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 March 31, 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.  44,679,496 shares of common
stock are issued and outstanding as of May 5, 2009.











CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


FORM
10-Q


March
31, 2009




TABLE
OF CONTENTS




Page
                    No.PART
      I. - FINANCIAL INFORMATIONItem
      1.
                  Financial
      Statements
                  3Item
      2.
                  Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                  27Item
      3
                  Quantitative
      and Qualitative Disclosures About Market Risk.
                  40Item
      4
                  Controls
      and Procedures.
                  41PART
      II - OTHER INFORMATIONItem
      2.
                  Unregistered
      Sales of Equity Securities and Use of Proceeds.
                  43Item
      6.
                  Exhibits.
                  43






1




FORWARD
LOOKING STATEMENTS




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




Although forward-looking statements in
this report reflect the good faith judgment of our management, such statements
can only be based on facts and factors currently known by us. Consequently,
forward-looking statements are inherently subject to risks and uncertainties and
actual results and outcomes may differ materially from the results and outcomes
discussed in or anticipated by the forward-looking statements. Factors that
could cause or contribute to such differences in results and outcomes include,
without limitation, those specifically addressed under the headings “Risks
Factors” and “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” in our annual report on Form 10-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





March
      31,
                              
                              
                              December
      31,2009
                              
                              
                              2008(Unaudited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                              
                              $
                              107,910
                              
                              
                              $
                              328,614Notes
      receivable
                              
                              
                              199,836
                              
                              
                              
                              269,549Accounts
      receivable, net of allowance for doubtful accounts (Note
2)
                              
                              
                              4,900,064
                              
                              
                              
                              4,518,259Inventories,
      net of reserve for obsolete inventory (Note 3)
                              
                              
                              2,409,723
                              
                              
                              
                              1,892,090Advances
      to suppliers
                              
                              
                              101,916
                              
                              
                              
                              117,795Due
      from related party (Note 8)
                              
                              
                              -
                              
                              
                              
                              437,688Prepaid
      expenses and other
                              
                              
                              79,240
                              
                              
                              
                              21,744Total
      Current Assets
                              
                              
                              7,798,689
                              
                              
                              
                              7,585,739PROPERTY
      AND EQUIPMENT - net (Note 4)
                              
                              
                              26,748,919
                              
                              
                              
                              25,939,596OTHER
      ASSETS:Land
      use rights, net (Note 5)
                              
                              
                              3,789,616
                              
                              
                              
                              3,806,422Total
      Assets
                              
                              $
                              38,337,224
                              
                              
                              $
                              37,331,757LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Loans
      payable (Note 7)
                              
                              $
                              1,314,713
                              
                              
                              $
                              1,021,272Accounts
      payable
                              
                              
                              2,445,776
                              
                              
                              
                              2,485,137Accrued
      expenses
                              
                              
                              233,517
                              
                              
                              
                              187,605VAT
      and service taxes payable
                              
                              
                              -
                              
                              
                              
                              97,341Advances
      from customers
                              
                              
                              100,096
                              
                              
                              
                              45,748Income
      taxes payable
                              
                              
                              336,710
                              
                              
                              
                              569,371Total
      Current Liabilities
                              
                              
                              4,430,812
                              
                              
                              
                              4,406,474LONG-TERM
      LIABILITIES:Loan
      payable - net of current portion and debt discount (Note
7)
                              
                              
                              158,515
                              
                              
                              
                              -Total
      Liabilities
                              
                              
                              4,589,327
                              
                              
                              
                              4,406,474RELATED
      PARY TRANSACTIONS (Note 8)COMMITMENTS
      (Note 11)STOCKHOLDERS'
      EQUITY: (Note 6)Preferred
      stock $0.001 par value;(March
      31, 2009 and December 31, 2008 - 60,000,000 shares authorized, all of
      whichwere
      designated as series A convertible preferred, 14,028,189 shares issued and
      outstanding; at March 31, 2009 and December 31, 2008,
      respectively)
                              
                              
                              14,028
                              
                              
                              
                              14,028Common
      stock ($0.001 par value; 150,000,000 shares authorized;44,979,667
      and 44,895,546 shares issued and outstandingat
      March 31, 2009 and December 31, 2008, respectively)
                              
                              
                              44,980
                              
                              
                              
                              44,896Additional
      paid-in capital
                              
                              
                              15,706,220
                              
                              
                              
                              15,571,288Retained
      earnings
                              
                              
                              14,231,262
                              
                              
                              
                              13,639,641Statutory
      reserve
                              
                              
                              675,640
                              
                              
                              
                              621,203Other
      comprehensive gain - cumulative foreign currency translation
      adjustment
                              
                              
                              3,075,767
                              
                              
                              
                              3,034,227Total
      Stockholders' Equity
                              
                              
                              33,747,897
                              
                              
                              
                              32,925,283Total
      Liabilities and Stockholders' Equity
                              
                              $
                              38,337,224
                              
                              
                              $
                              37,331,757





See notes
to unaudited consolidated financial statements




3




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME





For
      the Three Months EndedMarch
      31,2009
                  
                  
                  2008(Unaudited)
                  
                  
                  (Unaudited)NET
      REVENUES
                  
                  $
                  7,860,867
                  
                  
                  $
                  8,447,074COST
      OF SALES
                  
                  
                  6,264,218
                  
                  
                  
                  6,272,826GROSS
      PROFIT
                  
                  
                  1,596,649
                  
                  
                  
                  2,174,248OPERATING
      EXPENSES:Depreciation
                  
                  
                  77,530
                  
                  
                  
                  78,020Selling,
      general and administrative
                  
                  
                  500,948
                  
                  
                  
                  616,568Total
      Operating Expenses
                  
                  
                  578,478
                  
                  
                  
                  694,588INCOME
      FROM OPERATIONS
                  
                  
                  1,018,171
                  
                  
                  
                  1,479,660OTHER
      INCOME (EXPENSE):Interest
      income
                  
                  
                  230
                  
                  
                  
                  5,633Interest
      expense
                  
                  
                  (23,671
                  )
                  
                  
                  (2,259,694
                  )Foreign
      currency loss
                  
                  
                  (11
                  )
                  
                  
                  -Debt
      issuance costs
                  
                  
                  (12,000
                  )
                  
                  
                  (21,429
                  )Total
      Other Income (Expense)
                  
                  
                  (35,452
                  )
                  
                  
                  (2,275,490
                  )INCOME
      (LOSS) BEFORE INCOME TAXES
                  
                  
                  982,719
                  
                  
                  
                  (795,830
                  )INCOME
      TAXES
                  
                  
                  336,661
                  
                  
                  
                  454,031NET
      INCOME (LOSS)
                  
                  
                  646,058
                  
                  
                  
                  (1,249,861
                  )DEEMED
      PREFERRED STOCK DIVIDEND
                  
                  
                  -
                  
                  
                  
