
                      %Forged
      rolled rings - other industries
                      
                      
                      6,144
                      
                      
                      
                      2,412
                      
                      
                      
                      3,732
                      
                      
                      
                      154.7
                      %Electrical
      equipment
                      
                      
                      -
                      
                      
                      
                      587
                      
                      
                      
                      (587
                      )
                      
                      
                      (100.0
                      )%Total
      net revenues
                      
                      $
                      13,584
                      
                      
                      $
                      11,183
                      
                      
                      $
                      2,401
                      
                      
                      
                      21.5
                      %





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.




40




Revenues
from forging of rolled rings for the wind power industry amounted to $3,643,000
and revenues from other forging operations amounted to
$6,144,000.  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 118.2% in the three months ended June 30, 2009 compared to the three
months ended June 30, 2008.We experienced a 154.7% 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 June 30, 2009 increased $2,060,000 or 24.5%, from
$8,419,000 for the three months ended June 30, 2008 to $10,479,000 for the three
months ended June 30, 2009. Cost of goods sold for Dyeing was $2,959,000
for the three months ended June 30, 2009, as compared to $4,827,000 for the
three months ended June 30, 2008. Cost of sales related to electric power
generating equipment and the manufacture of forged rolled rings and other
components was $7,521,000 for the three months ended June 30, 2009 as compared
to $3,592,000 for the three months ended June 30, 2008.





Gross profit and gross
margin. Our gross profit was $3,105,000 for the three months ended June
30, 2009 as compared to $2,763,000 for the three months ended June 30, 2008,
representing gross margins of 22.9% and 24.7%, respectively. Gross profit for
Dyeing was $838,000 for the three months ended June 30, 2009 as compared to
$1,687,000 for the three months ended June 30, 2008, representing gross margins
of approximately 22.1% and 25.9%, 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
$2,266,000 for the three months ended June 30, 2009 as compared to $1,076,000
for the three months ended June 30, 2008, representing a gross margin of 23.2%
and 23.1%, respectively. We believe that our gross margins will improve to the
extent that we are able to utilize our factory more efficiently.





Depreciation.Depreciation
amounted to $522,000 for the three months ended June 30, 2009 and $164,000 for
the three months ended June 30, 2008, of which $439,000 and $22,000 is included
in cost of sales and $83,000 and $142,000 is included in operating expenses,
respectively. The overall increase in depreciation and amortization is
attributable to an increase in property and equipment. Additionally, during the
second quarter of fiscal 2009, our new facility was placed in services 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 $509,000
for the three months ended June 30, 2009, as compared to $589,000 for the three
months ended June 30, 2008, a decrease of $80,000 or approximately 13.6%.
Selling, general and administrative expenses consisted of the following (dollars
in thousands):





Three
      Months
                        Ended
      June 30,
                        2009
                      
                      
                      Three
      Months
                        Ended
      June 30,
                        2008Professional
      fees
                      
                      $
                      61
                      
                      
                      $
                      139Payroll
      and related benefits
                      
                      
                      113
                      
                      
                      
                      103Travel
                      
                      
                      30
                      
                      
                      
                      19Bad
      debt
                      
                      
                      142
                      
                      
                      
                      170Other
                      
                      
                      163
                      
                      
                      
                      158$
                      509
                      
                      
                      $
                      589





•
            Professional
      fees decreased by $78,000, or 56.1%, for the three months ended June 30,
      2009, as compared to the same period in 2008. The decrease was primarily
      attributed to the decrease in our investor relations fees and a decrease
      in our payments for consultation service for our electric power
      station.




•
            Bad
      debt decreased by $28,000, or 16.5%, for the three months ended June 30,
      2009, as compared to the comparable period in 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.




41




•
            Compensation
      and related benefits increased for the three months ended June 30, 2009 by
      $10,000, or 9.9%, as compared to the same period in 2008. The slight
      increase was primarily attributed to the increase in compensation and
      related benefits in our rolled rings operations resulting from the
      expansion of our rolled rings
operation.




•
            Travel
      expense for the three months ended June 30, 2009 increased by $10,000, or
      52.5%, as compared to the same period in 2008. The slight increase is
      related to an increase in travel by sales personnel and
      engineers.




•
            Other
      selling, general and administrative expenses increased by $5,000, or 3.3%,
      for the three months ended June 30, 2009 as compared with the same period
      in 2008. The slight increase was primarily attributed to an
      increase in shipping fees.




Income from operations.For
the three months ended June 30, 2009, income from operations was $2,512,000 as
compared to $2,032,000 for the three months ended June 30, 2008, an increase of
$480,000 or 23.6%.





