UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)





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





For the
quarterly period ended September 30, 2010





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





For the
transition period from __________ to __________





COMMISSION
FILE NUMBER: 001-34591





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
                     ̈
                    Smaller
      reporting company
                    þ(Do
      not check if smaller reporting company)





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





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.  18,557,071 shares of common
stock are issued and outstanding as of November 12, 2010.





CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


FORM
10-Q


September
30, 2010





TABLE
OF CONTENTS




Page
                            No.PART
      I. - FINANCIAL INFORMATIONItem
      1.
                          Financial
      Statements
                          3Consolidated
      Balance Sheets as of September 30, 2010 (Unaudited) and December 31, 2009
      (Audited)Consolidated
      Statements of Income and Comprehensive Income for the Three and Nine
      Months Ended September 30, 2010 and 2009 (unaudited)
                          4Consolidated
      Statements of Cash Flows for the Nine Months Ended June 30, 2010 and 2009
      (unaudited)
                          5Notes
      to Unaudited Consolidated Financial Statements.
                          6Item
      2.
                          Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                          27Item
      3
                          Quantitative
      and Qualitative Disclosures About Market Risk.
                          45Item
      4
                          Controls
      and Procedures.
                          45PART
      II - OTHER INFORMATIONItem
      2.
                          Unregistered
      Sales of Equity Securities and Use of Proceeds.
                          46Item
      6.
                          Exhibits.
                          46






FORWARD
LOOKING STATEMENTS




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




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




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




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


2


PART
1 - FINANCIAL INFORMATION





Item
1.                 Financial
Statements.





CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS





September 30, 2010
                  
                  
                  December 31, 2009(Unaudited)
                  
                  
                  (Audited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                  
                  $
                  1,773,709
                  
                  
                  $
                  2,278,638Notes
      receivable
                  
                  
                  353,226
                  
                  
                  
                  329,492Accounts
      receivable, net of allowance for doubtful accounts
                  
                  
                  8,631,036
                  
                  
                  
                  6,046,422Inventories,
      net of reserve for obsolete inventory
                  
                  
                  4,230,887
                  
                  
                  
                  2,232,264Advances
      to suppliers
                  
                  
                  1,506,709
                  
                  
                  
                  450,507Prepaid
      VAT on purchases
                  
                  
                  1,978,549
                  
                  
                  
                  378,543Prepaid
      expenses and other
                  
                  
                  42,994
                  
                  
                  
                  213,835Total
      Current Assets
                  
                  
                  18,517,110
                  
                  
                  
                  11,929,701PROPERTY
      AND EQUIPMENT - net
                  
                  
                  44,820,520
                  
                  
                  
                  36,863,501OTHER
      ASSETS:Land
      use rights, net
                  
                  
                  3,740,686
                  
                  
                  
                  3,729,427Total
      Assets
                  
                  $
                  67,078,316
                  
                  
                  $
                  52,522,629LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Loans
      payable
                  
                  $
                  1,343,665
                  
                  
                  $
                  2,040,111Accounts
      payable
                  
                  
                  6,880,157
                  
                  
                  
                  3,404,521Accrued
      expenses
                  
                  
                  351,863
                  
                  
                  
                  556,662VAT
      and service taxes payable
                  
                  
                  89,221
                  
                  
                  
                  25,284Advances
      from customers
                  
                  
                  237,671
                  
                  
                  
                  143,261Income
      taxes payable
                  
                  
                  1,190,504
                  
                  
                  
                  1,018,514Total
      Current Liabilities
                  
                  
                  10,093,081
                  
                  
                  
                  7,188,353STOCKHOLDERS'
      EQUITY:Preferred
      stock $0.001 par value (60,000,000 shares authorized, all of
      which  were designated as as series A convertible preferred,
      14,257,264 and 15,419,088 shares issued and outstanding; at September 30,
      2010 and December 31, 2009, respectively)
                  
                  
                  14,257
                  
                  
                  
                  15,419Common
      stock ($0.001 par value; 150,000,000 shares authorized; 18,270,571 and
      16,402,204 shares issued and outstanding at September 30, 2010 and
      December 31, 2009, respectively)
                  
                  
                  18,270
                  
                  
                  
                  16,402Additional
      paid-in capital
                  
                  
                  24,914,339
                  
                  
                  
                  22,332,756Retained
      earnings
                  
                  
                  26,366,830
                  
                  
                  
                  18,595,037Statutory
      reserve
                  
                  
                  1,424,971
                  
                  
                  
                  1,252,980Accumulated
      other comprehensive gain - foreign currency translation
      adjustment
                  
                  
                  4,246,568
                  
                  
                  
                  3,121,682Total
      Stockholders' Equity
                  
                  
                  56,985,235
                  
                  
                  
                  45,334,276Total
      Liabilities and Stockholders' Equity
                  
                  $
                  67,078,316
                  
                  
                  $
                  52,522,629





See notes
to unaudited consolidated financial statements


3





CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME





For the Three Months Ended
                  
                  
                  For the Nine Months EndedSeptember 30,
                  
                  
                  September 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009(Unaudited)
                  
                  
                  (Unaudited)
                  
                  
                  (Unaudited)
                  
                  
                  (Unaudited)NET
      REVENUES
                  
                  $
                  21,262,054
                  
                  
                  $
                  16,132,270
                  
                  
                  $
                  57,080,010
                  
                  
                  $
                  37,577,167COST
      OF REVENUES
                  
                  
                  15,840,889
                  
                  
                  
                  12,242,778
                  
                  
                  
                  42,264,893
                  
                  
                  
                  28,986,366GROSS
      PROFIT
                  
                  
                  5,421,165
                  
                  
                  
                  3,889,492
                  
                  
                  
                  14,815,117
                  
                  
                  
                  8,590,801OPERATING
      EXPENSES:Depreciation
                  
                  
                  78,478
                  
                  
                  
                  83,053
                  
                  
                  
                  239,493
                  
                  
                  
                  243,976Selling,
      general and administrative
                  
                  
                  1,206,058
                  
                  
                  
                  386,702
                  
                  
                  
                  3,502,239
                  
                  
                  
                  1,397,058Total
      Operating Expenses
                  
                  
                  1,284,536
                  
                  
                  
                  469,755
                  
                  
                  
                  3,741,732
                  
                  
                  
                  1,641,034INCOME
      FROM OPERATIONS
                  
                  
                  4,136,629
                  
                  
                  
                  3,419,737
                  
                  
                  
                  11,073,385
                  
                  
                  
                  6,949,767OTHER
      INCOME (EXPENSE):Interest
      income
                  
                  
                  490
                  
                  
                  
                  530
                  
                  
                  
                  3,212
                  
                  
                  
                  858Interest
      expense
                  
                  
                  (23,923
                  )
                  
                  
                  (54,251
                  )
                  
                  
                  (117,336
                  )
                  
                  
                  (253,980
                  )Foreign
      currency loss
                  
                  
                  (6,172
                  )
                  
                  
                  (3,395
                  )
                  
                  
                  (13,073
                  )
                  
                  
                  (3,406
                  )Grant
      income
                  
                  
                  132
                  
                  
                  
                  15
                  
                  
                  
                  49,278
                  
                  
                  
                  146,145Debt
      issuance costs
                  
                  
                  -
                  
                  
                  
                  (2,000
                  )
                  
                  
                  -
                  
                  
                  
                  (14,000
                  )Total
      Other Income (Expense)
                  
                  
                  (29,473
                  )
                  
                  
                  (59,101
                  )
                  
                  
                  (77,919
                  )
                  
                  
                  (124,383
                  )INCOME
      BEFORE INCOME TAXES
                  
                  
                  4,107,156
                  
                  
                  
                  3,360,636
                  
                  
                  
                  10,995,466
                  
                  
                  
                  6,825,384INCOME
      TAXES
                  
                  
                  1,133,566
                  
                  
                  
                  862,199
                  
                  
                  
                  3,051,682
                  
                  
                  
                  1,900,354NET
      INCOME
                  
                  
                  2,973,590
                  
                  
                  
                  2,498,437
                  
                  
                  
                  7,943,784
                  
                  
                  
                  4,925,030DEEMED
      PREFERRED STOCK DIVIDEND
                  
                  
                  -
                  
                  
                  
                  (462,000
                  )
                  
                  
                  -
                  
                  
                  
                  (462,000
                  )NET
      INCOME ALLOCABLE TO COMMON SHAREHOLDERS
                  
                  $
                  2,973,590
                  
                  
                  $
                  2,036,437
                  
                  
                  $
                  7,943,784
                  
                  
                  $
                  4,463,030NET
      INCOME
                  
                  $
                  2,973,590
                  
                  
                  $
                  2,498,437
                  
                  
                  $
                  7,943,784
                  
                  
                  $
                  4,925,030OTHER
      COMPREHENSIVE INCOME:Unrealized
      foreign currency translation gain
                  
                  
                  908,803
                  
                  
                  
                  39,536
                  
                  
                  
                  1,124,886
                  
                  
                  
                  84,329COMPREHENSIVE
      INCOME
                  
                  $
                  3,882,393
                  
                  
                  $
                  2,537,973
                  
                  
                  $
                  9,068,670
                  
                  
                  $
                  5,009,359NET
      INCOME PER COMMON SHARE:Basic
                  
                  $
                  0.16
                  
                  
                  $
                  0.13
                  
                  
                  $
                  0.45
                  
                  
                  $
                  0.29Diluted
                  
                  $
                  0.12
                  
                  
                  $
                  0.09
                  
                  
                  $
                  0.32
                  
                  
                  $
                  0.20WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING:Basic
                  
                  
                  18,177,405
                  
                  
                  
                  15,406,842
                  
                  
                  
                  17,671,530
                  
                  
                  
                  15,141,927Diluted
                  
                  
                  25,312,979
                  
                  
                  
                  23,506,936
                  
                  
                  
                  24,904,210
                  
                  
                  
                  21,969,692





See notes
to unaudited consolidated financial statements


4





CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





For
      the Nine Months EndedSeptember 30,2010
                  
                  
                  2009(Unaudited)
                  
                  
                  (Unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                  
                  $
                  7,943,784
                  
                  
                  $
                  4,925,030Adjustments
      to reconcile net income from operations to net cash provided by operating
      activities:Depreciation
                  
                  
                  2,145,463
                  
                  
                  
                  1,237,922Amortization
      of debt discount to interest expense
                  
                  
                  44,993
                  
                  
                  
                  32,495Amortization
      of land use rights
                  
                  
                  65,042
                  
                  
                  
                  64,794Increase
      in allowance for doubtful accounts
                  
                  
                  550,006
                  
                  
                  
                  132,073Interest
      expense related to debt conversion
                  
                  
                  -
                  
                  
                  
                  128,489Stock-based
      compensation expense
                  
                  
                  478,390
                  
                  
                  
                  157,778Changes
      in assets and liabilities:Notes
      receivable
                  
                  
                  (16,598
                  )
                  
                  
                  182,322Accounts
      receivable
                  
                  
                  (2,966,377
                  )
                  
                  
                  (1,606,523
                  )Inventories
                  
                  
                  (1,918,385
                  )
                  
                  
                  (1,114,510
                  )Prepaid
      value-added taxes on purchases
                  
                  
                  (1,564,513
                  )
                  
                  
                  (312,090
                  )Prepaid
      and other current assets
                  
                  
                  174,823
                  
                  
                  
                  (52,097
                  )Advances
      to suppliers
                  
                  
                  (1,028,678
                  )
                  
                  
                  (152,139
                  )Due
      from related party
                  
                  
                  -
                  
                  
                  
                  438,436Accounts
      payable
                  
                  
                  3,345,974
                  
                  
                  
                  162,519Accrued
      expenses
                  
                  
                  (212,262
                  )
                  
                  
                  266,205VAT
      and service taxes payable
                  
                  
                  62,311
                  
                  
                  
                  118,609Income
      taxes payable
                  
                  
                  148,220
                  
                  
                  
                  291,746Advances
      from customers
                  
                  
                  89,848
                  
                  
                  
                  19,750NET
      CASH PROVIDED BY OPERATING ACTIVITIES
                  
                  
                  7,342,041
                  
                  
                  
                  4,920,809CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
                  
                  
                  (9,212,125
                  )
                  
                  
                  (6,485,956
                  )NET
      CASH USED IN INVESTING ACTIVITIES
                  
                  
                  (9,212,125
                  )
                  
                  
                  (6,485,956
                  )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from loans payable
                  
                  
                  1,320,345
                  
                  
                  
                  1,213,689Repayment
      of loans payable
                  
                  
                  (2,090,460
                  )
                  
                  
                  -Proceeds
      from sale of preferred stock, net
                  
                  
                  -
                  
                  
                  
                  1,098,000Proceeds
      from exercise of warrants
                  
                  
                  2,100,000
                  
                  
                  
                  83,112NET
      CASH PROVIDED BY FINANCING ACTIVITIES
                  
                  
                  1,329,885
                  
                  
                  
                  2,394,801EFFECT
      OF EXCHANGE RATE ON CASH AND CASH EQUIVALENTS
                  
                  
                  35,270
                  
                  
                  
                  720NET
      (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
                  
                  
                  (504,929
                  )
                  
                  
                  830,374CASH
      AND CASH EQUILAVENTS - beginning of year
                  
                  
                  2,278,638
                  
                  
                  
                  328,614CASH
      AND CASH EQUIVALENTS - end of period
                  
                  $
                  1,773,709
                  
                  
                  $
                  1,158,988SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid for:Interest
                  
                  $
                  74,486
                  
                  
                  $
                  83,782Income
      taxes
                  
                  $
                  2,903,462
                  
                  
                  $
                  1,623,260NON-CASH
      INVESTING AND FINANCING ACTIVITIES:Debt
      discount for grant of warrants
                  
                  $
                  -
                  
                  
                  $
                  92,985Deemed
      preferred stock dividend reflected in paid-in capital
                  
                  $
                  -
                  
                  
                  $
                  462,000Series
      A preferred converted to common shares
                  
                  $
                  2,911
                  
                  
                  $
                  669Reclassification
      of common stock to paid-in capital due to reverse split
                  
                  $
                  -
                  
                  
                  $
                  30,926Common
      stock issued for debt
                  
                  $
                  -
                  
                  
                  $
                  152,963Common
      stock issued for future service
                  
                  $
                  3,900
                  
                  
                  $
                  46,667





See notes
to unaudited consolidated financial statements.