                  (2,884,062
                  )NET
      INCOME (LOSS) ALLOCABLE TO COMMON SHAREHOLDERS
                  
                  $
                  646,058
                  
                  
                  $
                  (4,133,923
                  )COMPREHENSIVE
      INCOME (LOSS):NET
      INCOME (LOSS)
                  
                  $
                  646,058
                  
                  
                  $
                  (1,249,861
                  )OTHER
      COMPREHENSIVE INCOME:Unrealized
      foreign currency translation gain
                  
                  
                  41,540
                  
                  
                  
                  1,007,245COMPREHENSIVE
      INCOME (LOSS)
                  
                  $
                  687,598
                  
                  
                  $
                  (242,616
                  )NET
      INCOME (LOSS) PER COMMON SHARE:Basic
                  
                  $
                  0.01
                  
                  
                  $
                  (0.11
                  )Diluted
                  
                  $
                  0.01
                  
                  
                  $
                  (0.11
                  )WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING:Basic
                  
                  
                  44,964,840
                  
                  
                  
                  37,484,504Diluted
                  
                  
                  58,993,029
                  
                  
                  
                  37,484,504





See notes
to unaudited consolidated financial statements





4





CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





For
      the Three Months EndedMatch
      31,2009
                    
                    
                    2008(Unaudited)
                    
                    
                    (Unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income (loss)
                    
                    $
                    646,058
                    
                    
                    $
                    (1,249,861
                    )Adjustments
      to reconcile net income (loss) from operations to net cashprovided
      by (used in) operating activities:Depreciation
                    
                    
                    175,113
                    
                    
                    
                    159,062Amortization
      of debt discount to interest expense
                    
                    
                    1,500
                    
                    
                    
                    2,263,661Amortization
      of debt offering costs
                    
                    
                    -
                    
                    
                    
                    21,429Amortization
      of land use rights
                    
                    
                    21,585
                    
                    
                    
                    2,784Increase
      in allowance for doubtful accounts
                    
                    
                    1,109
                    
                    
                    
                    -Stock-based
      compensation expense
                    
                    
                    42,031
                    
                    
                    
                    45,000Changes
      in assets and liabilities:Notes
      receivable
                    
                    
                    70,041
                    
                    
                    
                    -Accounts
      receivable
                    
                    
                    (377,183
                    )
                    
                    
                    (1,263,740
                    )Inventories
                    
                    
                    (515,182
                    )
                    
                    
                    (1,136,507
                    )Prepaid
      and other current assets
                    
                    
                    (57,485
                    )
                    
                    
                    (49,696
                    )Advances
      to suppliers
                    
                    
                    16,025
                    
                    
                    
                    320,583Due
      from related party
                    
                    
                    438,174
                    
                    
                    
                    -Accounts
      payable
                    
                    
                    (42,397
                    )
                    
                    
                    (1,225,962
                    )Accrued
      expenses
                    
                    
                    45,669
                    
                    
                    
                    7,150VAT
      and service taxes payable
                    
                    
                    (97,450
                    )
                    
                    
                    62,655Income
      taxes payable
                    
                    
                    (233,343
                    )
                    
                    
                    (64,183
                    )Advances
      from customers
                    
                    
                    54,282
                    
                    
                    
                    10,804NET
      CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
                    
                    
                    188,547
                    
                    
                    
                    (2,096,821
                    )CASH
      FLOWS FROM INVESTING ACTIVITIES:Decrease
      in due from related parties
                    
                    
                    -
                    
                    
                    
                    96,650Proceeds
      from sale of cost-method investee
                    
                    
                    -
                    
                    
                    
                    34,840Deposit
      on long-term assets - related party
                    
                    
                    -
                    
                    
                    
                    (822,212
                    )Purchase
      of property and equipment
                    
                    
                    (951,736
                    )
                    
                    
                    (3,907
                    )NET
      CASH USED IN INVESTING ACTIVITIES
                    
                    
                    (951,736
                    )
                    
                    
                    (694,629
                    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from loans
                    
                    
                    542,116
                    
                    
                    
                    139,360Proceeds
      from exercise of warrants
                    
                    
                    -
                    
                    
                    
                    187,340Payments
      on related party advances
                    
                    
                    -
                    
                    
                    
                    (100,441
                    )NET
      CASH PROVIDED BY FINANCING ACTIVITIES
                    
                    
                    542,116
                    
                    
                    
                    226,259EFFECT
      OF EXCHANGE RATE ON CASH
                    
                    
                    369
                    
                    
                    
                    120,480NET
      DECREASE IN CASH
                    
                    
                    (220,704
                    )
                    
                    
                    (2,444,711
                    )CASH  -
      beginning of year
                    
                    
                    328,614
                    
                    
                    
                    5,025,434CASH
      - end of period
                    
                    $
                    107,910
                    
                    
                    $
                    2,580,723SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid for:Interest
                    
                    $
                    21,264
                    
                    
                    $
                    16,752Income
      taxes
                    
                    $
                    580,004
                    
                    
                    $
                    518,214NON-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
      notes converted to series A preferred stock
                    
                    $
                    -
                    
                    
                    $
                    5,525,000





See notes
to unaudited consolidated financial statements.




5


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




NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Organization





China
Winds Systems, Inc. (the “Company”) was incorporated in Delaware on June 24,
1987 under the name of Malex, Inc.  On December 18, 2007, the
Company’s corporate name was changed to China Wind Systems, Inc. The Company
manufactures and sells textile dyeing and finishing machines and 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 through its affiliates, Wuxi Huayang Dyeing Machinery Co., Ltd.
(“Dyeing”) and Wuxi Huayang Electrical Power Equipment Co., Ltd. (“Electrical”),
and through its wholly-owned subsidiary, Wuxi Fulland Wind Energy Equipment Co.,
Ltd. (“Fulland Wind Energy”).





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





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





Wuxi
Huayang Dyeing Machinery Co., Ltd.





Dyeing is
a Chinese limited liability company and was formed under laws of the People’s
Republic of China on August 17, 1995.  Dyeing produces and sells a
variety of high and low temperature dyeing and finishing machinery.





Wuxi
Huayang Electrical Power Equipment Co., Ltd. and Wuxi Fulland Wind Energy
Equipment Co., Ltd.





Electric
a Chinese limited liability company and was formed under laws of the People’s
Republic of China on May 21, 2004.  On August 27, 2008, the Company
incorporated Fulland Wind Energy.  Fulland owns 100% of Fulland Wind
Energy, which is a WFOE organized under the laws of the PRC. Beginning in April
2007, Electric began to produce large-scaled forged rolled rings for the
wind-power and other industries that are up to three meters in
diameter.  Commencing in 2008, the sale of rolled rings accounted for
more than 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).
Electric equipment products mainly include various auxiliary equipment of power
stations, chemical equipment, dust removal and environmental protection
equipment, and metallurgy non- standard equipment. The Company refers to this
segment of its business as the forged rolled rings and electric power equipment
division





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
 March 31,
2009


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





These
consolidated financial statements should be read in conjunction with the summary
of significant accounting policies and notes to consolidated financial
statements included in the Company’s Form 10-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, Dyeing and
Electric.  All significant intercompany accounts and transactions have
been eliminated in consolidation.