Other income (expenses). For
the three months ended June 30, 2009, other expense amounted to $30,000 as
compared to other expenses of $15,000 for the three months ended June 30, 2008.
For the three months ended June 30, 2009, other income (expense)
included:




•
            interest
      expense of $48,000, consisting of non-cash interest expense of $15,500
      from the amortization of debt discount arising from our March 2009
      financing and interest expense of $32,000 incurred on our outstanding
      loans;




•
            Grant
      income of $146,000 from the Economic and Trade Bureau of Huishan
      District, Wuxi City on June 18, 2009.  We will use the grant for
      working capital purposes to increase production of forged products;
      and




•
            nominal
      interest income.




For the
three months ended June 30, 2008, other expenses represented interest expense of
$19,000; and, interest income of $4,000.




Income tax expense. Income
tax expense increased $95,000 or approximately 15.7%, for the three months ended
June 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.




Net income.For
the three months ended June 30, 2009, we recorded net income of $1,781,000, or
$0.04 per share (basic) and $0.03 per share (diluted) as compared to net income
of $1,411,184, or $0.04 per share (basic) and $0.02 per share (diluted) for the
three months ended June 30, 2008.





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 $3,300 for the three months ended June 30, 2009 as compared
to $605,000 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 June 30, 2009, comprehensive income was $1,784,000, as
compared with comprehensive income of $2,016,000 for the three months ended June
30, 2008.





42





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 June 30, 2009 and December 31, 2008, we had cash balances
of $721,000 and $329,000, respectively. These funds are located in financial
institutions located as follows (dollars in thousands):





June
      30, 2009
                  
                  
                  December
      31, 2008Country:United
      States
                  
                  $
                  10
                  
                  
                  
                  1.4
                  %
                  
                  $
                  1
                  
                  
                  
                  0.3
                  %China
                  
                  
                  711
                  
                  
                  
                  98.6
                  %
                  
                  
                  328
                  
                  
                  
                  99.7
                  %Total
      cash and cash equivalents
                  
                  $
                  721
                  
                  
                  
                  100.0
                  %
                  
                  $
                  329
                  
                  
                  
                  100.0
                  %





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





June
      30,
                          
                          
                          December
      31,
                          
                          
                          
                          
                          
                          PercentCategory
                          
                          2009
                          
                          
                          2008
                          
                          
                          Change
                          
                          
                          ChangeCurrent assets:Cash
      and cash equivalents
                          
                          
                          721
                          
                          
                          
                          329
                          
                          
                          
                          392
                          
                          
                          
                          119.4
                          %Notes
      receivable
                          
                          
                          402
                          
                          
                          
                          270
                          
                          
                          
                          132
                          
                          
                          
                          48.9
                          %Accounts
      receivable, net of allowance for doubtful accounts
                          
                          
                          6,272
                          
                          
                          
                          4,518
                          
                          
                          
                          1,754
                          
                          
                          
                          38.8
                          %Inventories,
      net of reserve for obsolete inventory
                          
                          
                          2,516
                          
                          
                          
                          1,892
                          
                          
                          
                          624
                          
                          
                          
                          33.0
                          %Advances
      to suppliers
                          
                          
                          124
                          
                          
                          
                          118
                          
                          
                          
                          6
                          
                          
                          
                          5.2
                          %Due
      from related party
                          
                          
                          -
                          
                          
                          
                          437
                          
                          
                          
                          (437
                          )
                          
                          
                          (100.0
                          )%Prepaid
      value-added taxes on purchases
                          
                          
                          234
                          
                          
                          
                          -
                          
                          
                          
                          234
                          
                          
                          
                          N/APrepaid
      expenses and other
                          
                          
                          72
                          
                          
                          
                          22
                          
                          
                          
                          50
                          
                          
                          
                          227.0
                          %Current liabilities:Loans
      payable
                          
                          
                          1,169
                          
                          
                          
                          1,021
                          
                          
                          
                          148
                          
                          
                          
                          14.4
                          %Accounts
      payable
                          
                          
                          2,891
                          
                          
                          
                          2,485
                          
                          
                          
                          406
                          
                          
                          
                          16.3
                          %Accrued
      expenses
                          
                          
                          270
                          
                          
                          
                          188
                          
                          
                          
                          82
                          
                          
                          
                          43.9
                          %VAT
      and service taxes payable
                          
                          
                          -
                          
                          
                          
                          97
                          
                          
                          
                          (97
                          )
                          
                          
                          (100.0
                          )%Advances
      from customers
                          
                          
                          472
                          
                          
                          
                          46
                          
                          
                          
                          426
                          
                          
                          
                          926.1
                          %Income
      taxes payable
                          
                          
                          701
                          
                          
                          
                          569
                          
                          
                          
                          132
                          
                          
                          
                          23.1
                          %Working capital:Total
      current assets
                          
                          
                          10,341
                          
                          
                          
                          7,586
                          
                          
                          
                          2,755
                          
                          
                          
                          36.3
                          %Total
      current liabilities
                          
                          
                          5,504
                          
                          
                          
                          4,406
                          
                          
                          
                          1,098
                          
                          
                          
                          24.9
                          %Working
      capital
                          
                          
                          4,837
                          
                          
                          
                          3,180
                          
                          
                          
                          1,657
                          
                          
                          
                          52.1
                          %





Our
working capital increased $1,657,000 to $4,837,000 at June 30, 2009 from
$3,180,000 at December 31, 2008. This increase in working capital results from
our increase in revenue and net income.  At June 30, 2009, our
accounts receivable were $6,272,000, of which $2,121,000 originated from our
Dyeing segment and $4,151,000 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.