5


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 1 –
ORGANIZATION AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Organization





China
Winds Systems, Inc. (the “Company”) was incorporated in Delaware on June 24,
1987 under the name of Malex, Inc.  On December 18, 2007, the
Company’s corporate name was changed to China Wind Systems,
Inc.  Through its affiliated companies and subsidiaries, the Company
manufactures and sells high precision forged rolled rings and related products
for the wind power industry and other industries.  The Company also
makes textile dyeing and finishing machines.  The Company previously
manufactured electric power auxiliary apparatuses (including coking
equipment). In the fourth quarter of 2009, the Company ceased the
production of electric power auxiliary apparatuses and sold its remaining units.
The Company is the sole owner of Fulland Limited, a Cayman Island limited
liability company, which was organized on May 9, 2007.  Fulland owns
100% of the capital stock of Green Power Environment Technology (Shanghai) Co.,
Ltd. (“Green Power”) and Wuxi Fulland Wind Energy Equipment Co., Ltd. (“Fulland
Wind Energy”), which are wholly foreign-owned enterprises (“WFOE”) organized
under the laws of the People’s Republic of China (“PRC” or
“China”).  Green Power is a party to a series of contractual
arrangements, as fully described below, dated October 12, 2007 with Wuxi Huayang
Electrical Power Equipment Co., Ltd. (“Electrical”) and Wuxi Huayang Dyeing
Machinery Co., Ltd. (“Dyeing”), both of which are limited liability companies
organized under the laws of, and based in, the PRC.   Electrical
and Dyeing are sometimes collectively referred to as the “Huayang
Companies.”





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





Electric
was formed on May 21, 2004, and Fulland Wind Energy was formed on August 27,
2008.  Beginning in April 2007, Electric began to produce large-scaled
forged rolled rings that are up to three meters in diameter for the wind-power
and other industries.  In 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.  The Company
refers to this segment of its business as the forged rolled rings and related
products division.  The Company’s electric power equipment business
was also included in this division prior to its discontinuation.





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





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





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





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, 2009.


6


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





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





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





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


7


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





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





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





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





Use of
estimates





The
preparation of the financial statements in conformity with accounting principles
generally accepted in the U.S. requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues,
expenses, and the related disclosures at the date of the financial statements
and during the reporting period. Actual results could materially differ from
these estimates. Significant estimates in 2010 and 2009 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 preferred stock, and the value of warrants granted upon the
conversion of debt to preferred stock.





Cash and cash
equivalents





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


8


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Fair value of financial
instruments





The
Company adopted the guidance of Accounting Standards Codification (“ASC”) 820
for fair value measurements which clarifies the definition of fair value,
prescribes methods for measuring fair value, and establishes a fair value
hierarchy to classify the inputs used in measuring fair value as
follows:





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




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




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





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





ASC
825-10 “Financial
Instruments,” allows entities to voluntarily choose to measure certain
financial assets and liabilities at fair value (fair value option). The fair
value option may be elected on an instrument-by-instrument basis and is
irrevocable, unless a new election date occurs. If the fair value option is
elected for an instrument, unrealized gains and losses for that instrument
should be reported in earnings at each subsequent reporting date. The Company
did not elect to apply the fair value option to any outstanding
instruments.





Concentrations of credit
risk





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





Financial
instruments which potentially subject the Company to concentrations of credit
risk consist principally of cash and trade accounts receivable. Substantially
all of the Company’s cash is maintained with state-owned banks within the PRC,
and no deposits are covered by insurance. The Company has not experienced any
losses in such accounts and believes it is not exposed to any risks on its cash
in bank accounts. A significant portion of the Company’s sales are credit sales
which are primarily to customers whose ability to pay is dependent upon the
industry economics prevailing in these areas; however, concentrations of credit
risk with respect to trade accounts receivables is limited due to generally
short payment terms.  The Company also performs ongoing credit
evaluations of its customers to help further reduce credit risk. At September
30, 2010 and December 31, 2009, the Company’s cash balances by geographic area
were as follows:





September 30, 2010
                  
                  
                  December 31, 2009Country:United
      States
                  
                  $
                  199,857
                  
                  
                  
                  11.3
                  %
                  
                  $
                  506,777
                  
                  
                  
                  22.2
                  %China
                  
                  
                  1,573,852
                  
                  
                  
                  88.7
                  %
                  
                  
                  1,771,861
                  
                  
                  
                  77.8
                  %Total
      cash and cash equivalents
                  
                  $
                  1,773,709
                  
                  
                  
                  100.0
                  %
                  
                  $
                  2,278,638
                  
                  
                  
                  100.0
                  %


9




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Notes
receivable





Notes
receivable represents trade accounts receivable due from various customers where
the customers’ bank has guaranteed the payment of the receivable. This amount is
non-interest bearing and is normally paid within three to six
months.   Historically, the Company has experienced no losses on
notes receivable. The Company‘s notes receivable totaled $353,226 and $329,492
at September 30, 2010 and December 31, 2009, respectively.





Accounts
receivable





Accounts
receivable are presented net of an allowance for doubtful accounts. The Company
maintains allowances for doubtful accounts for estimated losses. The Company
reviews the accounts receivable on a periodic basis and makes general and
specific allowances when there is doubt as to the collectability of individual
balances. In evaluating the collectability of individual receivable balances,
the Company considers many factors, including the age of the balance, a
customer’s historical payment history, its current credit-worthiness and current
economic trends. Accounts are written off after exhaustive efforts at
collection. At September 30, 2010 and December 31, 2009, the Company has
established, based on a review of its outstanding balances, an allowance for
doubtful accounts in the amount of $1,333,560 and $758,096,
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 $163,968 and $160,632 at September 30, 2010 and
December 31, 2009, respectively.





Advances to
suppliers




Advances
to suppliers represent the cash paid in advance for purchasing of raw material
from suppliers. The advance payments are intended to ensure preferential pricing
and delivery. The amounts advanced under such arrangements totaled $1,506,709
and $450,507 as of September 30, 2010 and December 31, 2009,
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 consisted 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


SEPTEMBER
30, 2010





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





Impairment of long-lived
assets





In
accordance with ASC Topic 360, the Company reviews long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be fully recoverable, or at least
annually. The Company recognizes an impairment loss when the sum of expected
undiscounted future cash flows is less than the carrying amount of the asset.
The amount of impairment is measured as the difference between the asset’s
estimated fair value and its book value. The Company did not record any
impairment charges for the nine months ended September 30, 2010 and
2009.





Advances from
customers





Advances
from customers at September 30, 2010 and December 31, 2009 amounted to
$237,671 and $143,261, 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.





Revenue
recognition





Pursuant
to the guidance of ASC Topic 605 and ASC Topic 360, 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 other components 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. Grant income is recognized when funds have been received and all
significant terms of the grant have been fulfilled by the Company. Warranty
revenue is valued based on estimated service person hours to complete a
service and generally is recognized over the contract period.  For the
nine months ended September 30, 2010 and 2009, 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.





Income
taxes





The
Company is governed by the Income Tax Law of the People’s Republic of China and
the United States. The Company accounts for income taxes using the
liability method prescribed by ASC 740, “Income Taxes”. Under this
method, deferred tax assets and liabilities are determined based on the
difference between the financial reporting and tax bases of assets and
liabilities using enacted tax rates that will be in effect in the year in which
the differences are expected to reverse. The Company records a valuation
allowance to offset deferred tax assets if based on the weight of available
evidence, it is more-likely-than-not that some portion, or all, of the deferred
tax assets will not be realized. The effect on deferred taxes of a change in tax
rates is recognized as income or loss in the period that includes the enactment
date.


11


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Income taxes
(continued)





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





Stock-based
compensation





Stock
based compensation is accounted for based on the requirements of the Share-Based
Payment topic of ASC 718 which requires recognition in the financial statements
of the cost of employee and director services received in exchange for an award
of equity instruments over the period the employee or director is required to
perform the services in exchange for the award (presumptively, the vesting
period). The Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (”ASC”) 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.





Pursuant
to ASC Topic 505-50, for share-based payments to consultants and other
third-parties, compensation expense is determined at the “measurement date.” The
expense is recognized over the vesting period of the award. Until the
measurement date is reached, the total amount of compensation expense remains
uncertain. The Company records compensation expense based on the fair value of
the award at the reporting date. The awards to consultants and other
third-parties are then revalued, or the total compensation is recalculated based
on the then current fair value, at each subsequent reporting date.





Shipping
costs





Shipping
costs are included in selling expenses and totaled $1,120,177 and $111,776 for
the nine months ended September 30, 2010 and 2009, respectively.





Employee
benefits





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





Advertising





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





Research and
development





Research
and development costs are expensed as incurred. For the nine months ended
September 30, 2010 and 2009, research and development costs were not
material.


12


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Foreign currency
translation





The
reporting currency of the Company is the U.S. dollar. The functional currency of
the parent company is the U.S. dollar and the functional currency of the
Company’s operating subsidiaries is the Chinese Renminbi (“RMB”). For the
subsidiaries and affiliates whose functional currencies are the 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. As
a result, amounts relating to assets and liabilities reported on the statements
of cash flows may not necessarily agree with the changes in the corresponding
balances on the balance sheets.  Translation adjustments resulting
from the process of translating the local currency financial statements into
U.S. dollars are included in determining comprehensive income.  The
cumulative translation adjustment and effect of exchange rate changes on cash
for the nine months ended September 30, 2010 and 2009 was $35,270 and $720,
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.





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





Asset and
liability accounts at September 30, 2010 and December 31, 2009 were translated
at 6.6981 RMB to $1.00 and at 6.8372 RMB to $1.00, respectively, which were the
exchange rates on the balance sheet dates. Equity accounts were stated at their
historical rate. The average translation rates applied to the statements of
income for the nine months ended September 30, 2010 and 2009 were 6.8164 RMB and
6.84251 RMB to $1.00, respectively.  Cash flows from the Company’s
operations are calculated based upon the local currencies using the average
translation rate. As a result, amounts related to assets and liabilities
reported on the statement of cash flows will not necessarily agree with changes
in the corresponding balances on the balance sheets.





Reverse stock
split





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





Income per share of common
stock




ASC 260
“Earnings Per Share,”
requires dual presentation of basic and diluted earnings per share (“EPS”) with
a reconciliation of the numerator and denominator of the basic EPS computation
to the numerator and denominator of the diluted EPS computation. Basic EPS
excludes dilution. Diluted EPS reflects the potential dilution that could occur
if securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity.




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:


13


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Income per share of common
stock(continued)





ThreeMonthsEnded
                    September30,
                  
                  
                  NineMonthsEnded
                    September30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Net
      income available to common shareholders for basic and diluted net income
      per common share
                  
                  $
                  2,973,590
                  
                  
                  $
                  2,036,437
                  
                  
                  $
                  7,943,784
                  
                  
                  $
                  4,463,030Weighted
      average common shares outstanding - basic
                  
                  
                  18,177,405
                  
                  
                  
                  15,406,842
                  
                  
                  
                  17,671,530
                  
                  
                  
                  15,141,927Effect
      of dilutive securities:Series
      A convertible preferred stock
                  
                  
                  4,752,421
                  
                  
                  
                  4,819,696
                  
                  
                  
                  4,752,421
                  
                  
                  
                  4,819,696Warrants
                  
                  
                  2,383,153
                  
                  
                  
                  3,280,398
                  
                  
                  
                  2,480,259
                  
                  
                  
                  2,008,069Weighted
      average common shares outstanding - diluted
                  
                  
                  25,312,979
                  
                  
                  
                  23,506,936
                  
                  
                  
                  24,904,210
                  
                  
                  
                  21,969,692Net
      income per common share - basic
                  
                  $
                  0.16
                  
                  
                  $
                  0.13
                  
                  
                  $
                  0.45
                  
                  
                  $
                  0.29Net
      income per common share - diluted
                  
                  $
                  0.12
                  
                  
                  $
                  0.09
                  
                  
                  $
                  0.32
                  
                  
                  $
                  0.20








The
Company's aggregate common stock equivalents at September 30, 2010 and 2009
include the following:





September 30, 2010
                    
                    
                    September 30, 2009Warrants
                    
                    
                    3,541,322
                    
                    
                    
                    5,438,835Series
      A convertible preferred stock
                    
                    
                    4,752,421
                    
                    
                    
                    4,819,696Total
                    
                    
                    8,293,743
                    
                    
                    
                    10,258,531





Deemed preferred stock
dividend





When we
issue shares of convertible preferred stock at a price that is, on an “as if
converted” basis, less than the market price of the underlying shares of common
stock, the difference between the value of the underlying shares of common stock
and the purchase price of the convertible preferred stock is treated as a deemed
preferred stock dividend.  In connection with the issuance of shares
of preferred stock upon exercise of warrants as a result of board approval of
the issuance of series A preferred stock instead of common stock, the Company
does not record a deemed preferred stock dividend since the number of shares of
series A preferred stock that the Company issues is convertible into the number
of shares of common stock which would have been issued upon
exercise.





Accumulated other
comprehensive income




Comprehensive
income is comprised of net income and all changes to the statements of
stockholders' equity, except those due to investments by stockholders, changes
in paid-in capital and distributions to stockholders. For the Company,
comprehensive income for the nine months ended September 30, 2010 and 2009
included net income and unrealized gains from foreign currency translation
adjustments.


14


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Related
parties





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





Subsequent events





For
purposes of determining whether a post-balance sheet event should be evaluated
to determine whether it has an effect on the financial statements for the period
ending September 30, 2010, subsequent events were evaluated by the Company as of
the date on which the unaudited consolidated financial statements were available
to be issued.





Recent accounting
pronouncements





In
October 2009, the FASB issued ASU No. 2009-13, “Multiple-Deliverable Revenue
Arrangements.” This ASU establishes the accounting and reporting guidance for
arrangements including multiple revenue-generating activities. This ASU provides
amendments to the criteria for separating deliverables, measuring and allocating
arrangement consideration to one or more units of accounting. The amendments in
this ASU also establish a selling price hierarchy for determining the selling
price of a deliverable. Significantly enhanced disclosures are also required to
provide information about a vendor’s multiple-deliverable revenue arrangements,
including information about the nature and terms, significant deliverables, and
its performance within arrangements. The amendments also require providing
information about the significant judgments made and changes to those judgments
and about how the application of the relative selling-price method affects the
timing or amount of revenue recognition. The amendments in this ASU are
effective prospectively for revenue arrangements entered into or materially
modified in the fiscal years beginning on or after June 15, 2010. Early
application is permitted. The adoption of this new ASU is not expected to have
any material impact on the Company’s consolidated financial
statements.





In
October 2009, the FASB issued ASU No. 2009-14, “Certain Revenue Arrangements
That Include Software Elements.” This ASU changes the accounting model for
revenue arrangements that include both tangible products and software elements
that are “essential to the functionality,” and scopes these products out of
current software revenue guidance. The new guidance will include factors to help
companies determine what software elements are considered “essential to the
functionality.” The amendments will now subject software-enabled products to
other revenue guidance and disclosure requirements, such as guidance surrounding
revenue arrangements with multiple-deliverables. The amendments in this ASU are
effective prospectively for revenue arrangements entered into or materially
modified in the fiscal years beginning on or after June 15, 2010. Early
application is permitted. The adoption of this new ASU is not expected to have
any material impact on the Company’s consolidated financial
statements.