The
Huayang Companies are considered variableinterestentities (“VIE”), and the
Company is the primary beneficiary.  The Company’s relationships with
the Huayang Companies and their shareholders are governed by a series of
contractual arrangements between Green Power, the Company’s wholly foreign-owned
enterprise in the PRC, and each of the Huayang Companies, which are the
operating companies of the Company in the PRC. Under PRC laws, each of Green
Power, Huayang Dye Machine and Huayang Electrical Power Equipment is an
independent legal 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. On October 12,
2007, the Company entered into the following contractual arrangements with each
of Huayang Dye Machine and Huayang Electrical Power Equipment:





Consulting Services
Agreement. Pursuant to the exclusive consulting services agreements
between Green Power and the Huayang Companies, Green Power has the exclusive
right to provide to the Huayang Companies general business operation services,
including advice and strategic planning, as well as consulting services related
to the technological research and development of dye and finishing machines,
electrical equipments and related products (the “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, the Huayang Companies agrees that without
the prior consent of Green Power, the Huayang Companies will not engage in any
transactions that could materially affect their respective assets, liabilities,
rights or operations, including, without limitation, incurrence or assumption of
any indebtedness, sale or purchase of any assets or rights, incurrence of any
encumbrance on any of their assets or intellectual property rights in favor of a
third party or transfer of any agreements relating to their business operation
to any third party. The term of this agreement, as amended on November 1, 2008,
is 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
 March 31,
2009


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





Equity Pledge
Agreement.Under
the equity pledge agreement between the Huayang Companies’ 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 obligations under the consulting services
agreement. If the Huayang Companies or the Huayang Companies’ Shareholders
breaches their respective contractual obligations, Green Power, as pledgee, will
be entitled to certain rights, including the right to sell the pledged equity
interests. 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 a VIE,the Huayang Companies’ sales are included in the Company’s
total sales, its income from operations is consolidated with the Company’s, and
the Company’s net income includes all ofthe Huayang
Companies net income. The Company does not have any non-controlling interest and
accordingly, did not subtract any net income in calculating the net income
attributable to the Company. Because of the contractual arrangements, the
Company had a pecuniary interest inthe Huayang
Companies that require consolidation of the Company’s andthe Huayang Companies financial statements.





Use of
estimates





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





8


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


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





Fair value of financial
instruments





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
People’s Republic of China of which no deposits are covered by insurance. The
Company has not experienced any losses in such accounts and believes it is not
exposed to any risks on its cash in bank accounts. A significant portion of the
Company's sales are credit sales which are primarily to customers whose ability
to pay is dependent upon the industry economics prevailing in these areas;
however, concentrations of credit risk with respect to trade accounts
receivables is limited due to generally short payment terms.  The
Company also performs ongoing credit evaluations of its customers to help
further reduce credit risk.




9


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


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





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





March
      31, 2009
                  
                  
                  December
      31, 2008Country:United
      States
                  
                  $
                  11,619
                  
                  
                  
                  10.8
                  %
                  
                  $
                  832
                  
                  
                  
                  0.3
                  %China
                  
                  
                  96,291
                  
                  
                  
                  89.2
                  %
                  
                  
                  327,782
                  
                  
                  
                  99.7
                  %Total
      cash and cash equivalents
                  
                  $
                  107,910
                  
                  
                  
                  100.0
                  %
                  
                  $
                  328,614
                  
                  
                  
                  100.0
                  %





Notes
receivable





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





Accounts
receivable





Accounts
receivable are presented net of an allowance for doubtful accounts. The Company
maintains allowances for doubtful accounts for estimated losses. The Company
reviews the accounts receivable on a periodic basis and makes general and
specific allowances when there is doubt as to the collectability of individual
balances. In evaluating the collectability of individual receivable balances,
the Company considers many factors, including the age of the balance, customer’s
historical payment history, its current credit-worthiness and current economic
trends. Accounts are written off after exhaustive efforts at collection. At
March 31, 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 $877,064 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 $79,269 and $79,170 at March 31, 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
 March 31,
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 three months ended March
31, 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 three months ended March 31, 2009
and 2008, amounts allocated to warranty revenues were not material. Based on
historical experience, warranty service calls and any related labor costs have
been minimal.




All other
product sales 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
 March 31,
2009


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





Advances from
customers





Advances
from customers at March 31, 2009 and December 31, 2008 amounted to $100,096
and $45,748, respectively, and consist of prepayments from customers for
merchandise that had not yet been shipped. The Company 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 $66,432 and $57,463 for the
three months ended March 31, 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 three months ended March
31, 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 quarter ended March 31, 2009 and
2008 was $369 and $120,480, respectively. Transactions denominated in foreign
currencies are translated into the functional currency at the exchange rates
prevailing on the transaction dates. Assets and 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
 March 31,
2009


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





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





Asset and
liability accounts at March 31, 2009 and December 31, 2008 were translated at
6.8456 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 three months ended March 31, 2009 and 2008 were 6.84659 RMB and
7.17568 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.





Incomeper shareof 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:





Three
      Months ended
                          March
      31,2009
                        
                        
                        2008Net
      income (loss) allocable to common shareholders for basic and diluted net
      income (loss) per common share
                        
                        $
                        646,058
                        
                        
                        $
                        (4,133,923
                        )Weighted
      average common shares outstanding – basic
                        
                        
                        44,964,840
                        
                        
                        
                        37,484,504Effect
      of dilutive securities:Series
      A convertible preferred stock
                        
                        
                        14,028,189
                        
                        
                        
                        -Weighted
      average common shares outstanding– diluted
                        
                        
                        58,993,029
                        
                        
                        
                        37,484,504Net
      income (loss) per common share  - basic
                        
                        $
                        0.01
                        
                        
                        $
                        (0.11
                        )Net
      income (loss) per common share  - diluted
                        
                        $
                        0.01
                        
                        
                        $
                        (0.11
                        )





The
Company's aggregate common stock equivalents at March 31, 2009 and 2008 include
the following:





2009
                      
                      
                      2008Warrants
                      
                      
                      16,571,001
                      
                      
                      
                      18,906,756Series
      A preferred stock
                      
                      
                      14,028,189
                      
                      
                      
                      14,787,135Total
                      
                      
                      30,599,190
                      
                      
                      
                      33,693,891





Using the
treasury stock method, there was no dilution resulting from the outstanding
warrants.