43





Net cash
flow provided by operating activities was $2,024,000 for the six months ended
June 30, 2009 as compared to net cash flow provided by operating activities of
$902,000 for the six months ended June 30 2008, an increase of $1,122,000. Net
cash flow provided by operating activities for the six months ended June 30,
2009 was mainly due to net income of $2,427,000, the add-back of non-cash items
of depreciation of $697,000, the amortization of debt discount of $17,000, the
amortization of land use rights of $43,000, the increase in our allowance for
bad debt of $143,000, the add-back  of interest expense of $128,000
resulting from the issuance of common stock in payment of principal and interest
on a note, and the add-back of stock-based compensation of $120,000, the
decrease in due from related party of $438,000, the increase in accounts payable
of $404,000, the increase in accrued expenses of $82,000, the increase in income
taxes payable of $131,000 and the increase in advances from customers of
$426,000 offset by an increase in notes receivable of $132,000, an increase in
accounts receivable of $1,891,000, an increase in inventories of $622,000, an
increase in prepaid and other current assets and prepaid value-added taxes on
purchases of $51,000, and an increase in advances to suppliers of $6,000 and a
decrease in VAT and service taxes payable of $97,000. Net cash flow provided by
operating activities for the six months ended June 30, 2008 was mainly due to
net income of $161,000, the add-back of non-cash items of depreciation and
amortization of $323,000, the amortization of land use rights of $67,000, 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 $170,000, and
the add-back of stock-based compensation of $75,000, the decrease in prepaid and
other assets of $235,000 and advances to suppliers of $647,000 offset by an
increase in accounts receivable of $1,860,000, inventories of $912,000, the
payment of accounts payable of $138,000 and the payment of VAT and service taxes
of $231,000.





Net cash
flow used in investing activities was $2,849,000 for the six months ended June
30, 2009 and compared to net cash used in investing activities of $4,730,000 for
the six months ended June 30, 2008. Net cash flow used in investing activities
for the six months ended June 30, 2009 was primarily due to the purchase of
property and equipment of $2,849,000. For the six months ended June 30, 2008, we
received cash from the repayment of amounts due from related parties of $98,000
and from the sale of our cost-method investee of $35,000 offset by the purchase
of property and equipment of $2,127,000 and the payment of deposits on factory
equipment of $2,737,000.





Net cash
flow provided by financing activities was $1,217,000 for the six months ended
June 30, 2009 as compared to net cash provided by financing activities of
$894,000 for the six months ended June 30, 2008. For the six months ended June
30, 2009, we received proceeds from loans of $1,134,000 and proceeds from the
exercise of warrants of $83,000. For the six months ended June 30, 2008, we
received proceeds from short-term bank loans of $141,000, and proceeds from the
exercise of warrants of $854,000 offset by the repayment of related party
advances of $102,000.





On
November 13, 2007, we raised gross proceeds of $5,525,000 from the sale of our
3% convertible notes in the principal amount of $5,525,000. On March 28, 2008,
the notes were automatically converted into an aggregate of 14,787,135 shares of
series A preferred stock and warrants to purchase 11,176,504 shares of common
stock at $0.58 per share, 5,588,252 shares of common stock at $0.83 per share,
and 2,065,000 shares of common stock at $0.92 per share upon the filing of
the restated certificate of incorporation and a statement of designations
setting forth the rights of the holders of the series A convertible preferred
stock. In November 2008, as a result of our sale of common stock at $0.40 per
share, the exercise price of warrants to purchase 6,501,077 shares of common
stock was reduced to $0.40 per share, and the exercise price of warrants to
purchase 9,232,424 was reduced to $0.567 per share, which was further reduced to
$0.566 as a result of the issuance of warrants in our March 2009 debt
financing.