In
January 2010, FASB issued ASU No. 2010-01, “Accounting for Distributions to
Shareholders with Components of Stock and Cash”. The amendments in this
ASU clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in earnings per share
prospectively and is not a stock dividend for purposes of applying Topics 505
and 260 (Equity and Earnings Per Share). The amendments in this ASU are
effective for interim and annual periods ending on or after December 15, 2009,
and should be applied on a retrospective basis. The adoption of this ASU did not
have a material impact on the Company’s consolidated financial
statements.


15


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Recent accounting
pronouncements (continued)




In
January 2010, FASB issued ASU No. 2010-06, “Improving Disclosures about Fair
Value Measurements”. This update provides amendments to Subtopic 820-10
that requires new disclosure as follows: 1) Transfers in and out of Levels 1 and
2. A reporting entity should disclose separately the amounts of significant
transfers in and out of Level 1 and Level 2 fair value measurements and describe
the reasons for the transfers. 2) Activity in Level 3 fair value measurements.
In the reconciliation for fair value measurements using significant unobservable
inputs (Level 3), a reporting entity should present separately information about
purchases, sales, issuances, and settlements (that is, on a gross basis rather
than as one net number). This update provides amendments to Subtopic 820-10 that
clarifies existing disclosures as follows: 1) Level of disaggregation. A
reporting entity should provide fair value measurement disclosures for each
class of assets and liabilities. A class is often a subset of assets or
liabilities within a line item in the statement of financial position. A
reporting entity needs to use judgment in determining the appropriate classes of
assets and liabilities. 2) Disclosures about inputs and valuation techniques. A
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and nonrecurring fair value
measurements. Those disclosures are required for fair value measurements that
fall in either Level 2 or Level 3. The new disclosures and clarifications of
existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements. Those disclosures are effective for fiscal years
beginning after December 15, 2010, and for interim periods within those fiscal
years. The Company adopted the provisions of the standard on January 1, 2010,
which did not have a material impact on the Company’s financial
statements.





In
February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855):
Amendments to Certain Recognition and Disclosure
Requirements”.  This amendment addresses both the interaction
of the requirements of this Topic with the SEC’s reporting requirements and the
intended breadth of the reissuance disclosure provision related to subsequent
events (paragraph 855-10-50-4).  All of the amendments in this Update
are effective upon issuance of the final Update, except for the use of the
issued date for conduit debt obligors. That amendment is effective for interim
or annual periods ending after June 15, 2010.  The adoption of this
ASU did not have a material impact on the Company’s financial
statements.





InMarch 2010, the FASB
issued ASU 2010-11, Derivatives and Hedging (Topic 815): Scope Exception Related
to Embedded Credit Derivatives.  The amendments in this Update are
effective for each reporting entity at the beginning of its first fiscal quarter
beginning after June 15, 2010.  Early adoption is permitted at the
beginning of each entity’s first fiscal quarter beginning after issuance of this
Update.  The Company does not expect the provisions of ASU 2010-11 to
have a material effect on the financial position, results of operations or cash
flows of the Company.





InApril 2010, the FASB
issued ASU 2010-13, Compensation-Stock Compensation (Topic 718): Effect of
Denominating the Exercise Price of a Share-Based Payment Award in the Currency
of the Market in Which the Underlying Equity Security Trades - a consensus of
the FASB Emerging Issues Task Force.  The amendments in this Update
are effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2010.  Earlier application is
permitted.  The Company does not expect the provisions of ASU 2010-13
to have a material effect on the financial position, results of operations or
cash flows of the Company.





In May
2010, the FASB issued ASU 2010-19, Foreign Currency (Topic 830): Foreign
Currency Issues: Multiple Foreign Currency Exchange Rates.  The
amendments in this Update are effective as of the announcement date of March 18,
2010. The adoption of this update did not have a material effect on the
financial position, results of operations or cash flows of the
Company.


16


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Recent
accountingpronouncements (continued)





Other
accounting standards that have been issued or proposed by FASB that do not
require adoption until a future date are not expected to have a material impact
on the consolidated financial statements upon adoption.





NOTE 2 –
ACCOUNTS
RECEIVABLE





At September 30, 2010 and December 31, 2009,
accounts receivable consisted of the following:





September 30, 2010
                    
                    
                    December 31, 2009Accounts
      receivable
                    
                    $
                    9,964,596
                    
                    
                    $
                    6,804,518Less:
      allowance for doubtful accounts
                    
                    
                    (1,333,560
                    )
                    
                    
                    (758,096
                    )$
                    8,631,036
                    
                    
                    $
                    6,046,422





NOTE 3 -
INVENTORIES





At
September 30, 2010 and December 31, 2009, inventories consisted of the
following:





September 30, 2010
                  
                  
                  December 31, 2009Raw
      materials
                  
                  $
                  2,715,741
                  
                  
                  $
                  1,366,220Work
      in process
                  
                  
                  1,211,377
                  
                  
                  
                  288,811Finished
      goods
                  
                  
                  467,737
                  
                  
                  
                  737,8654,394,855
                  
                  
                  
                  2,392,896Less:
      reserve for obsolete inventory
                  
                  
                  (163,968
                  )
                  
                  
                  (160,632
                  )$
                  4,230,887
                  
                  
                  $
                  2,232,264





NOTE 4 -
PROPERTY AND
EQUIPMENT





At
September 30, 2010 and December 31, 2009, property and equipment consist of the
following:





Useful Life
                    
                    
                    September 30,
                      2010
                    
                    
                    December 31, 2009Office
      equipment and furniture
                    
                    5 Years
                    
                    
                    $
                    125,879
                    
                    
                    $
                    103,320Manufacturing
      equipment
                    
                    5 – 10 Years
                    
                    
                    
                    35,028,308
                    
                    
                    
                    17,405,814Vehicles
                    
                    5 Years
                    
                    
                    
                    118,028
                    
                    
                    
                    79,570Construction
      in progress
                    
                    -
                    
                    
                    
                    421,947
                    
                    
                    
                    9,546,200Building
      and building improvements
                    
                    20 Years
                    
                    
                    
                    16,779,633
                    
                    
                    
                    15,153,04652,473,795
                    
                    
                    
                    42,287,950Less:
      accumulated depreciation
                    
                    
                    
                    
                    
                    (7,653,275
                    )
                    
                    
                    (5,424,449
                    )$
                    44,820,520
                    
                    
                    $
                    36,863,501





For the
nine months ended September 30, 2010 and 2009, depreciation expense amounted to
$2,145,463 and $1,237,922, of which $1,905,970 and $993,946 is included in cost
of sales, respectively.  Upon completion of the construction in
progress, the assets will be classified to its respective property and equipment
category.


17


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010




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 have terms of 45 and 50 years and expire on January 1, 2053 and
October 30, 2053.  The Company amortizes the land use rights over the
term of the respective land use right. For the nine months ended September 30,
2010 and 2009, amortization of land use rights amounted to $65,042 and $64,794,
respectively.





At
September 30, 2010 and December 31, 2009, land use rights consist of the
following:





Useful Life
                    
                    September 30, 2010
                    
                    
                    December 31, 2009Land
      Use Rights
                    
                    45
      - 50 years
                    
                    $
                    4,031,113
                    
                    
                    $
                    3,949,101Less:
      Accumulated Amortization
                    
                    
                    
                    
                    (290,427
                    )
                    
                    
                    (219,674
                    )$
                    3,740,686
                    
                    
                    $
                    3,729,427





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





Periods
      ending September 30:2011
                  
                  $
                  88,2552012
                  
                  
                  88,2552013
                  
                  
                  88,2552014
                  
                  
                  88,2552015
                  
                  
                  88,255Thereafter
                  
                  
                  3,299,411$
                  3,740,686





NOTE 6 –
STOCKHOLDERS’
EQUITY





(a)
            Common stock issued
      for services





During
the nine months ended September 30, 2010, the Company issued 3,000 shares of
common stock to its Chief Financial Officer for services rendered pursuant to an
employment agreement. The shares, which were issued pursuant to the Company’s
2010 long–term incentive plan, were valued at fair value on the respective dates
of grant, and the Company recorded stock-based compensation of $10,770 and
prepaid expense of $3,900.





During
the nine months ended September 30, 2010, the Company issued an aggregate of
49,000 shares of common stock to its Chief Executive Officer pursuant to its
2010 long-term incentive plan. The shares were valued at fair value of the
common stock on the date of grant, and the Company recorded stock-based
compensation of $249,970.





During
the nine months ended September 30, 2010, the Company issued an aggregate of
35,000 shares of common stock to two key employees who are not executive
officers pursuant to its 2010 long-term incentive plan. The shares were valued
at fair value on the respective dates of grant, and the Company recorded
stock-based compensation of $178,550.


18


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(a)
            Common stock issued
      for services (continued)





The
Company has a consulting agreement with a company that provides the services of
its vice president of financial reporting.  Pursuant to this
agreement, the Company issued 2,000 shares of common stock on each of March 31,
2010, June 30, 2010 and September 30, 2010 for an aggregate of 6,000 shares of
common stock.  The shares were valued at fair value on the respective
dates of grant, and the Company recorded stock-based compensation of $27,400
during the nine months ended September 30, 2010.





On July
29, 2010, the Company entered into an amended director’s agreement with a
director for the period from July 1, 2010 to June 30, 2011.  Pursuant
to this agreement, the Company is to issue an aggregate of 10,000 shares of its
common stock of which 2,500 were issued on July 29, 2010 and 2,500 are issuable
on a quarterly basis on each of October 1, 2010, January 1, 2011 and April 1,
2011.  The shares are valued at fair value on the date of grant, and
the Company recorded stock-based compensation of $11,700 during the nine months
ended September 30, 2010.





(b) Common stock issued for
exercise of warrants and preferred share conversions





On May 4,
2010, the Company issued 43,750 shares of its common stock upon cashless
exercise of warrants to purchase 58,333 shares of common stock.





On July
9, 2010, the Company issued 100,118 shares of its common stock upon the exercise
of warrants for which the Company received cash proceeds of
$170,000.





On July
16, 2010, the Company issued 825,000 shares of its series A preferred stock to
an investor upon the exercise of warrants, for which the Company received cash
proceeds of $330,000.





During
the nine months ended September 30, 2010, the Company issued 1,455,666 shares of
common stock upon the conversion of 4,367,000 shares of series A preferred
stock.





In
January and February 2010, the Company issued 173,333 shares of its common stock
and 2,380,176 shares of its series A preferred stock to investors upon the
exercise of warrants, for which the Company received cash proceeds of
$1,600,000.  In connection with the issuance of the 2,380,176 shares
of series A preferred stock, the investor entered into an agreement with the
Company’s chief executive officer, who is the Company’s principal beneficial
owner of common stock, pursuant to which the chief executive officer has the
right to vote the series A preferred stock and the underlying common stock as to
all matters for which stockholder approval is obtained as long as the investor
or its affiliates own the stock.  Upon the sale of the series A
preferred stock or the underlying common stock to a person other than an
affiliate of the investor, the voting agreement terminates as to the transferred
shares and the chief executive officer has no voting rights with respect to the
transferred shares.  The investor had executed similar agreements in
connection with the purchase of series A preferred stock in September and
October 2009.


19


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(c)
            Agreement with respect
      to Series A Preferred Stock and Common Stock Purchase
      Warrants





On March
26, 2010, the holders of the outstanding shares of series A preferred
shareholders and the sole holder of all of the Company’s common stock purchase
warrants that included a provision that provided for an adjustment in the
exercise price in the event of a sale of common stock at a price below the
exercise price of the warrants agreed to eliminate and waive any rights they may
have under the provisions of the Statement of Designations relating to the
series A preferred stock that provide for a reduction in the conversion price of
the series A preferred stock, in the event that the Company issues stock at a
price which is less than the conversion price of the series A preferred stock;
and the warrant holder agreed to delete from the warrants the provisions that
provide for a reduction in the exercise price of the warrants in the event that
the Company issues stock at a price which is less than the exercise price of the
warrants. The Company agreed not to issue shares of Common Stock at a price, or
options, warrants or convertible securities with an exercise or conversion
price, that is less than the conversion price of the then outstanding series A
preferred stock or the exercise price of the then outstanding warrants, as the
case may be.   Accordingly, the Company did not record a derivative
liability related to the warrants at December 31, 2009.





(d)
            Series A Preferred
      Stock





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





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





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





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





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





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





·
            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.


20


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(d)
            Series A Preferred
      Stock (continued)





·
              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.





(e)
            November 2007
      Securities Purchase
Agreement





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




·
            The
      Company agreed to have appointed such number of independent directors that
      would result in a majority of its directors being independent directors,
      that the audit committee would be composed solely of not less than three
      independent directors and the compensation committee would have at least
      three directors, a majority of which shall be independent
      directors.  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 is in compliance with this
    covenant.




·
            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, quarterly 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 quarterly
      report under the Securities Exchange Act of
  1934.




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




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




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





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





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


21


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(f)
            March 2009 Issuance of
      Notes and Warrants and Other Warrant
  Matters




On March
23, 2009, Company sold to two investors, for $250,000, its 18-month, 15% notes
in the aggregate principal amount of $250,000 and five-year warrants purchasing
145,833 shares at an exercise price of $1.20 per share.  These
warrants were treated as a discount on the secured notes and were valued at
$92,985 to be amortized over the 18-month note term. The fair value of these
warrants was estimated on the date of grant using the Black-Scholes
option-pricing model 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.  The Company repaid the
notes in full in February 2010 and fully amortized the balance of the debt
discount in February 2010.  For the nine months ended September 30,
2010 and 2009, amortization of debt discount to interest expense was $44,993 and
$32,495, respectively.