Accumulated other
comprehensive income




The
Company follows Statement of Financial Accounting Standards No. 130 (SFAS
130) “Reporting Comprehensive
Income” to recognize the elements of comprehensive income. Comprehensive
income is comprised of net income and all changes to the statements of
stockholders' equity, except those due to investments by stockholders, changes
in paid-in capital and distributions to stockholders. For the Company,
comprehensive income for the three months ended March 31, 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
 March 31,
2009


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





Related
parties





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





Recent accounting
pronouncements





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





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





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





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





14


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


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





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





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





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





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





NOTE 2 –
ACCOUNTS
RECEIVABLE





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





March
      31, 2009
                  
                  
                  December
      31, 2008Accounts
      receivable
                  
                  $
                  5,777,128
                  
                  
                  $
                  5,393,115Less:
      allowance for doubtful accounts
                  
                  
                  (877,064
                  )
                  
                  
                  (874,856
                  )$
                  4,900,064
                  
                  
                  $
                  4,518,259





15


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


NOTE 3 -
INVENTORIES





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





March
      31, 2009
                  
                  
                  December
      31, 2008Raw
      materials
                  
                  $
                  1,073,316
                  
                  
                  $
                  1,054,182Work
      in process
                  
                  
                  407,241
                  
                  
                  
                  254,960Finished
      goods
                  
                  
                  1,008,435
                  
                  
                  
                  662,1182,488,992
                  
                  
                  
                  1,971,260Less:
      Reserve for obsolete inventory
                  
                  
                  (79,269
                  )
                  
                  
                  (79,170
                  )$
                  2,409,723
                  
                  
                  $
                  1,892,090





NOTE 4 -
PROPERTY AND
EQUIPMENT





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





Useful
      Life
                                      
                                      
                                      2009
                                      
                                      
                                      2008Office
      equipment and furniture
                                      
                                      5
      Years
                                      
                                      
                                      $
                                      99,686
                                      
                                      
                                      $
                                      99,561Manufacturing
      equipment
                                      
                                      5 –
      10 Years
                                      
                                      
                                      
                                      15,355,800
                                      
                                      
                                      
                                      14,754,250Vehicles
                                      
                                      5
      Years
                                      
                                      
                                      
                                      79,472
                                      
                                      
                                      
                                      79,372Construction
      in progress
                                      
                                      
                                      -
                                      
                                      
                                      
                                      286,612
                                      
                                      
                                      
                                      207,605Building
      and building improvements
                                      
                                      20
      Years
                                      
                                      
                                      
                                      14,712,628
                                      
                                      
                                      
                                      14,404,41930,534,198
                                      
                                      
                                      
                                      29,545,207Less:
      accumulated depreciation
                                      
                                      
                                      
                                      
                                      
                                      
                                      (3,785,279
                                      )
                                      
                                      
                                      (3,605,611
                                      )$
                                      26,748,919
                                      
                                      
                                      $
                                      25,939,596





For the
three months ended March 31, 2009 and 2008, depreciation expense amounted
to $175,113 and $159,062, respectively, of which $97,583 and $83,826,
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. The Company’s land use
rights are valued at a fixed amount, which is RMB 27,000,795 at March 31, 2009
and the dollar value of the land use right fluctuates based on the exchange
rate.  In 2008, in connection with the acquisition of land use rights
from a related party, 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 three months ended March 31, 2009 and 2008, amortization of land use
rights amounted to $21,585 and $2,784, respectively.





16


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


NOTE
5 – LAND USE RIGHTS
(continued)





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


Useful
      Life
                          
                          2009
                          
                          
                          2008Land
      Use Rights
                          
                          45
      - 50 years
                          
                          $
                          3,944,256
                          
                          
                          $
                          3,939,307Less:
      Accumulated Amortization
                          
                          
                          
                          
                          (154,640
                          )
                          
                          
                          (132,885
                          )$
                          3,789,616
                          
                          
                          $
                          3,806,422




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





Period
      ending March 31:2010
                  
                  $
                  86,3522011
                  
                  
                  86,3522012
                  
                  
                  86,3522013
                  
                  
                  86,352Thereafter
                  
                  
                  3,444,208$
                  3,789,616




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.





On March
31, 2009, the Company issued 13,889 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 $6,944.





17


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





(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 liquidated 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.




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




18


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


NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(d)           Securities Purchase
Agreement





Pursuant
to the securities purchase agreement 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.




19


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


NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





●
            In
      connection with the securities purchase agreement, $30,000 was paid
      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.





There was
no warrant activity during the three months ended March 31,
2008.  Warrant activity for the three months ended March 31, 2009 is
summarized as follows:




Number
      of
                      Warrants
                    
                    
                    Weighted
                      Average
                      Exercise
      PriceBalance
      at beginning of year
                    
                    
                    16,133,501
                    
                    
                    $
                    0.50Granted
                    
                    
                    437,500
                    
                    
                    
                    0.40Exercised
                    
                    
                    -
                    
                    
                    
                    -Balance
      at end of period
                    
                    
                    16,571,001
                    
                    
                    $
                    0.50Warrants
      exercisable at end of period
                    
                    
                    16,571,001
                    
                    
                    $
                    0.50





The
following table summarizes the shares of the Company's common stock issuable
upon exercise of warrants outstanding at March 31, 2009:




Warrants
      Outstanding
                                  
                                  
                                  Warrants
      ExercisableRange
      of
                                    Exercise
                                    Price
                                  
                                  Number
                                    Outstanding
      at
                                    March
      31,
                                    2009
                                  
                                  
                                  Weighted
                                    Average
                                    Remaining
                                    Contractual
                                    Life
      (Years)
                                  
                                  
                                  Weighted
                                    Average
                                    Exercise
                                    Price
                                  
                                  
                                  Number
                                    Exercisable
      at
                                    March
      31,
                                    2009
                                  
                                  
                                  Weighted
                                    Average
                                    Exercise
                                    Price$
                                  0.50
                                  
                                  
                                  400,000
                                  
                                  
                                  
                                  3.62
                                  
                                  
                                  $
                                  0.50
                                  
                                  
                                  
                                  400,000
                                  
                                  
                                  $
                                  0.500.567
                                  
                                  
                                  9,232,424
                                  
                                  
                                  
                                  3.62
                                  
                                  
                                  
                                  0.567
                                  
                                  
                                  
                                  9,232,424
                                  
                                  
                                  
                                  0.5670.40
                                  
                                  
                                  6,938,577
                                  
                                  
                                  
                                  3.71
                                  
                                  
                                  
                                  0.40
                                  
                                  
                                  
                                  6,938,577
                                  
                                  
                                  
                                  0.4016,571,001
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  0.50
                                  
                                  
                                  
                                  16,571,001
                                  
                                  
                                  $
                                  0.50





20


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


NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(f)           Beneficial Conversion
FeatureandDeemed
Dividend





In
November 2007, the Company evaluated the application of EITF 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios,” and EITF 00-27, “Application of Issue No. 98-5 to
Certain Convertible Instruments” and concluded that the convertible notes
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 three months ended March 31, 2008. The estimated fair
market value of the warrants of $2,884,062 has been recorded as additional
paid-in capital and a reduction to retained earnings.