In 2008,
we received $2,188,000 from the exercise of warrants to purchase 3,096,255
shares of common stock.  During the six months ended June 30, 2009, we
received $83,000 from the exercise of warrants to purchase 207,780 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 1,531,250 shares
of common stock into escrow.  The note holders have the right to take
these shares, valued at $0.20 per share, in payment of the interest or
principal, as the case may be, if we do not pay the interest on or principal of
the note before it becomes an event of default.  Pursuant to the loan
documents, in the event of that Leo Wang ceases to be employed by us as our
chief financial officer the holders of not less than $126,000 principal amount
of the notes, shall have the right, on not less than 60 days’ notice, to declare
the notes in default.  If Mr. Wang ceases to be employed by us as a
result of his death, disability or a termination for cause, than we shall have
60 days to replace Mr. Wang with a chief financial officer acceptable to
investors.




44




In
addition to the loans described in the preceding paragraph, during the six
months ended June 30, 2009, we received several bank and third-party loans for
aggregate proceeds of approximately $1,134,000.





We are
currently seeking a loan of RMB 6,000,000 to RMB 10,000,000 (approximately
$875,000 to $1,500,000) from a bank in Wuxi, using our newly completed forging
facility and the related land use rights as collateral.  We can
give no assurance that we will be able to obtain such
financing.   We are also evaluating accounts receivable financing
opportunities to improve our cash flow.   If we are unable to
obtain any of these financing, we may need to seek financing from other
sources.  During the fourth quarter of 2008 and the first half year of
2009 we raised funds through the sale of equity and the issuance of notes on
terms that were not favorable to us.  In the event that we require
additional financing, we cannot assure you we will be able to obtain funding on
favorable terms, if any.  We expect that any equity financing would
result in dilution to our stockholders.





Contractual
Obligations and Off-Balance Sheet Arrangements




Contractual
Obligations




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




Payments
      Due by PeriodTotal
                                                                                
                                                                                Less
      than
                                                                                  1
      year
                                                                                
                                                                                1-3
      Years
                                                                                
                                                                                3-5
                                                                                  Years
                                                                                
                                                                                5
      Years
                                                                                  +Contractual
      Obligations :Bank
      indebtedness (1)
                                                                                
                                                                                $
                                                                                1,753
                                                                                
                                                                                $
                                                                                1,169
                                                                                
                                                                                $
                                                                                -
                                                                                
                                                                                $
                                                                                584
                                                                                
                                                                                $
                                                                                -Loans
      payable
                                                                                
                                                                                
                                                                                250
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                250
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                -Total
      Contractual Obligations:
                                                                                
                                                                                $
                                                                                2,003
                                                                                
                                                                                $
                                                                                1,169
                                                                                
                                                                                $
                                                                                250
                                                                                
                                                                                $
                                                                                584
                                                                                
                                                                                $
                                                                                -




(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 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 six months ended June 30, 2009, we has
unrealized foreign currency translation gain of $45,000, 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 June 30, 2009.





45





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, 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 June 30,
2009.





Management’s
Report on Internal Control over Financial Reporting




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act.  Our management is also required to
assess and report on the effectiveness of our internal control over financial
reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002
(“Section 404”).   Management assessed the effectiveness of our
internal control over financial reporting as of December 31, 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 June 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 resources 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 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.
  46
   ̈
              We
      elected an independent director in March 2009 to serve on our audit
      committee and we are seeking an additional independent director, who will
      also serve on our audit committee.  We have also set up a
      compensation committee to be headed by one of our independent
      directors.
   ̈
              Due
      to our size and nature, segregation of all conflicting duties may not
      always be possible and may not be economically
      feasible.  However, to the extent possible, we will implement
      procedures to assure that the initiation of transactions, the custody of
      assets and the recording of transactions will be performed by separate
      individuals.




We
believe that the foregoing steps 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.





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 June 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.





Auditor
Attestation





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





Changes in
Internal Controls over Financial Reporting




There
were no changes in our internal controls over financial reporting during the
fourth quarter of fiscal year 2008 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.





47





PART II -
OTHER INFORMATION





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





On
June 4, 2009, we issued 207,780 shares of its common stock to Eos Holdings for
exercise of common stock purchase warrants that were issued upon conversion of
notes issued in our November 2007 private placement. The Company received cash
of $83,112 upon such exercise.





On June
5, 2009, we issued 401,461 shares of its common stock to Eos Holdings upon
conversion of shares of series A preferred stock that were issued upon
conversion of notes issued in our November 2007 private placement.





On June
17, 2009, we issued 17,059 shares of common stock to our chief financial officer
for services rendered pursuant to his employment agreement.





On June
17, 2009, we issued 52,980 shares of common stock to our vice president of
financial reporting for services rendered pursuant to an engagement
agreement.





On June
18, 2009, we issued 74,469 shares of its common stock to a newly-elected
director pursuant to an agreement with the director.





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





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:
      August 14, 2009
                  
                  By:
                  /s/ Jianhua WuJianhua
      Wu, Chief Executive OfficerDate:
      August 14, 2009
                  
                  By:
                  /s/ Leo WangLeo
      Wang, Chief Financial
Officer


48