Warrant
activities for the nine months ended September 30, 2010 are summarized as
follows:





Nine Months Ended September 30, 2010Number of
                    Warrants
                  
                  
                  Weighted Average
                    Exercise PriceBalance
      at beginning of year
                  
                  
                  4,941,498
                  
                  
                  $
                  1.49Granted
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  (1,400,176
                  )
                  
                  
                  1.55Forfeited
                  
                  
                  -
                  
                  
                  
                  -Balance
      at end of period
                  
                  
                  3,541,322
                  
                  
                  $
                  1.47Warrants
      exercisable at end of period
                  
                  
                  3,541,322
                  
                  
                  $
                  1.47





The
following table summarizes the shares of the Company's common stock issuable
upon exercise of warrants outstanding at September 30, 2010:


Warrants Outstanding
                            
                            
                            Warrants ExercisableRange of
                              Exercise
                              Price
                            
                            
                            Number
                              Outstanding at
                              September 30,
                              2010
                            
                            
                            Weighted
                              Average
                              Remaining
                              Contractual
                              Life (Years)
                            
                            
                            Weighted
                              Average
                              Exercise
                              Price
                            
                            
                            Number
                              Exercisable at
                              September 30,
                              2010
                            
                            
                            Weighted
                              Average
                              Exercise Price$
                            1.698
                            
                            
                            
                            1,885,563
                            
                            
                            
                            2.12
                            
                            
                            $
                            1.698
                            
                            
                            
                            1,885,563
                            
                            
                            $
                            1.698$
                            1.200
                            
                            
                            
                            1,655,759
                            
                            
                            
                            2.19
                            
                            
                            
                            1.200
                            
                            
                            
                            1,655,759
                            
                            
                            
                            1.2003,541,322
                            
                            
                            
                            2.16
                            
                            
                            $
                            1.47
                            
                            
                            
                            3,541,322
                            
                            
                            $
                            1.47





(g)
            2010 Long-Term
      Incentive Plan





In
January 2010, the Company’s board of directors adopted, and in March 2010, the
stockholders approved the Company’s 2010 long-term incentive plan, which covers
2,000,000 shares of common stock.  The plan provides for the grant of
incentive and non-qualified options and stock grants to employees, including
officers, directors and consultants. The plan is to be administered by a
committee of not less than three directors, each of whom is to be an independent
director.  In the absence of a committee, the plan is administered by
the board of directors.   Members of the committee are not eligible
for stock options or stock grants pursuant to the plan unless such stock options
or stock grant are granted by a majority of the Company’s independent directors
other than the proposed grantee.  As of September 30, 2010, the
Company had issued a total of 95,500 shares of common stock, for which it
expensed compensation in the amount of $478,390 and recorded prepaid expenses of
$3,900.


22


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 7 –
INCOME
TAXES





The
Company accounts for income taxes pursuant to the accounting standards that
requires the recognition of deferred tax assets and liabilities for both the
expected impact of differences between the financial statements and the tax
basis of assets and liabilities, and for the expected future tax benefit to be
derived from tax losses and tax credit carryforwards.  Additionally,
the accounting standards require the establishment of a valuation allowance to
reflect the likelihood of realization of deferred tax assets. Realization of
deferred tax assets, including those related to the U.S. net operating loss
carryforwards, are dependent upon future earnings, if any, of which the timing
and amount are uncertain.





Accordingly,
the net deferred tax asset related to the U.S. net operating loss carryforward
has been fully offset by a valuation allowance. The Company is governed by the
Income Tax Law of the People’s Republic of China and the United States. In 2010
and 2009, 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
VIEs (Dyeing and Electric) and the Company’s subsidiary, Fulland Wind Energy,
are subject to these statutory rates. The Company’s wholly-owned subsidiary,
Fulland Limited was incorporated in the Cayman Islands. Under the current laws
of the Cayman Islands, this entity is not subject to income taxes.





NOTE 8 –
LOANS
PAYABLE





At
September 30, 2010 and December 31, 2009, loans payable consisted of the
following:





September30,
                              
                              
                              December31,2010
                              
                              
                              2009Loan
      payable to Industrial and Commercial Bank of China, due on September 24,
      2010 with annual interest at September 30, 2010 and December 31, 2009 of
      5.84% and 5.84%, respectively, secured by assets of the Company and repaid
      in August 2010.
                              
                              $
                              -
                              
                              
                              $
                              146,259Loan
      payable to Industrial and Commercial Bank of China, due on September 15,
      2010 with annual interest at September 30, 2010 and December 31, 2009 of
      5.58% and 5.58%, respectively, secured by assets of the Company and repaid
      in August 2010.
                              
                              
                              -
                              
                              
                              
                              146,259Loan
      payable to Industrial and Commercial Bank of China, due on September 22,
      2010 with annual interest at September 30, 2010 and December 31, 2009 of
      5.58% and 5.58%, respectively, secured by assets of the Company and repaid
      in August 2010.
                              
                              
                              -
                              
                              
                              
                              146,259Loan
      payable to Bank of Communications, due on June 8, 2010 with annual
      interest at December 31, 2009 of 5.84%, respectively, the rate being
      adjusted quarterly based on People’s Bank of China’s base rate times 120%
      and repaid on due date
                              
                              
                              -
                              
                              
                              
                              438,775Loan
      payable to Bank of Communications, due on June 14, 2010 with annual
      interest at December 31, 2009 of 5.84%, respectively, the rate being
      adjusted quarterly based on People’s Bank of China’s base rate times 120%
      and repaid on due date
                              
                              
                              -
                              
                              
                              
                              292,517




23


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 8 –
LOANS PAYABLE
(continued)





Loan
      payable to Bank of Communications, due on February 1, 2011 with annual
      interest at September 30, 2010 of 4.86%, respectively, the rate being
      adjusted quarterly based on People’s Bank of China’s base rate times
      120%.
                
                
                746,481
                
                
                
                -Loan
      payable to Agricultural and Commercial Bank, due on March 31, 2011
      with annual interest at September 30, 2010 and December 31, 2009 of 5.75%
      and 6.90%, respectively, secured by certain assets of the
      Company.
                
                
                597,184
                
                
                
                585,035Principal
      amount of loan payable to an investor, due on February 7, 2011 with annual
      interest at December 31, 2009 of 12% and repaid in January
      2010.
                
                
                -
                
                
                
                80,000Principal
      amount of loan payable to investors, due on September 23, 2010, with
      interest of 15% per annum (see (a) below) and repaid in January
      2010.
                
                
                -
                
                
                
                250,000Total
      loans payable
                
                
                1,343,665
                
                
                
                2,085,104Less:
      debt discount (a)
                
                
                -
                
                
                
                (44,993
                )Current
      portion of  loans payable – net
                
                $
                1,343,665
                
                
                $
                2,040,111





(a)
            In
      March 2009, the Company sold to two investors its 18-month, 15% notes in
      the aggregate principal amount of $250,000 and warrants to purchase
      145,833 shares at an exercise price of $1.20 per share for a total of
      $250,000. The debt discount represents the unamortized value of the
      warrants issued in the transaction.  The notes were paid during
      the quarter ended March 31, 2010 (See Note
  6(f)).





NOTE 9 -
SEGMENT
INFORMATION





For the
three and nine months ended September 30, 2010 and 2009, 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 related components
for the wind power and other industries and, in the three and nine months ended
September 30, 2009, electric power auxiliary apparatuses (including coking
equipment) although no revenue was generated from and no expenses were incurred
in connection with the electric power auxiliary equipment business, which was
discontinued in the fourth quarter of 2009. The Company's reportable segments
are strategic business units that offer different products. They are managed
separately based on the fundamental differences in their
operations.  All of the Company’s operations are conducted in the PRC.
Information with respect to these reportable business segments for the three and
nine months ended September 30, 2010 and 2009 is as follows:


24


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 9 -
SEGMENT INFORMATION
(continued)


FortheThreeMonthsEnded
                  
                  
                  FortheNineMonthsEndedSeptember30,
                  
                  
                  September30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Revenues:Dyeing
      and finishing equipment
                  
                  $
                  5,559,091
                  
                  
                  $
                  4,983,302
                  
                  
                  $
                  15,776,814
                  
                  
                  $
                  12,309,750Forged
      rolled rings and related components
                  
                  
                  15,702,963
                  
                  
                  
                  11,148,968
                  
                  
                  
                  41,303,196
                  
                  
                  
                  25,267,41721,262,054
                  
                  
                  
                  16,132,270
                  
                  
                  
                  57,080,010
                  
                  
                  
                  37,577,167Depreciation:Dyeing
      and finishing equipment
                  
                  
                  136,649
                  
                  
                  
                  104,335
                  
                  
                  
                  371,751
                  
                  
                  
                  308,027Forged
      rolled rings and related components
                  
                  
                  808,172
                  
                  
                  
                  436,460
                  
                  
                  
                  1,773,712
                  
                  
                  
                  929,895944,821
                  
                  
                  
                  540,795
                  
                  
                  
                  2,145,463
                  
                  
                  
                  1,237,922Interest
      expense:Dyeing
      and finishing equipment
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Forged
      rolled rings and related components
                  
                  
                  23,923
                  
                  
                  
                  27,965
                  
                  
                  
                  69,393
                  
                  
                  
                  72,104Other
      (a)
                  
                  
                  -
                  
                  
                  
                  26,286
                  
                  
                  
                  47,943
                  
                  
                  
                  181,87623,923
                  
                  
                  
                  54,251
                  
                  
                  
                  117,336
                  
                  
                  
                  253,980Net
      income (loss):Dyeing
      and finishing equipment
                  
                  
                  580,281
                  
                  
                  
                  705,206
                  
                  
                  
                  1,782,784
                  
                  
                  
                  1,596,797Forged
      rolled rings and related components
                  
                  
                  2,580,906
                  
                  
                  
                  2,032,910
                  
                  
                  
                  7,068,661
                  
                  
                  
                  4,104,264Other
      (a)
                  
                  
                  (187,597
                  )
                  
                  
                  (239,679
                  )
                  
                  
                  (907,661
                  )
                  
                  
                  (776,031
                  )2,973,590
                  
                  
                  
                  2,498,437
                  
                  
                  
                  7,943,784
                  
                  
                  
                  4,925,030





Identifiable
      long-lived tangible assets at September 30, 2010 and December 31, 2009 by
      segment:Dyeing
      and finishing equipment
                                  
                                  $
                                  6,113,165
                                  
                                  
                                  $
                                  5,728,590Forged
      rolled rings and related components
                                  
                                  
                                  38,707,355
                                  
                                  
                                  
                                  31,134,911$
                                  44,820,520
                                  
                                  
                                  $
                                  36,863,501Identifiable
      long-lived tangible assets at September 30, 2010 and December 31, 2009 by
      geographical location:China
                                  
                                  $
                                  44,820,520
                                  
                                  
                                  $
                                  36,863,501United
      States
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -$
                                  44,820,520
                                  
                                  
                                  $
                                  36,863,501





(a)      The
Company does not allocate any general and administrative expenses of its U.S.
activities to its reportable segments, because these activities are managed at a
corporate level.





NOTE 10 –
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. Prior to December 31, 2009,
the Company appropriated the required maximum 50% of its registered capital to
statutory reserves for Dyeing and Electric.


25


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 10 –
STATUTORY RESERVES
(continued)





For the
nine months ended September 30, 2010, statutory reserve activity is as
follows:





Dyeing
                  
                  
                  Electric
                  
                  
                  Wuxi Fulland
                  
                  
                  TotalBalance
      – December 31, 2009
                  
                  $
                  72,407
                  
                  
                  $
                  1,168,796
                  
                  
                  $
                  11,777
                  
                  
                  $
                  1,252,980Additional
      to statutory reserves
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  171,991
                  
                  
                  
                  171,991Balance
      – September 30, 2010
                  
                  $
                  72,407
                  
                  
                  $
                  1,168,796
                  
                  
                  $
                  183,768
                  
                  
                  $
                  1,424,971





NOTE 11 –
CONCENTRATIONS





Customers





During
the nine months ended September 30, 2010, one customer of the forged rolled
rings and related components segment accounted for 15% of the Company’s total
sales. No customer accounted for more than 10% of the Company’s total sales for
the nine months ended September 30, 2009.





Suppliers





Three
major suppliers provided approximately 47% of the Company’s purchases of raw
materials for the nine months ended September 30, 2010 primarily consisting of
steel for the forged rolled rings and related components segment. No supplier
provided more than 10% of the Company’s purchases of raw materials for the nine
months ended September 30, 2009.





NOTE 12 –
RESTRICTED NET
ASSETS





Regulations
in the PRC permit payments of dividends by our PRC VIEs only out of retained
earnings, if any, as determined in accordance with PRC accounting standards and
regulations. Subject to certain cumulative limit, a statutory reserve fund
requires annual appropriations of at least 10% of after-tax profit, if any, of
the relevant PRC VIE’s and subsidiary. The statutory reserve funds are not
distributable as cash dividends.





Pursuant
to PRC regulations, our PRC subsidiaries and VIEs require government approval in
order to transfer assets, including cash, outside of the PRC, and certain
transfers may be subject to a 10% tax.  As a result, the net assets of
our PRC subsidiaries and VIEs are treated as restricted assets.  As of
September 30, 2010 and December 31, 2009, the Company’s restricted net assets
were approximately $65,516,000 and $51,652,000, respectively.





NOTE 13 –
SUBSEQUENT
EVENTS





On
October 1, 2010, the Company issued 2,500 shares of its common stock to its
director for services pursuant to an amended director’s agreement described in
Note 6. The shares were valued at fair value on the date of grant and the
Company recorded prepaid expense of $10,850.





During
October and November 2010, the Company issued 284,000 shares of its common stock
upon the conversion of 852,000shares of Series A Convertible Preferred
Stock.





During
October 2010, the Company issued 1,375,002 shares of its series A preferred
stock to an investor upon the exercise of warrants, for which the Company
received cash proceeds of $550,000.


26


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





Overview





We are
engaged in two business segments – the forged rolled rings and related
components segment, in which we manufacture and sell high precision forged
rolled rings, shafts, flanges, and other forged components for the wind power
and other industries, and the dyeing and finishing equipment segment, in which
we manufacture and sell textile dyeing and finishing machines.





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





ThreeMonthsEndedSeptember30,
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      NineMonthsEndedSeptember30,2010
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      2009
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      2010
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      2009Dollars
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      Dollars
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      Dollars
                                                                                                                                      
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      Dollars
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      %Forged
      rolled rings and related components
                                                                                                                                        -
      wind power industry
                                                                                                                                      
                                                                                                                                      $
                                                                                                                                      12,425
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      58.4
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      $
                                                                                                                                      6,877
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      42.9
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      $
                                                                                                                                      28,559
                                                                                                                                      
                                                                                                                                      50.0
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      $
                                                                                                                                      13,243
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      35.2
                                                                                                                                      %Forged
      rolled rings and related components- other industries
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      3,278
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      15.5
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      4,272
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      26.6
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      12,744
                                                                                                                                      
                                                                                                                                      22.4
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      12,024
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      32.0
                                                                                                                                      %Dyeing
      and finishing equipment
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      5,559
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      26.1
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      4,983
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      30.5
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      15,777
                                                                                                                                      
                                                                                                                                      27.6
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      12,310
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      32.8
                                                                                                                                      %Total
                                                                                                                                      
                                                                                                                                      $
                                                                                                                                      21,262
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      100
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      $
                                                                                                                                      16,132
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      100
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      $
                                                                                                                                      57,080
                                                                                                                                      
                                                                                                                                      100
                                                                                                                                      %
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      $
                                                                                                                                      37,577
                                                                                                                                      
                                                                                                                                      
                                                                                                                                      100
                                                                                                                                      %





Forged
Rolled Rings and Related Components Segment





Through
our forged rolled rings and other related products division, we supply precision
forged rolled rings and other forged components to the wind industry. 
These components are used in wind turbines, which are used to generate wind
power.  The government of the PRC has announced its desire to expand
significantly its goal for installed wind energy capacity.  We began to
manufacture shafts and forged rolled rings for gear rims, flanges and other
applications in our new 108,000 square foot manufacturing facility which became
operational in March 2009.