For the
three months ended March 31, 2008, amortization of debt issue costs was $21,429
and included any remaining balance of debt issue costs that was expensed upon
conversion of the convertible notes to the series A preferred stock and
warrants.  The amortization of debt discounts for the three months
ended March 31, 2009 and 2008 was $1,500 and $2,263,661, respectively, which has
been included in interest expense on the accompanying statements of
income.   For the three 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.





21


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


NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





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





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





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





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





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





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





22


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


NOTE 7 –
LOANS
PAYABLE





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





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





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





23


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


NOTE 8 –
RELATED PARTY
TRANSACTIONS





Due
from related party





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





Name
              
              Relationship
              
              March
      31,
                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.





24


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


NOTE 10 -
SEGMENT
INFORMATION





The
following information is presented in accordance with SFAS No. 131, Disclosure
about Segments of an Enterprise and Related Information.  For the
three months ended March 31, 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 month ended
March 31, 2009 and 2008 is as follows:




2009
                                              
                                              
                                              2008Revenues:Dyeing
      and finishing equipment
                                              
                                              $
                                              3,529,441
                                              
                                              
                                              $
                                              4,653,138Forged
      rolled rings and electric power equipment
                                              
                                              
                                              4,331,426
                                              
                                              
                                              
                                              3,793,9367,860,867
                                              
                                              
                                              
                                              8,447,074Depreciation:Dyeing
      and finishing equipment
                                              
                                              
                                              100,107
                                              
                                              
                                              
                                              97,838Forged
      rolled rings and electric power equipment
                                              
                                              
                                              75,006
                                              
                                              
                                              
                                              61,224175,113
                                              
                                              
                                              
                                              159,062Interest
      expense:Dyeing
      and finishing equipment
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -Forged
      rolled rings and electric power equipment
                                              
                                              
                                              21,264
                                              
                                              
                                              
                                              16,752Other
      (a)
                                              
                                              
                                              2,407
                                              
                                              
                                              
                                              2,242,94223,671
                                              
                                              
                                              
                                              2,259,694Net
      income (loss):Dyeing
      and finishing equipment
                                              
                                              
                                              464,503
                                              
                                              
                                              
                                              704,386Forged
      rolled rings and electric power equipment
                                              
                                              
                                              424,036
                                              
                                              
                                              
                                              640,949Other
      (a)
                                              
                                              
                                              (242,481
                                              )
                                              
                                              
                                              (2,595,196
                                              )646,058
                                              
                                              
                                              
                                              (1,249,861
                                              )Identifiable
      assets at March 31, 2009 andDecember
      31, 2008 by segment:Dyeing
      and finishing equipment
                                              
                                              $
                                              17,595,919
                                              
                                              
                                              $
                                              17,884,877Forged
      rolled rings and electric power equipment
                                              
                                              
                                              20,709,971
                                              
                                              
                                              
                                              19,415,748Other
      (a)
                                              
                                              
                                              31,334
                                              
                                              
                                              
                                              31,132$
                                              38,337,224
                                              
                                              
                                              $
                                              37,331,757Identifiable
      assets at March 31, 2009 andDecember
      31, 2008 by geographical location:China
                                              
                                              $
                                              38,306,030
                                              
                                              
                                              $
                                              37,321,465United
      States
                                              
                                              
                                              31,194
                                              
                                              
                                              
                                              10,292$
                                              38,337,224
                                              
                                              
                                              $
                                              37,331,757




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




25


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


NOTE 11 –
STATUTORY
RESERVES





The
Company is required to make appropriations to reserve funds, comprising the
statutory surplus reserve, statutory public welfare fund and discretionary
surplus reserve, based on after-tax net income determined in accordance with
generally accepted accounting principles of the 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 March 31, 2009, the
Company appropriated the required maximum 50% of its registered capital to
statutory reserves for Dyeing.





For the
three months ended March 31, 2009, statutory reserve activity is as
follows:





Dyeing
                  
                  
                  Electric
                  
                  
                  TotalBalance
      – December 31, 2008
                  
                  
                  72,407
                  
                  
                  
                  548,796
                  
                  
                  
                  621,203Additional
      to statutory reserves
                  
                  
                  -
                  
                  
                  
                  54,437
                  
                  
                  
                  54,437Balance
      – March 31, 2009
                  
                  $
                  72,407
                  
                  
                  $
                  603,233
                  
                  
                  $
                  675,640




26




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





Overview





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





Historically,
the dyeing and finishing equipment business has been the principal source of our
revenue and operating income, accounting for 44.9% of revenue for the three
months ended March 31, 2009 and 55.1% of revenues for the three months ended
March 31, 2008.  Substantially all of our sales of these products are
made to companies in the PRC. As a result, we are dependent upon the continued
growth of the textile industry in the PRC. To the extent that growth in this
industry stagnates in the PRC, whether as a result of export restrictions from
countries such as the United States, who are major importers of Chinese-made
textiles, or shifts in international manufacturing to countries which may have a
lower cost than the PRC, or overexpansion of the Chinese textile industry, we
will have more difficulty in selling these products in the PRC, and we may have
difficulty exporting our equipment. Further, as the textile industry seeks to
lower costs by purchasing equipment that uses the most technological
developments to improve productivity, reduce costs and have less adverse
environmental impact, if we are not able to offer products utilizing the most
current technology, our ability to market our products will suffer. 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 55.1% of revenues for the three months
ended March 31, 2009, and 44.9% of revenues for the three months ended March 31,
2008.





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





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




27


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 quarter of 2009.  We also believe
that potential customers in this market are seeking price reductions which could
impair our overall gross margins.  Our revenue from the sale of
electric power equipment was 5.5% of total revenue in 2008.  We do not
expect to generate significant revenue from the sale of electrical power
equipment during the remainder of 2009.





Our
products are sold for use by manufacturers of industrial
equipment.  Because of the recent decline in oil prices and the
general international economic trends, the demand for products used in
manufacturing in general 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 purchases raw materials in order to avoid increases in costs
which we cannot recoup through increases in sales prices.  Similarly,
in times of decreasing prices, we may have purchased metals at prices which are
high in terms of the price at which we can sell our products, which also can
impair our margins.





Critical
Accounting Policies and Estimates





Our
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States. 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


28


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.


29


Property
and equipment





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





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




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





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.





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.


30


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





Warranty
revenue is valued based on estimated service person hours to complete a service
and generally is recognized over the contract period. For the three months ended
March 31, 2009 and 2008, amounts allocated to warranty revenues were not
material. Based on historical experience, warranty service calls and any related
labor costs have been minimal.




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





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 three months
ended March 31, 2009 and 2008.





Income
taxes





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




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





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





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





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





Recent
accounting pronouncements





In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”(“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
any non-controlling interest in the acquiree and the goodwill acquired. The
Statement also establishes disclosure requirements which will enable users to
evaluate the nature and financial effects of the business combination. SFAS
141(R) is effective for fiscal years beginning after December 15, 2008. The
adoption of SFAS 141(R) may have an impact on accounting for future business
combinations.


31




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





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





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





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





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





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




32


At its
June 25, 2008 meeting, the Financial Accounting Standards Board ratified the
consensus reached by the Emerging Issues Task Force Issue 07-5 Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entity’s Own Stock  (EITF
07-5).  The adoption of EITF 07-5’s requirements will affect accounting for
convertible instruments and warrants with down-round
provisions.   Convertible instruments and warrants which are
derivatives and have down-round protection will no longer be recorded in
equity.  EITF 07-5 is effective for financial statements issued for fiscal
years beginning after December 15, 2008, and interim periods within those fiscal
years.  After reviewing FAS 133 and EITF 07-5, we do not believe that EITF
07-5 has a material effect on the Company’s financial condition, results of
operations or cash flows.





Currency
Exchange Rates





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





Our
exposure to foreign exchange risk primarily relates to currency gains or losses
resulting from timing differences between signing of sales contracts and
settling of these contracts. Furthermore, we translate monetary assets and
liabilities denominated in other currencies into RMB, the functional currency of
our operating business. Our results of operations and cash flow are translated
at average exchange rates during the period, and assets and liabilities are
translated at the unified exchange rate as quoted by the People’s Bank of China
at the end of the period. Translation adjustments resulting from this process
are included in accumulated other comprehensive income in our statement of
shareholders’ equity. We have not used any forward contracts, currency options
or borrowings to hedge our exposure to foreign currency exchange risk. We cannot
predict the impact of future exchange rate fluctuations on our results of
operations and may incur net foreign currency losses in the 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 is RMB. The value of your investment in our
stock will be affected by the foreign exchange rate between U.S. dollars
and RMB. To the extent we hold assets denominated in U.S. dollars, any
appreciation of the RMB against the U.S. dollar could result in a change to
our statement of operations and a reduction in the value of our U.S. dollar
denominated assets. On the other hand, a decline in the value of RMB against the
U.S. dollar could reduce the U.S. dollar equivalent amounts of our
financial results, the value of your investment in our company and the dividends
we may pay in the future, if any, all of which may have a material adverse
effect on 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:


33





Three Months EndedMarch31,2009
                            
                            
                            2008Dollars
                            
                            
                            Percent
                            
                            
                            Dollars
                            
                            
                            PercentNET
      REVENUES
                            
                            $
                            7,860,867
                            
                            
                            
                            100.0
                            %
                            
                            $
                            8,447,074
                            
                            
                            
                            100.0
                            %COST
      OF REVENUES
                            
                            
                            6,264,218
                            
                            
                            
                            79.7
                            %
                            
                            
                            6,272,826
                            
                            
                            
                            74.3
                            %GROSS
      PROFIT
                            
                            
                            1,596,649
                            
                            
                            
                            20.3
                            %
                            
                            
                            2,174,248
                            
                            
                            
                            25.7
                            %OPERATING
      EXPENSES
                            
                            
                            578,478
                            
                            
                            
                            7.3
                            %
                            
                            
                            694,588
                            
                            
                            
                            8.2
                            %INCOME
      FROM OPERATIONS
                            
                            
                            1,018,171
                            
                            
                            
                            13.0
                            %
                            
                            
                            1,479,660
                            
                            
                            
                            17.5
                            %OTHER
      INCOME (EXPENSES)
                            
                            
                            (35,452
                            )
                            
                            
                            0.5
                            %
                            
                            
                            (2,275,490
                            )
                            
                            
                            (26.9
                            )%INCOME
      (LOSS) BEFORE PROVISION FOR INCOME TAXES
                            
                            
                            982,719
                            
                            
                            
                            12.5
                            %
                            
                            
                            (795,830
                            )
                            
                            
                            (9.4
                            )%PROVISION
      FOR INCOME TAXES
                            
                            
                            336,661
                            
                            
                            
                            4.3
                            %
                            
                            
                            454,031
                            
                            
                            
                            5.4
                            %NET
      INCOME (LOSS)
                            
                            
                            646,058
                            
                            
                            
                            8.2
                            %
                            
                            
                            (1,249,861
                            )
                            
                            
                            (14.8
                            )%OTHER
      COMPREHENSIVE INCOMEForeign
      currency translation adjustment
                            
                            
                            41,540
                            
                            
                            
                            0.5
                            %
                            
                            
                            1,007,245
                            
                            
                            
                            11.9
                            %COMPREHENSIVE
      INCOME (LOSS)
                            
                            $
                            687,598
                            
                            
                            
                            8.7
                            %
                            
                            $
                            (242,616
                            )
                            
                            
                            (2.9
                            )%




The
following table sets forth information as to the gross margin for our two lines
of business for the three months ended March 31, 2009 and 2008.




Three Months Ended December 31,2009
                                              
                                              
                                              2008Dyeing
      and finishing equipment:Revenue
                                              
                                              $
                                              3,529,441
                                              
                                              
                                              $
                                              4,653,138Cost
      of sales
                                              
                                              
                                              2,778,325
                                              
                                              
                                              
                                              3,439,227Gross
      profit
                                              
                                              
                                              751,116
                                              
                                              
                                              
                                              1,213,911Gross
      margin
                                              
                                              
                                              21.3
                                              %
                                              
                                              
                                              26.1
                                              %Forged
      rolled rings and electric power equipment:Revenue
                                              
                                              $
                                              4,331,426
                                              
                                              
                                              $
                                              3,793,936Cost
      of sales
                                              
                                              
                                              3,485,893
                                              
                                              
                                              
                                              2,833,599Gross
      profit
                                              
                                              
                                              845,533
                                              
                                              
                                              
                                              960,337Gross
      margin
                                              
                                              
                                              19.5
                                              %
                                              
                                              
                                              25.3
                                              %




Revenues. For the three
months ended March 31, 2009, we had revenues of $7,860,867, as compared to
revenues of $8,447,074 for the three months ended March 31, 2008, a decrease of
approximately 6.9%. The decrease in total revenue was attributable to
decrease in Dyeing revenues offset by an increase in revenue from forged rolled
rings and is summarized as follows:


34





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





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. We are currently
evaluating the market and cannot predict when the textile market will recover
from this downturn.  Although we believe that recent policy measures
initiated by the Chinese government may stimulate the textile industry and we
have seen an increase in orders for textile equipment, we are experienced
pricing pressures from other suppliers. We cannot predict the level of revenues
associated with the lowering of our sale price as we continue to evaluate
profitability.  However, we do not plan to seek or accept orders at
prices which we do not believe will generate an acceptable margin.




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




Cost of sales. Cost of sales
for the three months ended March 31, 2009 decreased $8,608, or 0.1%,
from $6,272,826 for the three months ended March 31, 2008 to $6,264,218 for the
three months ended March 31, 2009. Cost of goods sold for Dyeing was $2,778,325
for the three months ended March 31, 2009, as compared to $3,439,227 for the
same period year in 2008. Cost of sales related to the manufacture of forged
rolled rings and other components was $3,485,893 for the three months ended
March 31, 2009 as compared to $2,833,599 for the same period year
2008.