We
produce precision forgings using axial close-die forging technology, which is a
new technology for producing rotary precision forgings, using forging equipment
which we manufactured for our own use. The axial close-die forging technology
reduces the use of raw materials by as much as 35%, provides a high precision
and surface flatness, reduces the cutting output, has excellent mechanical
strength and high flexibility, and is a fully automatic operation. We believe
that our forging capabilities will continue to increase as we implement our
expansion plans.





In
addition to the wind industry, we sell our forged rolled rings and other forged
components in other industries, including heavy machinery manufacturing,
petrochemical, metallurgical, sea port machinery, defense and radar
manufacturing industries, which use our forged rolled rings railway as
components in the manufacture of equipment.





In
October 2009, we ordered the initial machinery to expand our completed
state-of-the-art forged product facility with a new production line, enabling us
to manufacture electro-slag re-melted (“ESR”) forged products for the high
performance components market for various industries.  We believe that ESR
forged products will be important components in the next generation of larger
wind turbines and other high performance components, which will require stronger
steel alloy precision forged components than the smaller turbines.  ESR is
used to increase the durability and quality of steel and to blend specific
alloys that are required to meet the anticipated strength requirements of the
next generation of wind turbines.  We delivered the initial units from this
production line in July 2010 to one customer, which has been our only ESR
customer through September 30, 2010.  We generated revenue of
$3,167,000 from this sale during the three and nine months ended September 30,
2010.  This customer will use our ESR products in light industry,
automobile, construction and railway industries.


27





The
forged rolled rings segment has become a more significant percentage of our
total revenues since we expanded our manufacturing facilities to enable us to
manufacture forged rolled rings with a larger diameter in order to meet the
perceived needs of the wind power industry. Our rolled rings are essentially
hollow cylindrical sections forged from a stainless steel stock piece with
varying thickness and height; the rings are created from the forging process.
Forging is a manufacturing process where metal is pressed, pounded or squeezed
under great pressure into high strength parts. Rolled ring forging turns a
hollow round piece of metal under extreme pressure against a rotating roller,
thereby squeezing out a single-piece ring without any welding required. We
believe that there is a market for our rolled rings in the wind power industry.
Through this division, which was formerly known as the forged rolled ring and
electric power equipment division, until the end of 2009, we designed,
manufactured and sold both standard and custom auxiliary equipment used to
improve and promote efficient coal use at both coking and power plants. In the
fourth quarter of 2009, we sold our remaining units of auxiliary electrical
equipment and we no longer produce these products.





Currently,
wind power accounts for an insignificant percentage of the power generated in
the PRC, According to the Global Wind Energy Council’s “Global Wind 2008 Report,
Annual installed capacity by region 2003-2008” as published on the website,
global installed wind energy capacity reached 120 GW and the global market
topped 27 GW at year-end 2008. Further, investment in new power generation
equipment topped $50 billion during 2008. China’s installed capacity doubled for
the fourth consecutive year and surpassed 12 GW in 2008. While China ranked
fourth in the world in installed capacity at the end of 2008, behind the United
States (25 GW), Germany (24 GW), and Spain (17 GW), China ranked second globally
for installed new capacity in 2008 with 6 GW, behind the United States with 8
GW. According to an  article titled “High Winds in China” at
www.compositesworld.com/articles/high-wind-in-china, the Chinese government
announced its new goal to increase China's projected installed wind capacity to
150 GW by 2020, representing a potential $200 billion market for wind power
components and projects in China.   Our ability to market to this
segment is dependent upon both the growth of the acceptance of wind power as an
energy source in the PRC and the acceptance of our products.





Our
products are sold for use by manufacturers of industrial equipment.  The
demand for products used in manufacturing in general including wind power
industries, is uncertain.  Although we believe that over the long term, the
Forged Rolled Rings and Related Components 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 and related components declines, our
revenue and net income will be affected.





In
November 2010, we signed a conditional purchase contract for approximately $1.0
million to supply precision manufactured subassemblies for solar cell
manufacturing equipment that indicates our expansion into the solar
market.  The purchase contract is conditional upon the successful
inspection and acceptance by the customer of sample units by the end of December
2010. Upon successful inspection and acceptance of the initial components, we
agreed to supply initial production units for the balance of the contract during
first and second quarters of 2011. Based on our customer's current estimates and
anticipated order flow, if this initial order proves successful, its potential
purchases from us on annual basis during 2011 could total between $12 million
and $20 million.





Dyeing
and Finishing Equipment Segment





Prior to
2009, the manufacturing of textile dyeing and finishing machines was our
principal source of revenue. We have changed our focus to the manufacture of
forged rolled rings, shafts, gear rims and yaw bearings in order to meet the
growing demands of China’s wind energy industry.





In
connection with our Dyeing and finishing equipment segment, despite the world
economic slowdown, for the whole year of 2009, China’s gross output value of
textile rose by 10.3% year in year to RMB 3.8 trillion, while the amount of
clothes produced increased by 6.9% year on year to 23.75 billion units (source:
China National Textile and Apparel Council, Ministry and Industry Information
Technology). We believe weak overseas demand has been more than offset by strong
demand within China. If the local demand for textile machinery deteriorates, we
will discontinue the business and focus on the fast-growing wind components
business.





Recently,
we developed a new model of dyeing machine – High (Low) Temperature Airflow
Dyeing Machine.  We believe that this new model of dyeing machine is highly
efficient and cost effective and can provide the competitive edge to meet the
most challenge of the market today.  As of September 30, 2010, we sold two
units of the new dyeing machine model.





28





Raw
Materials




A major
element of our cost of revenues is raw materials, principally steel and other
metals. These metals are subject to price fluctuations, and recently these
fluctuations have been significant.  In times of increasing prices, we need
to try to fix the price at which we purchase raw materials in order to avoid
increases in costs which we cannot recoup through increases in sales
prices.  Similarly, in times of decreasing prices, we may have purchased
metals at prices which are high in terms of the price at which we can sell our
products, which also can impair our margins. Three major suppliers provided
approximately 47% of our purchases of raw materials for the nine months ended
September 30, 2010 primarily consisting of steel for the forged rolled rings and
related components segment. No supplier provided more than 10% of the Company’s
purchases of raw materials for the nine months ended September 30,
2009.





Restricted
Assets





Regulations
in the PRC permit payments of dividends by our PRC VIEs only out of retained
earnings, if any, as determined in accordance with PRC accounting standards and
regulations. Subject to certain cumulative limit, a statutory reserve fund
requires annual appropriations of at least 10% of after-tax profit, if any, of
the relevant PRC VIE’s and subsidiary. The statutory reserve funds are not
distributable as cash dividends.





Pursuant
to PRC regulations, our PRC subsidiaries and VIEs require government approval in
order to transfer assets, including cash, outside of the PRC, and certain
transfers may be subject to a 10% tax.  As a result, the net assets of our
PRC subsidiaries and VIEs are treated as restricted assets.  As of
September 30, 2010 and December 31, 2009, the Company’s restricted net assets
were approximately $65,516,000 and $51,652,000, respectively.





Critical
Accounting Policies and Estimates





Our
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which 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





Variable
Interest Entities





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





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


29





The
accounts of the Huayang Companies are consolidated in the accompanying financial
statements. As VIEs, the Huayang Companies sales are included in our total
sales, their income from operations is consolidated with ours, and our net
income includes all of the Huayang Companies’ net income, and their assets and
liabilities are included in our consolidated balance sheet. The VIEs do not have
any non-controlling interest and accordingly, we 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 to determine whether an allowance is
necessary based on an analysis of past due accounts and other factors that may
indicate that the realization of an account may be in doubt.  Account
balances deemed to be uncollectible are charged to the allowance after all means
of collection have been exhausted and the potential for recovery is considered
remote.





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





Inventories





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





Property
and equipment





Property
and equipment are stated at cost less accumulated
depreciation. 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.





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.


30





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.





Revenue
recognition





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





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





Warranty
revenue is valued based on estimated service person hours to complete a service
and generally is recognized over the contract period. For the nine months ended
September 30, 2010 and 2009, 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 forged rolled rings, 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.  We incurred minimal
research and development expenses in the nine months ended September 30, 2010
and 2009.  Product development expenses 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.





Income
taxes





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





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.


31





Deemed
preferred stock dividend





When we
sell shares of convertible preferred stock at a price that is, on an “as if
converted” basis, less than the market price of the underlying shares of common
stock, the difference between the value of the underlying shares of common stock
and the purchase price of the convertible preferred stock is treated as a deemed
preferred stock dividend.  In connection with the issuance of shares of
preferred stock upon exercise of warrants as a result of board approval of the
issuance of series A preferred stock instead of common stock, the Company does
not record a deemed preferred stock dividend since the Company issues the number
of shares of series A preferred stock which are convertible into the number of
shares of common stock that were issuable upon exercise.





Stock-based
compensation





Stock
based compensation is accounted for based on the requirements of the Share-Based
Payment topic of ASC 718 which requires recognition in the financial statements
of the cost of employee and director services received in exchange for an award
of equity instruments over the period the employee or director is required to
perform the services in exchange for the award (presumptively, the vesting
period). The Accounting Standards Codification also requires measurement of the
cost of employee and director services received in exchange for an award based
on the grant-date fair value of the award.





Pursuant
to ASC Topic 505-50, for share-based payments to consultants and other
third-parties, compensation expense is determined at the “measurement date.” The
expense is recognized over the vesting period of the award. Until the
measurement date is reached, the total amount of compensation expense remains
uncertain. The Company records compensation expense based on the fair value of
the award at the reporting date. The awards to consultants and other
third-parties are then revalued, or the total compensation is recalculated based
on the then current fair value, at each subsequent reporting date.





Recent
accounting pronouncements





In
October 2009, the FASB issued ASU No. 2009-13, “Multiple-Deliverable Revenue
Arrangements.” This ASU establishes the accounting and reporting guidance for
arrangements including multiple revenue-generating activities. This ASU provides
amendments to the criteria for separating deliverables, measuring and allocating
arrangement consideration to one or more units of accounting. The amendments in
this ASU also establish a selling price hierarchy for determining the selling
price of a deliverable. Significantly enhanced disclosures are also required to
provide information about a vendor’s multiple-deliverable revenue arrangements,
including information about the nature and terms, significant deliverables, and
its performance within arrangements. The amendments also require providing
information about the significant judgments made and changes to those judgments
and about how the application of the relative selling-price method affects the
timing or amount of revenue recognition. The amendments in this ASU are
effective prospectively for revenue arrangements entered into or materially
modified in the fiscal years beginning on or after June 15, 2010. Early
application is permitted. The adoption of this new ASU is not expected to have a
material impact on our consolidated financial statements.





In
October 2009, the FASB issued ASU No. 2009-14, “Certain Revenue Arrangements
That Include Software Elements.” This ASU changes the accounting model for
revenue arrangements that include both tangible products and software elements
that are “essential to the functionality,” and scopes these products out of
current software revenue guidance. The new guidance will include factors to help
companies determine what software elements are considered “essential to the
functionality.” The amendments will now subject software-enabled products to
other revenue guidance and disclosure requirements, such as guidance surrounding
revenue arrangements with multiple-deliverables. The amendments in this ASU are
effective prospectively for revenue arrangements entered into or materially
modified in the fiscal years beginning on or after June 15, 2010. Early
application is permitted. The adoption of this new ASU is not expected to have
any material impact on our consolidated financial statements.




In
January 2010, FASB issued ASU No. 2010-01, “Accounting for Distributions to
Shareholders with Components of Stock and Cash”. The amendments in this
ASU clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in earnings per share
prospectively and is not a stock dividend for purposes of applying Topics 505
and 260 (Equity and Earnings Per Share). The amendments in this ASU are
effective for interim and annual periods ending on or after December 15, 2009,
and should be applied on a retrospective basis. The adoption of this ASU did not
have a material impact on our consolidated financial
statements.


32




In
January 2010, FASB issued ASU No. 2010-06, “Improving Disclosures about Fair
Value Measurements”. This update provides amendments to Subtopic 820-10
that requires new disclosure as follows: 1) Transfers in and out of Levels 1 and
2. A reporting entity should disclose separately the amounts of significant
transfers in and out of Level 1 and Level 2 fair value measurements and describe
the reasons for the transfers. 2) Activity in Level 3 fair value measurements.
In the reconciliation for fair value measurements using significant unobservable
inputs (Level 3), a reporting entity should present separately information about
purchases, sales, issuances, and settlements (that is, on a gross basis rather
than as one net number). This update provides amendments to Subtopic 820-10 that
clarifies existing disclosures as follows: 1) Level of disaggregation. A
reporting entity should provide fair value measurement disclosures for each
class of assets and liabilities. A class is often a subset of assets or
liabilities within a line item in the statement of financial position. A
reporting entity needs to use judgment in determining the appropriate classes of
assets and liabilities. 2) Disclosures about inputs and valuation techniques. A
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and nonrecurring fair value
measurements. Those disclosures are required for fair value measurements that
fall in either Level 2 or Level 3. The new disclosures and clarifications of
existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements. Those disclosures are effective for fiscal years
beginning after December 15, 2010, and for interim periods within those fiscal
years. The Company adopted the provisions of the standard on January 1, 2010,
which did not have a material impact on the Company’s financial
statements.





In
February 2010, the FASB issued ASU 2010-09, Subsequent Events (Topic 855):
Amendments to Certain Recognition and Disclosure Requirements.  This
amendment addresses both the interaction of the requirements of this Topic with
the SEC’s reporting requirements and the intended breadth of the reissuance
disclosure provision related to subsequent events (paragraph 855-10-50-4). 
All of the amendments in this Update are effective upon issuance of the final
Update, except for the use of the issued date for conduit debt obligors. That
amendment is effective for interim or annual periods ending after June 15,
2010.  The adoption of this ASU did not have a material impact on our
consolidated financial statements.





InMarch 2010, the FASB
issued ASU 2010-11, Derivatives and Hedging (Topic 815): Scope Exception Related
to Embedded Credit Derivatives.  The amendments in this Update are
effective for each reporting entity at the beginning of its first fiscal quarter
beginning after June 15, 2010.  Early adoption is permitted at the
beginning of each entity’s first fiscal quarter beginning after issuance of this
Update.  We do not expect the provisions of ASU 2010-11 to have a material
effect on our financial position, results of operations or cash
flows.





InApril 2010, the FASB
issued ASU 2010-13, Compensation-Stock Compensation (Topic 718): Effect of
Denominating the Exercise Price of a Share-Based Payment Award in the Currency
of the Market in Which the Underlying Equity Security Trades - a consensus of
the FASB Emerging Issues Task Force.  The amendments in this Update are
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2010.  Earlier application is
permitted.  We do not expect the provisions of ASU 2010-13 to have a
material effect on the financial position, results of operations or cash flows
of the Company.