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




35


Depreciation. Depreciation
was $175,113 for the three months ended March 31, 2009 and $159,062 for the
comparable period in 2008, of which $97,583 in the 2009 quarter and $81,042 in
the 2008 quarter is included in cost of sales and $77,530 in the 2009 quarter
and $78,020 in the 2008 quarter is included in operating expenses. Commencing in
the second quarter of 2009, we will commence depreciation on our new factory
building and related equipment, which will increase our depreciation
expense.




Selling, general and administrative
expenses. Selling, general and administrative expenses totaled $500,948
for the three months ended March 31, 2009, as compared to $616,568 for the
same period in 2008, a decrease of $115,620 or approximately 18.8%. Selling,
general and administrative expenses consisted of the following:





2009
                  
                  
                  2008Professional
      fees
                  
                  $
                  147,559
                  
                  
                  $
                  241,705Bad
      debt
                  
                  
                  1,109
                  
                  
                  
                  -Compensation
      and related benefits
                  
                  
                  102,664
                  
                  
                  
                  119,816Travel
                  
                  
                  38,268
                  
                  
                  
                  82,392Other
                  
                  
                  211,348
                  
                  
                  
                  172,655$
                  500,948
                  
                  
                  $
                  616,568





●
            For
      the three months ended March 31, 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.




●
            Bad
      debt increased by $1,109. In 2008, we did not have any bad debt
      expense.  Based on our periodic review of accounts receivable
      balances, we recorded bad debt expense and increased the allowance for
      doubtful accounts after considering management’s evaluation of the
      collectability of individual receivable balances, including the analysis
      of subsequent collections, the customers’ collection history, and recent
      economic events.




●
            Compensation
      and related benefits decreased for the three months ended March 31, 2009
      by $17,152, or 14.3%, as compared to the same period in 2008. For the
      three months ended March 31, 2009, we had an increase in compensation and
      related benefits of $8,317 in both our dying and rolled rings operations
      resulting from the expansion of our rolled rings operations, and net
      decrease in compensation for our unallocated overhead of $25,469
      consisting of a decrease in stock-based compensation of $37,969 offset by
      an increase in executive compensation of
  $12,500.




●
            Travel
      expense for the three months ended March 31, 2009 decreased by
      $44,124, or 53.6%, 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 $38,693 for
      the three months ended March 31, 2009 as compared with the same period in
      2008.




Income from operations.For the three
months ended March 31, 2009, income from operations was $1,018,171, as compared
to $1,479,660 for the three months ended December 31, 2008, a decrease of
$461,489 or 31.2%.





Other income (expenses). For
the three months ended March 31, 2009, other expense amounted to $35,452 as
compared to other expense of $2,275,490 for the same period in year
2008.  For the three months ended March 31, 2009, other income
(expense) included:




●
            interest
      expense of $23,671, consisting of non-cash interest expense of $1,500 from
      the amortization of debt discount arising from our March 2009 financing
      and interest expense of $22,171 incurred on our outstanding
      loans:;




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




●
            nominal
      foreign currency losses and interest
income.




36


For the
three months ended March 31, 2008, other expenses included:




●
            non-cash
      interest expense of $2,263,661from the amortization of the balance of debt
      discount arising from the valuation of the beneficial conversion features
      recorded in connection with our November 2007 private placement offset by
      the reversal of accrued interest of
$20,719;




●
            amortization
      of debt issuance costs of $21,429,
and




●
            interest
      income of $5,633.




.           Income tax expense. Income
tax expense decreased $117,370, or approximately 25.8%, for the three months
ended March 31, 2009 as compared to the comparable period in 2008 primarily
as a result of the decrease in taxable income generated by our operating
entities.




Net income (loss). As a
result of the factors described above, our net income for the three months ended
March 31, 2009 was $646,058, or $0.01 per share (basic and
diluted).  For the three months ended March 31, 2008, we had a net
loss of $1,249,861.   The conversion of our convertible notes
into shares of series A preferred stock and warrants in the first quarter of
2008 resulted in a deemed preferred stock dividend of $2,884,923, representing
the value of the warrants issued to the investors.  As a result, the
net loss attributable to common shareholders was $4,133,923, or $(0.11) per
share (basic and diluted).





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 $41,540 for the three months ended March 31, 2009 as
compared to $1,007,245 for the same period year 2008. This non-cash gain had the
effect of increasing our reported comprehensive income.




Comprehensive income.For the
three months ended March 31, 2009, comprehensive income of $687,598 is derived
from the sum of our net income of $646,058 plus foreign currency translation
gains of $41,540.





Non-GAAP
Information





We
believe that net income, as adjusted for certain non-cash expenses, which is a
non-GAAP performance measure, is reasonable means of understanding our business
in view of the significant non-cash charges which we believe do not relate to
the operation of our business.  In connection with our November 2007
private placement, we issued 3% convertible notes to the investors in the
principal amount of the $5,525,000.  Because of the favorable
conversion terms, the debt was issued deemed issued as a discount of
$2,610,938.  Upon the conversion of the debt into equity in March
2008, the unamortized debt discount of $2,263,661 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
$2,884,062 was classified as a deemed dividend to the holders of the series A
preferred stock. The amortization of the debt discount and the deemed dividend
are non-cash events which do not affect our operations.  The following
table shows the relationship between net income (loss) allocable to common
shareholders and net income, as adjusted, for the three months ended March 31,
2009 and 2008.




Three
      Months Ended
                        March
      31,2009
                      
                      
                      2008Net
      income (loss) allocable to common shareholders
                      
                      $
                      646,058
                      
                      
                      $
                      (4,133,923
                      )Add
      back of:Deemed
      dividend to preferred stockholders
                      
                      
                      -
                      
                      
                      
                      2,884,062Non-cash
      interest from amortization of debt discount
                      
                      
                      23,671
                      
                      
                      
                      2,263,661Amortization
      of debt issuance costs
                      
                      
                      -
                      
                      
                      
                      21,429Reversal
      of accrued interest
                      
                      
                      
                      
                      
                      
                      (20,719
                      )Net
      income, as adjusted
                      
                      $
                      669,729
                      
                      
                      $
                      1,014,510




37


For the
reasons discussed under “Results of Operations,” our net income, as adjusted,
decreased from $1,014,510, or $0.027 per share (basic) and
$0.016  (diluted), for the three months ended March 31, 2008 to
$669,729, or $0.01 per share (basic and diluted), for the three months ended
March 31, 2009.





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 March 31, 2009 and December 31, 2008, we had cash balances
of $107,910 and $328,614, respectively. These funds are located in financial
institutions located as follows:





March 31, 2009
                  
                  
                  December 31, 2008Country:United
      States
                  
                  $
                  11,759
                  
                  
                  
                  10.9
                  %
                  
                  $
                  832
                  
                  
                  
                  0.3
                  %China
                  
                  
                  96,151
                  
                  
                  
                  89.1
                  %
                  
                  
                  327,782
                  
                  
                  
                  99.7
                  %Total
      cash and cash equivalents
                  
                  $
                  107,910
                  
                  
                  
                  100.0
                  %
                  
                  $
                  328,614
                  
                  
                  
                  100.0
                  %





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


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


*           Less
than 1%.





Our
working capital increased approximately $188,000 to $3,368,000 at March 31, 2009
from working capital of $3,179,265 at December 31, 2008. This increase in
working capital is primarily attributable to.





At March 31, 2009, our accounts
receivable were $4,900,064, of which $1,960,910 were generated from our Dyeing
segment and $2,939,153 were generated by our forged rolled rings
segment.   We believe that our collection remains strong and that
our reserves for bad debts reflect the risk of nonpayment by our customers.
However, the worldwide economic downturn may affect our customers’ ability to
pay, particularly in the Dyeing segment.




38


Net cash
flow provided by operating activities was $188,547 for the three months ended
March 31, 2009 as compared to net cash flow used in operating activities of
$2,096,821 for the three months ended March 31, 2008, an increase of $2,285,368.
Net cash flow provided by operating activities for the three months ended March
31, 2009 was mainly due to net income of $646,058, the add-back of non cash
items such as depreciation of $175,113 the amortization of debt discount of
$1,500, the amortization of land-use rights of $21,585 and stock-based
compensation of $42,031,  a decrease in notes receivable of $70,041, a
decrease in due from related party of $438,174, an increase of accrued expense
of $45,669 and an increase in advances from customers of $54,282, offset by an
increase in inventory of $515,182, a decrease in income tax payable of $233,343
and an increase in accounts receivable of $377,183. For the three months
ended March 31, 2008, net cash flow used in operating activities was mainly due
to the decrease in accounts payable of $1,225,962, an increase in accounts
receivable of $1,263,740 and an increase in inventories of $1,136,507, which was
offset by the add-back of non-cash items of depreciation of $159,062, the
amortization of debt discount of $2,263,661, the amortization of deferred debt
costs of $21,429 and the add-back of stock-based compensation of
$45,000.




Net cash
flow used in investing activities was $951,736 for the three months ended March
31, 2009, as compared to net cash used in investing activities of $694,629 for
the three months ended March 31, 2008. For the three months ended March 31,
2009, we used cash to purchase of property and equipment of
$951,736.  For the three months ended March 31, 2008, we received cash
from the repayment of amounts due from related parties of $96,650 and from the
sale of our cost-method investee of $34,840 offset by the purchase of property
and equipment of $3,907 and the payment of deposits on long-term assets of
$822,212.





Net cash
flow provided by financing activities was $542,116 for the three months ended
March 31, 2009 as compared to net cash provided by financing activities of
$226,259 for the same period in 2008. For the three months ended March 31, 2009,
we received gross proceeds from our loans payable of $542,116. For the three
months ended March 31, 2008, we received proceeds from short-term bank loans of
$139,360, and proceeds from the exercise of warrants of $187,340 offset by the
repayment of related party advances of $100,441.





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 $2,187,566 from the exercise of warrants to purchase 3,096,255
shares of common stock.  As of the date of this report, the market
price for our common stock is less than the exercise price of the warrants and
we have not registered the shares of common stock underlying
the warrants.  As a result, we do not anticipate that we will
receive any proceeds from the exercise of the warrants issued in the
November  private placement unless the market price of the stock is
greater than the exercise price, as to which we can give no assurance, and we
have registered the underlying 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.


39


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





Contractual
Obligations and Off-Balance Sheet Arrangements




Contractual
Obligations




We have
certain fixed contractual obligations and commitments that include future
estimated payments. Changes in our business needs, cancellation provisions,
changing interest rates, and other factors may result in actual payments
differing from the estimates. We cannot provide certainty regarding the timing
and amounts of payments. We have presented below a summary of the most
significant assumptions used in our determination of amounts presented in
the tables, in order to assist in the review of this information within the
context of our consolidated financial position, results of operations, and cash
flows.





The
following tables summarize our contractual obligations as of March 31, 2009, and
the effect these obligations are expected to have on our liquidity and cash
flows in future periods.





Payments Due by
      PeriodTotal
                                    
                                    Less than1
      year
                                    
                                    1-3
Years
                                    
                                    3-5
                                      Years
                                    
                                    5 Years
                                      +Contractual
      Obligations
      :Bank
      indebtedness (1)
                                    
                                    $
                                    1,168,634
                                    
                                    
                                    $
                                    1,168,634
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    -Loans
      payable
                                    
                                    
                                    396,079
                                    
                                    
                                    
                                    146,079
                                    
                                    
                                    
                                    250,000
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Total
      Contractual Obligations:
                                    
                                    $
                                    1,564,713
                                    
                                    
                                    $
                                    1,314,713
                                    
                                    
                                    $
                                    250,000
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    -




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




Off-balance
Sheet Arrangements




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





Foreign Currency Exchange
Rate Risk





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





ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





Not
required for smaller reporting companies.




40


ITEM 4.
CONTROLS AND PROCEDURES





Disclosure
Controls and Procedures





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





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





Management
conducted its evaluation of disclosure controls and procedures under the
supervision of our chief executive officer and our chief financial officer.
Based on that evaluation, we concluded that because of the significant
deficiencies in internal control over financial reporting described below, our
disclosure controls and procedures were not effective as of March 31,
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.





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 our financial reporting,
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 vice president of financial
      reporting.  Mr. Wasserman has extensive experience in internal
      control and U.S. GAAP reporting compliance, and, together with our chief
      executive and financial officers will oversee and manage our financial
      reporting process and required training of the accounting staff.




41


·
            We
      have committed to the establishment of effective internal audit functions,
      however, due to the scarcity of qualified candidates with extensive
      experience in U.S. GAAP reporting and accounting in the region, we were
      not able to hire sufficient internal audit resources before March 31,
      2009. However, we will increase our search for qualified candidates with
      assistance from recruiters and through
  referrals.




·
            Since
      2008, we have elected independent directors to serve on our audit
      committee and we have set up a compensation committee to be headed by one
      of our independent directors.




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




We
believe that the foregoing steps will remediate the significant 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 March 31, 2009.  The reportable conditions
and other areas of our internal control over financial reporting identified by
us as needing improvement have not resulted in a material restatement of our
financial statements. Nor are we aware of any instance where such reportable
conditions or other identified areas of weakness have resulted in a material
misstatement of omission in any report we have filed with or submitted to the
Commission.





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





Auditor
Attestation





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





Changes
in Internal Controls over Financial Reporting




There
were no changes in our internal controls over financial reporting during the
first quarter of fiscal year 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




42


PART II -
OTHER INFORMATION





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





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





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





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





The
issuance was 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


43




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


44