In May
2010, the FASB issued ASU 2010-19, Foreign Currency (Topic 830): Foreign
Currency Issues: Multiple Foreign Currency Exchange Rates.  The amendments
in this Update are effective as of the announcement date of March 18, 2010. The
adoption of this update did not have a material effect on our financial
position, results of operations or cash flows.





Other
accounting standards that have been issued or proposed by FASB that do not
require adoption until a future date are not expected to have a material impact
on the consolidated financial statements upon adoption.




Currency
Exchange Rates





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


33


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 subsidiaries. Our results of operations and cash flow are
translated at average exchange rates during the year, and assets and liabilities
are translated at the unified exchange rate as quoted by the Peoples’ Bank of
China at the end of the year. 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.





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


34





RESULTS
OF OPERATIONS





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





NineMonthsEndedSeptember 30,2010
                
                
                2009Dollars
                
                
                Percent
                
                
                Dollars
                
                
                PercentNet
      revenues
                
                $
                57,080
                
                
                
                100.0
                %
                
                $
                37,577
                
                
                
                100.0
                %Cost
      of revenues
                
                
                42,265
                
                
                
                74.0
                %
                
                
                28,986
                
                
                
                77.1
                %Gross
      profit
                
                
                14,815
                
                
                
                26.0
                %
                
                
                8,591
                
                
                
                22.9
                %Operating
      expenses
                
                
                3,742
                
                
                
                6.6
                %
                
                
                1,641
                
                
                
                4.4
                %Income
      from operations
                
                
                11,073
                
                
                
                19.4
                %
                
                
                6,950
                
                
                
                18.5
                %Other
      income (expenses)
                
                
                (78
                )
                
                
                (0.1
                )
      %
                
                
                (124
                )
                
                
                (0.3
                )%Income
      before provision for income taxes
                
                
                10,995
                
                
                
                19.3
                %
                
                
                6,825
                
                
                
                18.2
                %Provision
      for income taxes
                
                
                3,051
                
                
                
                5.3
                %
                
                
                1,900
                
                
                
                5.1
                %Net
      income
                
                
                7,944
                
                
                
                13.9
                %
                
                
                4,925
                
                
                
                13.1
                %Deemed
      preferred stock dividend
                
                
                -
                
                
                
                -
                %
                
                
                (462
                )
                
                
                (1.3
                )
      %Net
      income allocable to common shareholders
                
                
                7,944
                
                
                
                13.9
                %
                
                
                4,463
                
                
                
                11.9
                %Other
      comprehensive income:Foreign
      currency translation adjustment
                
                
                1,125
                
                
                
                2.0
                %
                
                
                84
                
                
                
                0.2
                %Comprehensive
      income
                
                $
                9,069
                
                
                
                15.9
                %
                
                $
                5,009
                
                
                
                13.3
                %





ThreeMonthsEndedSeptember 30,2010
                
                
                2009Dollars
                
                
                Percent
                
                
                Dollars
                
                
                PercentNet
      revenues
                
                $
                21,262
                
                
                
                100.0
                %
                
                $
                16,132
                
                
                
                100.0
                %Cost
      of revenues
                
                
                15,841
                
                
                
                74.5
                %
                
                
                12,243
                
                
                
                75.9
                %Gross
      profit
                
                
                5,421
                
                
                
                25.5
                %
                
                
                3,889
                
                
                
                24.1
                %Operating
      expenses
                
                
                1,285
                
                
                
                6.0
                %
                
                
                470
                
                
                
                2.9
                %Income
      from operations
                
                
                4,136
                
                
                
                19.5
                %
                
                
                3,420
                
                
                
                21.2
                %Other
      income (expenses)
                
                
                (29
                )
                
                
                (0.1
                )
      %
                
                
                (59
                )
                
                
                (0.4
                )%Income
      before provision for income taxes
                
                
                4,107
                
                
                
                19.3
                %
                
                
                3,360
                
                
                
                20.8
                %Provision
      for income taxes
                
                
                1,134
                
                
                
                5.3
                %
                
                
                862
                
                
                
                5.3
                %Net
      income
                
                
                2,973
                
                
                
                14.0
                %
                
                
                2,498
                
                
                
                15.5
                %Deemed
      preferred stock dividend
                
                
                -
                
                
                
                0.0
                %
                
                
                (462
                )
                
                
                (2.9
                )
      %Net
      income allocable to common shareholders
                
                
                2,973
                
                
                
                14.0
                %
                
                
                2,036
                
                
                
                12.6
                %Other
      comprehensive income:Foreign
      currency translation adjustment
                
                
                909
                
                
                
                4.3
                %
                
                
                40
                
                
                
                0.2
                %Comprehensive
      income
                
                $
                3,882
                
                
                
                18.3
                %
                
                $
                2,538
                
                
                
                15.7
                %


35





The
following table sets forth information as to the gross margin for our two
current lines of business for the three  and nine months ended September
30, 2010 and 2009 (dollars in thousands).


Forged
                      rolled rings
                      and related
                      products
                    
                    
                    Dyeing
                      and
                      finishing
                      equipment
                    
                    
                    Total
                    
                    
                    Forged
                      rolled rings
                      and related
                      products
                    
                    
                    Dyeing
                      and
                      finishing
                      equipment
                    
                    
                    TotalThree Months Ended September 30, 2010
                    
                    
                    Nine Months Ended September 30, 2010Revenues
                    
                    $
                    15,703
                    
                    
                    $
                    5,559
                    
                    
                    $
                    21,262
                    
                    
                    $
                    41,303
                    
                    
                    $
                    15,777
                    
                    
                    $
                    57,080Cost
      of revenues
                    
                    $
                    11,471
                    
                    
                    $
                    4,370
                    
                    
                    $
                    15,841
                    
                    
                    $
                    29,767
                    
                    
                    $
                    12,498
                    
                    
                    $
                    42,265Gross
      profit
                    
                    $
                    4,232
                    
                    
                    $
                    1,189
                    
                    
                    $
                    5,421
                    
                    
                    $
                    11,536
                    
                    
                    $
                    3,279
                    
                    
                    $
                    14,815Gross
      margin %
                    
                    
                    27.0
                    %
                    
                    
                    21.4
                    %
                    
                    
                    25.5
                    %
                    
                    
                    27.9
                    %
                    
                    
                    20.8
                    %
                    
                    
                    26.0
                    %
 
 Forged
                          rolled rings
                          and related
                          products
                        
                        
                        Dyeing
                          and
                          finishing
                          equipment
                        
                        
                        Total
                        
                        
                        Forged
                          rolled rings
                          and related
                          products
                        
                        
                        Dyeing and
                          finishing
                          equipment
                        
                        
                        TotalThree Months Ended September 30, 2009
                        
                        
                        Nine Months Ended September 30, 2009Revenue
                        
                        $
                        11,149
                        
                        
                        $
                        4,983
                        
                        
                        $
                        16,132
                        
                        
                        $
                        25,267
                        
                        
                        $
                        12,310
                        
                        
                        $
                        37,577Cost
      of revenues
                        
                        $
                        8,345
                        
                        
                        $
                        3,897
                        
                        
                        $
                        12,242
                        
                        
                        $
                        19,352
                        
                        
                        $
                        9,634
                        
                        
                        $
                        28,986Gross
      profit
                        
                        $
                        2,804
                        
                        
                        $
                        1,086
                        
                        
                        $
                        3,890
                        
                        
                        $
                        5,915
                        
                        
                        $
                        2,676
                        
                        
                        $
                        8,591Gross
      margin %
                        
                        
                        25.1
                        %
                        
                        
                        21.7
                        %
                        
                        
                        24.1
                        %
                        
                        
                        23.4
                        %
                        
                        
                        21.7
                        %
                        
                        
                        22.9
                        %





Nine
Months Ended September 30, 2010 and 2009





Revenues. For the nine months
ended September 30, 2010, we had revenues of $57,080,000 as compared to revenues
of $37,577,000 for the nine months ended September 30, 2009, an increase of
$19,503,000, or 51.9%. The increase in revenue was attributable to the increases
in revenue primarily from our forged rolled rings and related products segment
and, to a lesser extent, from our dyeing and finishing equipment segment, and is
summarized as follows (dollars in thousands):





For the Nine
                  Months Ended
                  September 30,
                  2010
                
                
                For the Nine
                  Months Ended
                  September 30,
                  2009
                
                
                Increase
                
                
                Percentage
                  ChangeForged
      rolled rings and related products - wind power industry
                
                $
                28,559
                
                
                $
                13,243
                
                
                $
                15,316
                
                
                
                115.6
                %Forged
      rolled rings – other industries
                
                
                12,744
                
                
                
                12,024
                
                
                
                720
                
                
                
                6.0
                %Dyeing
      and finishing equipment
                
                
                15,777
                
                
                
                12,310
                
                
                
                3,467
                
                
                
                28.2
                %Total
      net revenues
                
                $
                57,080
                
                
                $
                37,577
                
                
                $
                19,503
                
                
                
                51.9
                %





The
increase in revenues from the sale of dyeing and finishing equipment was
primarily attributable to the effects of the policy of the PRC government to
encouragement the development of the textile industry as the Chinese economy
improved. In the 2009 period, due to the financial crisis, we experienced a
decline in demand for our dyeing and finishing equipment. During the 2010
period, we have seen a steady increase in orders and we expect demand to remain
steady.




Revenues
from forging of rolled rings and related products totaled $41,303,000 for the
nine months ended September 30, 2010, with revenues from the wind power industry
amounting to $28,559,000 and revenues from other forging operations amounting to
$12,744,000.  Due to the shift in focus of our sales effort to the wind
segment, we increased sales of forged rolled rings to the wind power industry by
115.6% for the nine months ended September 30, 2010 compared to the nine months
ended September 30, 2009. We also experienced a 6.0% increase in forging
revenues from other industries, such as the railway, heavy machinery
manufacturing, petrochemical, metallurgical, sea port machinery, and defense and
radar industries.  During 2010, we have been able to secure new customers
though our marketing efforts. Additionally, as of September 30, 2010, we
delivered 1079 tons of ESR products to this customer for revenue of
approximately $3,167,000 which has been included in revenue from forged rolled
rings and related components – other industries and we expect future sales from
this customer to increase.  We believe that the  increase in forging
revenues from the wind industry reflects both the Chinese government’s stated
desire to increase the use of wind power as an energy source and our shift in
focus of our sales effort to wind market,


36





Cost of revenues. Cost of
revenues for the nine months ended September 30, 2010 increased $13,279,000 or
45.8%, from $28,986,000 for the nine months ended September 30, 2009 to
$42,265,000 for the nine months ended September 30, 2010. Cost of revenues for
Dyeing was $12,498,000 for the nine months ended September 30, 2010, as compared
to $9,634,000 for the nine months ended September 30, 2009. Cost of revenues
related to the manufacture of forged rolled rings and related products was
$29,767,000 for the nine months ended September 30, 2010 as compared to
$19,352,000 for the nine months ended September 30, 2009.





Gross profit and gross
margin. Our gross profit was $14,815,000 for the nine months ended
September 30, 2010 as compared to $8,591,000 for the nine months ended September
30, 2009, representing gross margins of 26.0% and 22.9%, respectively. Gross
profit for Dyeing was $3,278,000 for the nine months ended September 30, 2010 as
compared to $2,676,000 for the nine months ended September 30, 2009,
representing gross margins of approximately 20.8% and 21.7%, 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 the nine months ended September 30, 2010 as well as a
reduction of our sales price due to stronger competition in the textile industry
in China.  Gross profit from forged rolled rings and related products
segment was $11,537,000 for the nine months ended September 30, 2010 as compared
to $5,915,000 for the nine months ended September 30, 2009, representing gross
margins of approximately 27.9% and 23.4%, respectively. The increase in our
gross margin was mainly attributed to operational efficiencies from the increase
in our production in the nine months ended September 30, 2010 as compared to the
comparable period of 2009.  In addition, during the nine months ended
September 30, 2010, we increased our prices to offset shipping costs which we
paid and which were included in general and administrative expenses, which had
the effect of increasing our gross margin slightly.  During the comparable
period of 2009, we charged the customers separately for shipping charges and the
payments were not included in our revenue. We experienced an increase of less
than 5% in our cost of raw materials.  We did not increase our sales prices
for this increase in the cost of raw materials.





Depreciation. Depreciation
was $2,145,000 for the nine months ended September 30, 2010 and $1,238,000 for
the nine months ended September 30, 2009, of which $1,906,000 for the nine
months ended September 30, 2010 and $994,000 for the nine months ended September
30, 2009 is included in cost of revenues and $239,000 for the nine months ended
September 30, 2010 and $244,000 for the nine months ended September 30, 2009 is
included in operating expenses. The overall increase in depreciation is
attributable to the increase in our depreciable production equipment, primarily
relating to our forged rolled rings and other related products segment.  We
expect depreciation to increase in future periods, as we install and place in
service new equipment and facilities related to our new production line for
electro-slag re-melted forged products.





Selling, general and administrative
expenses. Selling, general and administrative expenses totaled $3,502,000
for the nine months ended September 30, 2010, as compared to $1,397,000 for the
nine months ended September 30, 2009, an increase of $2,105,000 or approximately
150.7%. Selling, general and administrative expenses consisted of the following
(dollars in thousands):





Nine Months Ended
                    September 30, 2010
                  
                  
                  Nine Months Ended
                    September 30, 2009Professional fees
                  
                  $
                  198
                  
                  
                  $
                  319Bad
      debt expense
                  
                  
                  550
                  
                  
                  
                  132Payroll
      and related benefits
                  
                  
                  891
                  
                  
                  
                  335Travel
                  
                  
                  236
                  
                  
                  
                  115Shipping
                  
                  
                  1,120
                  
                  
                  
                  112Other
                  
                  
                  507
                  
                  
                  
                  384$
                  3,502
                  
                  
                  $
                  1,397


37





•
            Professional
      fees decreased for the nine months ended September 30, 2010 by $121,000,
      as compared to the nine months ended September 30, 2009. The decrease is
      primarily attributed to a decrease in accounting expense of approximately
      $72,000 related to a change in the method of accruing for our auditing
      fees. In the 2009 period, we expensed the 2008 auditing fees reflecting
      the period in which the services were performed. In order to reflect the
      audit and review fees in the period in which the services relate to, in
      December 2009, we accrued the entire 2009 auditing fee. Accordingly,
      accounting fees for the nine months ended September 30, 2010 only reflects
      the fee for our quarterly reviews. The decrease in professional fees also
      reflected a decrease in investor relations expenses of approximately
      $77,000 offset by an increase in legal fees of approximately $14,000 and
      an increase in stock transfer fees of approximately
    $13,000.





•
            Bad
      debt expense increased for the nine months ended September 30, 2010 by
      $418,000. Based on our periodic review of accounts receivable balances, we
      adjusted the allowance for doubtful accounts after considering
      management’s evaluation of the collectability of individual receivable
      balances, including the analysis of subsequent collections, the customers’
      collection history, and recent economic
events.





•
            Payroll
      and related benefits increased for the nine months ended September 30,
      2010 by $556,000, as compared to the nine months ended September 30, 2009.
      The increase was mainly attributable to an increase in stock-based and
      other compensation for our management of approximately $358,000 and an
      increase in compensation and related benefits of approximately $214,000 in
      our forged rolled rings and related products segment resulting from
      increased operations offset by a decrease in compensation and related
      benefits of approximately $16,000 in our dyeing and finishing
      segment.





•
            Travel
      expense for the nine months ended September 30, 2010 increased by
      $121,000, as compared to the nine months ended September 30, 2009. The
      increase is primarily related to an increase in travel for investor road
      shows and conferences.





•
            Shipping
      expense for the nine months ended September 30, 2010 increased by
      $1,008,000, as compared to the nine months ended September 30, 2009. For
      the nine months ended September 30, 2009, we charged partial shipping fees
      to our customers while, for the nine months ended September 30, 2010, we
      paid the related shipping fees for our customers. Therefore, our selling
      expense was substantially increased. For customers that we have absorbed
      shipping costs, we negotiated a higher selling price with these customers
      to offset the shipping costs, which also had a modest positive effect upon
      our gross margins.




•
            Other
      selling, general and administrative expenses increased by $123,000 for the
      nine months ended September 30, 2010 as compared with the nine months
      ended September 30, 2009. The increase was primarily attributed to an
      increase in advertising expense of approximately $20,000, an increase in
      insurance expenses of approximately $42,000 and an increase in other
      miscellaneous expenses of approximately
$61,000.





Income from operations.For
the nine months ended September 30, 2010, income from operations amounted to
$11,073,000, as compared to $6,950,000 for the nine months ended September 30,
2009, an increase of $4,123,000 or 59.3%.





Other income (expenses). For
the nine months ended September 30, 2010, other expenses amounted to $78,000 as
compared to $124,000 for the nine months ended September 30, 2009.  For the
nine months ended September 30, 2010, other income (expenses)
included:





•
            interest
      expense of $117,000, consisting of non-cash interest expense of $45,000
      from the amortization of debt discount arising from our March 2009
      financing and interest expense of $72,000 incurred on our outstanding
      loans;





•
            foreign
      currency losses of $13,000;





•
            grant
      income of $49,000 from local government. We used the grant for working
      capital purposes to increase production of forged products;
      and





•
            interest
      income of $3,000.





38




For the
nine months ended September 30, 2009, other income (expenses)
included:


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





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





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





·
            nominal
      foreign currency losses and interest
income.





Income tax expense. Income
tax expense totaled $3,051,000 for the nine months ended September 30, 2010, as
compared to $1,900,000 for the nine months ended September 30, 2009, an increase
of $1,151,000, or approximately 60.6%, which was primarily attributable to the
increase in taxable income generated by our operating entities.





Net income.  As a result
of the foregoing, our net income was $7,943,784 for the nine months ended
September 30, 2010, as compared with $4,925,030 for the nine months ended
September 30, 2009.





Deemed preferred stock
dividend. For the nine months ended September 30, 2010, we did not have
any deemed preferred stock dividend. In September 2009, we sold 1,100,000 shares
of series A preferred stock for $1,100,000.  Each share of series A
preferred stock is convertible into one-third of a share of common stock. 
The effective price per share of common stock issuable upon conversion of the
series A preferred stock was $3.00 per share, which was less than the market
price on the date of the sale.  We recognized a deemed preferred stock
dividend equal to the difference between the fair market value of the 1,100,000
shares of series A preferred stock, determined on an “as if converted” basis and
the consideration we received for the series A preferred stock ($1,100,000),
which was $462,000.





Net income allocable to common
shareholders. Our net income allocable to common shareholders for
the nine months ended September 30, 2010 was $7,944,000, or $0.45 per share
(basic) and $0.32 per share (diluted), which was the same as our net income. As
a result of the deemed preferred stock dividend during the nine months ended
September 30, 2009, our net income allocable to common shareholders was
$4,463,030, or $0.29 per share (basic) and $0.20 per share
(diluted).





Foreign currency translation gain.The functional currency of our subsidiaries and variable interest
entities 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 and were minimal. As a result of
unrealized foreign currency translations, which are a non-cash adjustment, we
reported a foreign currency translation gain of $1,125,000 for the nine months
ended September 30, 2010 as compared to $84,000 for the nine months ended
September 30, 2009. This non-cash gain had the effect of increasing our reported
comprehensive income.




Comprehensive income.As a
result of our unrealized foreign currency translation gains, we had
comprehensive income for the nine months ended September 30, 2010 of $9,069,000,
compared with $5,009,000 for the nine months ended September 30,
2009.





Three
Months Ended September 30, 2010 and 2009





Revenues. For the three
months ended September 30, 2010, we had revenues of $21,262,000, as compared to
revenues of $16,132,000 for the three months ended September 30, 2009, an
increase of approximately 31.8%. The increase in total revenue was attributable
to the increases in revenue from forged rolled rings related to wind power
industry and revenue from dyeing and finishing equipment, offset by the decrease
in revenue from forged rolled rings related to other industries and is
summarized as follows (dollars in thousands):


For the Three
                  Months Ended
                  September 30,
                  2010
                
                
                For the Three
                  Months Ended
                  September 30,
                  2009
                
                
                Increase
                  (Decrease)
                
                
                Percentage
                  ChangeForged
      rolled rings - wind power industry
                
                $
                12,425
                
                
                $
                6,876
                
                
                $
                5,549
                
                
                
                80.7
                %Forged
      rolled rings – other industries
                
                
                3,278
                
                
                
                4,272
                
                
                
                (994
                )
                
                
                (23.3
                )%Dyeing
      and finishing equipment
                
                
                5,559
                
                
                
                4,984
                
                
                
                575
                
                
                
                11.6
                %Total
      net revenues
                
                $
                21,262
                
                
                $
                16,132
                
                
                $
                5,130
                
                
                
                31.8
                %


39





The
increase in revenues from the sale of dyeing and finishing equipment was
primarily attributable to the effects of the policy of the PRC government to
encouragement the development of the textile industry as the Chinese economy
improved as discussed above.




Revenues
from forging of rolled rings and other components totaled $15,703,000 for the
three months ended September 30, 2010, with revenues from the wind power
industry amounting to $12,425,000 and revenues from other forging operations
amounting to $3,278,000.  Due to the shift in focus of our sales effort to
the wind segment, we increased sales of forged rolled rings and other related
products to the wind power industry by 80.7% for the three months ended
September 30, 2010 compared to the three months ended September 30, 2009. We
also experienced a 23.3% decrease in forging revenues from other industries,
such as the railway, heavy machinery manufacturing, petrochemical,
metallurgical, sea port machinery, and defense and radar industries. The
decrease in forging revenues from other industries was mainly attributable to
the timing of shipments to our customers during the quarterly periods. Although
during the three months ended September 30, 2010, we had a decrease in forging
revenues from other industries, we experienced a 6.0% increase in forging
revenues from other industries for the nine months ended September 30, 2010. We
expect forging for other industries to increase.  We have recently added
one new customer.  As of September 30, 2010, we delivered 1079 tons of ESR
products to this customer for revenue of approximately $3,167,000 which has been
included in revenue from forged rolled rings and related components – other
industries ad new expect future sales from this customer to
increase.


,


Cost of revenues. Cost of
revenues for the three months ended September 30, 2010 increased $3,599,000 or
29.4%, from $12,242,000 for the three months ended September 30, 2009 to
$15,841,000 for the three months ended September 30, 2010. Cost of goods sold
for Dyeing was $4,370,000 for the three months ended September 30, 2010, as
compared to $3,897,000 for the three months ended September 30, 2009. Cost of
revenues related to the manufacture of forged rolled rings and related products
was $11,471,000 for the three months ended September 30, 2010 as compared to
$8,345,000 for the three months ended September 30, 2009.





Gross profit and gross
margin. Our gross profit was $5,421,000 for the three months ended
September 30, 2010 as compared to $3,889,000 for the three months ended
September 30, 2009, representing gross margins of 25.5% and 24.1%, respectively.
Gross profit for Dyeing was $1,189,000 for the three months ended September 30,
2010 as compared to $1,087,000 for the three months ended September 30, 2009,
representing gross margins of approximately 21.4% and 21.7%, respectively. The
slight 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 the third quarter of fiscal 2010 as well as a
reduction of our sales price due to stronger competition in the textile industry
in China.  Gross profit from forged rolled rings and related products
segment was $4,232,000 for the three months ended September 30, 2010 as compared
to $2,804,000 for the three months ended September 30, 2009, representing gross
margins of approximately 26.9% and 25.1%, respectively. The increase in our
gross margin was mainly attributed to operational efficiencies from the increase
in our production in the third quarter of fiscal 2010 as compared to the
corresponding period of fiscal 2009. We believe that our gross margins will
improve to the extent that we are able to utilize our factory capacity more
efficiently.





Depreciation. Depreciation
was $944,000 and $541,000 for the three months ended September 30, 2010 and
2009, respectively, of which $866,000 for the three months ended September 30,
2010 and $458,000 for the three months ended September 30, 2009 is included in
cost of revenues and $78,000 for the three months ended September 30, 2010 and
$83,000 for the three months ended September 30, 2009 is included in operating
expenses. The overall increase in depreciation is attributable to an increase in
our depreciable production equipment, primarily relating to our forged rolled
rings and other related products.





Selling, general and administrative
expenses. Selling, general and administrative expenses totaled $1,206,000
for the three months ended September 30, 2010, as compared to $387,000 for the
three months ended September 30, 2009, an increase of $819,000 or approximately
211.9%. Selling, general and administrative expenses consisted of the following
(dollars in thousands):


Three Months Ended
                    September 30, 2010
                  
                  
                  Three Months Ended
                    September 30, 2009Professional
      fees
                  
                  $
                  42
                  
                  
                  $
                  110Bad
      debt expense (recovery)
                  
                  
                  327
                  
                  
                  
                  (12
                  )Payroll
      and related benefits
                  
                  
                  184
                  
                  
                  
                  120Travel
                  
                  
                  73
                  
                  
                  
                  47Shipping
                  
                  
                  427
                  
                  
                  
                  12Other
                  
                  
                  153
                  
                  
                  
                  109$
                  1,206
                  
                  
                  $
                  386


40





•
            Professional
      fees decreased for the three months ended September 30, 2010 by $68,000,
      as compared to the three months ended September 30, 2009. The decrease was
      primarily attributable to a decrease in investor relations of
      approximately $46,000 and a decrease in other professional fees of
      approximately $22,000.





•
            Bad
      debt expense increased for the three months ended September 30, 2010 by
      $339,000. Based on our periodic review of accounts receivable balances, we
      adjusted the allowance for doubtful accounts after considering
      management’s evaluation of the collectability of individual receivable
      balances, including the analysis of subsequent collections, the customers’
      collection history, and recent economic
events.





•
            Payroll
      and related benefits increased for the three months ended September 30,
      2010 by $64,000, as compared to the three months ended September 30, 2009.
      The increase was mainly attributable to an increase in compensation for
      our management of approximately $22,000 and an increase in compensation
      and related benefits of approximately $42,000 in our forged rolled rings
      and related products segment resulting from increased
      operations.





•
            Travel
      expense for the three months ended September 30, 2010 increased by
      $26,000, as compared to the three months ended September 30, 2009. The
      increase is related to the increase in travel for investor road shows and
      conferences.





•
            Shipping
      expense for the three months ended September 30, 2010 increased by
      $415,000, as compared to the three months ended September 30, 2009. For
      the three months ended September 30, 2009, we charged partial shipping
      fees to our customers while, for the three months ended September 30,
      2010, we paid the related shipping fees for our customers. Therefore, our
      selling expense was substantially increased. For customers that we have
      absorbed shipping costs, we negotiated a higher selling price with these
      customers to offset the shipping costs, which had a modest positive effect
      on our gross margin.





•
            Other
      selling, general and administrative expenses increased by $44,000, for the
      three months ended September 30, 2010 as compared with the three months
      ended September 30, 2009.




Income from operations.For
the three months ended September 30, 2010, income from operations amounted to
$4,137,000, as compared to $3,420,000 for the three months ended September 30,
2009, an increase of $717,000 or 21.0%.





Other income (expenses). For
the three months ended September 30, 2010, other expenses amounted to $29,000 as
compared to other expenses of $59,000 for the three months ended September 30,
2009.  For the three months ended September 30, 2010, other income
(expenses) included:





•
            interest
      expense of $24,000, which was incurred on our outstanding loans,
      and





•
            foreign
      currency losses of $6,000;




For the
three months ended September 30, 2009, other income (expenses)
included:





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





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





·
            debt
      issuance costs of $2,000 and





··
            nominal
      interest income.





Income tax expense. Income
tax expense totaled $1,133,000 for the three months ended September 30, 2010, as
compared to $862,000 for the three months ended September 30, 2009, an increase
of $271,000, or approximately 31.5% which was primarily attributable to the
increase in taxable income generated by our operating entities.





Net income.  As a result
of the foregoing, our net income was $2,973,590 for the three months ended
September 30, 2010, as compared with $2,498,437 for the three months ended
September 30, 2009.


41





Deemed preferred stock
dividend.   For the three months ended September 30, 2010, we
did not have any deemed preferred stock dividend. In September 2009, we sold
1,100,000 shares of series A preferred stock for $1,100,000.  Each share of
series A preferred stock is convertible into one-third of a share of common
stock.  The effective price per share of common stock issuable upon
conversion of the series A preferred stock was $3.00 per share, which was less
than the market price on the date of the sale.  We recognized a deemed
preferred stock dividend equal to the difference between the fair market value
of the 1,100,000 shares of series A preferred stock, determined on an “as if
converted” basis and the consideration we received for the series A preferred
stock ($1,100,000), which was $462,000.





Net income allocable to common
shareholders.  Our net income allocable to common shareholders for
the three months ended September 30, 2010 was $2,974,000, or $0.16 per
share (basic) and $0.12 per share (diluted), which was the same as our net
income. As a result of the deemed preferred stock dividend during the three
months ended September 30, 2009, our net income allocable to common shareholders
was $2,036,000, or $0.13 per share (basic) and $0.09 per share
(diluted).





Foreign currency translation gain.The functional currency of our subsidiaries and variable interest
entities operating in the PRC is the RMB. The financial statements of our
subsidiaries are translated to U.S. dollars using period end rates of exchange
for assets and liabilities, and average rates of exchange (for the period) for
revenues, costs, and expenses. Net gains and losses resulting from foreign
exchange transactions are included in the consolidated statements of operations
and were minimal. As a result of unrealized foreign currency translations, which
are a non-cash adjustment, we reported an unrealized foreign currency
translation gain of $909,000 and $40,000 for the three months ended September
30, 2010 and 2009, respectively. This non-cash gain had the effect of increasing
our reported comprehensive income.




Comprehensive income.As a
result of our foreign currency translation gains, we had comprehensive income
for the three months ended September 30, 2010 of $3,882,000, compared with
$2,538,000 for the three months ended June 30, 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 September 30, 2010 and December 31, 2009, we had cash balances
of $1,773,709 and $2,278,638, respectively. These funds are located in financial
institutions located as follows (dollars in thousands):





September 30, 2010
                  
                  
                  December 31, 2009Country:United
      States
                  
                  $
                  200
                  
                  
                  
                  11.3
                  %
                  
                  $
                  507
                  
                  
                  
                  22.2
                  %China
                  
                  
                  1,574
                  
                  
                  
                  88.7
                  %
                  
                  
                  1,772
                  
                  
                  
                  77.8
                  %Total
      cash and cash equivalents
                  
                  $
                  1,774
                  
                  
                  
                  100.0
                  %
                  
                  $
                  2,279
                  
                  
                  
                  100.0
                  %





The
following table sets forth information as to the principal changes in the
components of our working capital from December 31, 2009 to September 30, 2010
(dollars in thousands):


December 31, 2009 to
                        September 30, 2010Category
                      
                      2010
                      
                      
                      2009
                      
                      
                      Change
                      
                      
                      Percentage
                        ChangeCurrent
      assets:Cash
      and cash equivalents
                      
                      $
                      1,774
                      
                      
                      $
                      2,279
                      
                      
                      $
                      (505)
                      
                      
                      
                      (22.2)
                      %Notes
      receivable
                      
                      
                      353
                      
                      
                      
                      329
                      
                      
                      
                      24
                      
                      
                      
                      7.2
                      %Accounts
      receivable, net of allowance for doubtful accounts
                      
                      
                      8,631
                      
                      
                      
                      6,046
                      
                      
                      
                      2,585
                      
                      
                      
                      42.7
                      %Inventories,
      net of reserve for obsolete inventory
                      
                      
                      4,231
                      
                      
                      
                      2,232
                      
                      
                      
                      1,999
                      
                      
                      
                      89.5
                      %Advances
      to suppliers
                      
                      
                      1,507
                      
                      
                      
                      451
                      
                      
                      
                      1,056
                      
                      
                      
                      234.4
                      %Prepaid
      value-added taxes on purchase
                      
                      
                      1,979
                      
                      
                      
                      379
                      
                      
                      
                      1,600
                      
                      
                      
                      422.7
                      %Prepaid
      expenses and other current assets
                      
                      
                      43
                      
                      
                      
                      214
                      
                      
                      
                      (171)
                      
                      
                      
                      (79.9)
                      %Current
      liabilities:Loans
      payable
                      
                      
                      1,344
                      
                      
                      
                      2,040
                      
                      
                      
                      (696)
                      
                      
                      
                      (34.1)
                      %Accounts
      payable
                      
                      
                      6,880
                      
                      
                      
                      3,405
                      
                      
                      
                      3,475
                      
                      
                      
                      102.1
                      %Accrued
      expenses
                      
                      
                      352
                      
                      
                      
                      557
                      
                      
                      
                      (205)
                      
                      
                      
                      (36.8)
                      %VAT
      and service taxes payable
                      
                      
                      89
                      
                      
                      
                      25
                      
                      
                      
                      64
                      
                      
                      
                      252.9
                      %Advances
      from customers
                      
                      
                      238
                      
                      
                      
                      143
                      
                      
                      
                      95
                      
                      
                      
                      65.9
                      %Income
      tax payable
                      
                      
                      1,191
                      
                      
                      
                      1,019
                      
                      
                      
                      172
                      
                      
                      
                      16.9
                      %Working
      capital:Total
      current assets
                      
                      
                      18,518
                      
                      
                      
                      11,930
                      
                      
                      
                      6,588
                      
                      
                      
                      55.2
                      %Total
      current liabilities
                      
                      
                      10,094
                      
                      
                      
                      7,189
                      
                      
                      
                      2,905
                      
                      
                      
                      40.4
                      %Working
      capital
                      
                      $
                      8,424
                      
                      
                      $
                      4,741
                      
                      
                      $
                      3,683
                      
                      
                      
                      77.7
                      %


42





Our
working capital increased $3,683,000 to $8,424,000 at September 30, 2010 from
working capital of $4,741,000 at December 31, 2009. This increase in working
capital is primarily attributable to:





·
            an
      increase in accounts receivable, net of allowance for doubtful accounts,
      of $2,585,000 related to increased
revenues,


·
            an
      increase in inventories, net of reserve for obsolete inventory, of
      $1,999,000 attributable to the purchase of steel forged rolled rings and
      other related products division and for our new production line to
      manufacture ESR forged products for the high performance components market
      of the wind power and other industries which we began manufacturing in
      July 2010.  Our ESR inventory represents work in process in
      connection with an order from one customer, which is currently our only
      ESR customer.


·
            an
      increase in advances to suppliers of $1,056,000 to receive stable pricing
      of raw materials,


·
            an
      increase in prepaid VAT taxes on purchases of $1,600,000, resulting from
      the payment of VAT taxes on the purchase of equipment which can be applied
      against future VAT taxes due. a decrease in loans payable of $696,000 due
      to the repayment of certain loans,





offset
by





·
            a
      decrease in cash and cash equivalents of $505,000,
  and


·
            an
      increase in accounts payable of
$3,475,000.





During
the nine months ended September 30, 2010, we used cash of approximately
$9,200,000 for the construction of and equipment for our new electro-slag
re-melted production line.  In July 2010, substantially all construction in
progress costs was transferred to its respective property and equipment
account.





We plan
to add an additional electro-slag re-melted production line, if needed. We are
currently preparing a budget in connection with this plan which would require us
to construct or purchase a new factory and to purchase equipment.  We may
not have sufficient working capital to fund this expansion as well as providing
working capital necessary for our ongoing operations and obligations. We will
need to raise additional capital to complete this project. We may seek to raise
additional capital through the sale of equity securities. At this time, we have
no commitments or plans to obtain additional capital.





Net cash
flow provided by operating activities was $7,342,000 for the nine months ended
September 30, 2010 as compared to net cash flow provided by operating activities
of $4,921,000 for the nine months ended September 30, 2009, an increase of
$2,421,000.





Net cash
flow provided by operating activities for the nine months ended September 30,
2010 was mainly due to:


·
            net
      income of $7,944,000 adjusted for the add-back of non-cash items 
      such as depreciation of $2,145,000, the amortization of debt discount to
      interest expense of $45,000, the amortization of land use rights of
      $65,000,  the increase in allowance for doubtful accounts of
      $550,000, and stock-based compensation of
  $478,000,


·
            changes
      in operating assets and liabilities such
as


·
            a
      decrease in prepaid and other current assets of
  $175,000,


·
            an
      increase in accounts payable of
$3,346,000,


·
            an
      increase in VAT and service taxes payable of
  $62,000,


·
            an
      increase in income taxes payable of $148,000
and


·
            an
      increase in advances from customers of
$90,000


43





·
            offset
      by:


·
            an
      increase in accounts receivable of
$2,966,000,


·
            an
      increase in inventories of
$1,918,000,


·
            an
      increase in prepaid value-added taxes on purchases of
      $1,565,000,


·
            an
      increase in advances to suppliers of $1,029,000,
  and


·
            a
      decrease in accrued expenses of
$212,000.







Net cash
flow provided by operating activities for the nine months ended September 30,
2009 was mainly due to:





·
            net
      income of $4,925,000 adjusted for the add-back of non-cash items such as
      depreciation of $1,238,000, the amortization of debt discount of $32,000,
      the amortization of land use rights of $65,000, an increase in our
      allowance for bad debt of $132,000, interest expense of $128,000 resulting
      from the issuance of common stock for the payment of interest on a note,
      and stock-based compensation of
$158,000,


·
            changes
      in operating assets and liabilities such
as


·
            a
      decrease in notes receivable of
$182,000,


·
            a
      decrease in due from related party of
$438,000,


·
            an
      increase in accounts payable of
$163,000,


·
            an
      increase in accrued expense of
$266,000,


·
            an
      increase in VAT and service taxes payable of
  $119,000,


·
            an
      increase in income taxes payable of $292,000,
  and


·
            an
      increase in advances from customers of
$20,000.


·
            offset
      by:


·
            an
      increase in accounts receivable of
$1,607,000,


·
            an
      increase in inventories of
$1,115,000,


·
            an
      increase in prepaid value-added taxes on purchase of
    $312,000,


·
            an
      increase in prepaid and other current assets of $52,000,
    and


·
            an
      increase in advances to suppliers of
$152,000.




Net cash
flow used in investing activities was $9,212,000 for the nine months ended
September 30, 2010 as compared to net cash used in investing activities of
$6,486,000 for the nine months ended September 30, 2009. For the nine months
ended September 30, 2010, we purchased property and equipment of $9,212,000. For
the nine months ended September 30, 2009, we used cash to purchase of property
and equipment of $6,486,000. During the nine months ended September 30, 2010, we
acquired property and equipment in connection with our expansion into a new
production line, enabling us to manufacture electro-slag re-melted forged
products for the high performance components market of the wind power
industry.  We believe that electro-slag re-melted forged products will be
important components in the next generation of larger wind turbines, which will
require stronger steel alloy precision forged components than the smaller
turbines.





Net cash
flow provided by financing activities was $1,330,000 for the nine months ended
September 30, 2010 as compared to net cash provided by financing activities of
$2,395,000 for the nine months ended September 30, 2009. For the nine months
ended September 30, 2010, we received proceeds from loans of $1,320,000 and
proceeds of $2,100,000 from the exercise of warrants and made repayments for
loans payable of $2,090,000. For the nine months ended September 30, 2009, we
received proceeds from loans of $1,214,000, proceeds from the exercise of
warrants of $83,000 and proceeds from sale of preferred stock of
$1,098,000.





Contractual
Obligations and Off-Balance Sheet Arrangements





We have
certain fixed contractual obligations and commitments that include future
estimated payments. Changes in our business needs, cancellation provisions,
changing interest rates, and other factors may result in actual payments
differing from the estimates. We cannot provide certainty regarding the timing
and amounts of payments. We have presented below a summary of the most
significant assumptions used in our determination of amounts presented in the
tables, in order to assist in the review of this information within the context
of our consolidated financial position, results of operations, and cash flows.
The following tables summarize our contractual obligations as of September 30,
2010 (dollars in thousands), and the effect these obligations are expected to
have on our liquidity and cash flows in future periods.


44





Payments Due by PeriodTotal
                  
                  
                  Less than
                    1 year
                  
                  
                  1-3
                    Years
                  
                  
                  3-5
                    Years
                  
                  
                  5 Years
                    +Contractual obligations :Bank
      indebtedness (1)
                  
                  $
                  1,344
                  
                  
                  $
                  1,344
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -Total
                  
                  $
                  1,344
                  
                  
                  $
                  1,344
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -





(1)
            Bank
      indebtedness consists of short term bank loans. Historically, we have
      refinanced these bank loans for an additional term of one year and we
      expect to refinance these loans upon
expiration.





Off-balance
Sheet Arrangements




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





Foreign
Currency Exchange Rate Risk





We
produce and sell almost all of our products in China. Thus, most of our revenues
and operating results may be impacted by exchange rate fluctuations between RMB
and US dollars.  For the nine months ended September 30, 2010, we had
unrealized foreign currency translation gain of $1,124,886, because of the
change in the exchange rate.





ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





Not
required for smaller reporting companies.





ITEM 4.
CONTROLS AND PROCEDURES





Our
management, including Jianhua Wu, our chief executive officer, and Teresa Zhang,
our chief financial officer, evaluated the effectiveness of the design and
operation of our disclosure controls and procedures as of September 30,
2010.





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





Management
conducted its evaluation of disclosure controls and procedures under the
supervision of our chief executive officer and our chief financial officer.
Based on that evaluation, our management, including Mr. Wu and Miss Zhang,
concluded that because of the significant deficiencies in internal control over
financial reporting described below, our disclosure controls and procedures were
not effective as of September 30, 2010.





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, 2009.  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, 2009,
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. Although
management believes that these deficiencies do not amount to a material
weakness, our internal controls over financial reporting were not effective at
September 30, 2010.


45





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




•
            Our
      chief financial officer Teresa Zhang and Adam Wasserman, our vice
      president of financial reporting have experience in internal control
      and U.S. GAAP reporting compliance, and, together with our chief executive
      officer oversees and manages our financial reporting process and the
      required training of the accounting
staff.




•
            We
      have committed to the establishment of effective internal audit functions,
      however, due to the scarcity of qualified candidates with extensive
      experience in U.S. GAAP reporting and accounting in the region, we were
      not able to hire sufficient internal audit resources before end of third
      quarter of 2010. However, we will increase our search for qualified
      candidates with assistance from recruiters and through
      referrals.




•
            Due
      to our size and nature, segregation of all conflicting duties may not
      always be possible and may not be economically feasible and we have not
      been able to take steps to improve our internal controls over financial
      reporting during the third quarter of 2010.  We have, however,
      adopted a formal plan and we expect to take significant steps to implement
      this plan during the next few months.   However, to the extent
      possible, we are implementing procedures to assure that the initiation of
      transactions, the custody of assets and the recording of transactions will
      be performed by separate
individuals.





Changes
in Internal Controls over Financial Reporting




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





PART II -
OTHER INFORMATION





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





On July
9, 2010, we issued 100,118 shares of our common stock upon the exercise of
warrants for which we received cash proceeds of $170,000.  On July 16,
2010, we issued 825,000 shares of series A preferred stock to an investor upon
the exercise of warrants, for which we received cash proceeds of $330,000. 
The issuance of these shares was exempt from the registration requirements of
the Securities Act pursuant to Section 4(2) of the Securities Act of 1933, as a
transaction not involving a public offering.  The certificates bear a
restricted stock legend and our transfer agent has placed stock transfer
restriction against the transfer of the shares except pursuant to an exemption
to the registration requirements of such Act.





During
the nine months ended September 30, 2010, the Company issued 1,455,666 shares of
common stock upon the conversion of 4,367,000 shares of series A preferred
stock.  The issuance of these shares was exempt from the registration
requirement of the Securities Act by virtue of Section 3(a)(9) of such
Act.





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


46





SIGNATURES





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





CHINA
      WIND SYSTEMS, INC.Date:
      November 15, 2010
              By:
              /s/ Jianhua WuJianhua
      Wu, Chief Executive OfficerDate:
      November 15, 2010
              By:
              /s/ Ying (Teresa) ZhangTeresa
      Zhang, Chief Financial Officerand
      Principal Accounting
Officer


47