UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)





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





For the
quarterly period ended March 31, 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
                (Do
      not check if smaller reporting company)
               ̈
              Smaller
      reporting company
              þ





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





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.  17,571,120 shares of common
stock are issued and outstanding as of May 14, 2010.





CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


FORM
10-Q


March
31, 2010





TABLE
OF CONTENTS





Page
                          No.PART
      I. - FINANCIAL INFORMATIONItem
      1.
                        Financial
      Statements
                        3Consolidated
      Balance Sheets as of March 31, 2010 (Unaudited) and December 31, 2009
      (Audited)
                        3Consolidated
      Statements of Income and Comprehensive Income for the Three Months Ended
      March 31, 2010 and 2009 (unaudited)
                        4Consolidated
      Statements of Cash Flows for the Three Months Ended March 31, 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.
                        37Item
      4
                        Controls
      and Procedures.
                        37PART
      II - OTHER INFORMATIONItem
      2.
                        Unregistered
      Sales of Equity Securities and Use of Proceeds.
                        39Item
      6.
                        Exhibits.
                        39




FORWARD
LOOKING STATEMENTS




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




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




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




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


2





PART
1 - FINANCIAL INFORMATION





Item
1.           Financial
Statements.





CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS





March
      31, 2010
                            
                            
                            December
      31, 2009(Unaudited)
                            
                            
                            (Audited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                            
                            $
                            2,470,245
                            
                            
                            $
                            2,278,638Notes
      receivable
                            
                            
                            226,737
                            
                            
                            
                            329,492Accounts
      receivable, net of allowance for doubtful accounts
                            
                            
                            6,871,154
                            
                            
                            
                            6,046,422Inventories,
      net of reserve for obsolete inventory
                            
                            
                            3,328,226
                            
                            
                            
                            2,232,264Advances
      to suppliers
                            
                            
                            561,357
                            
                            
                            
                            450,507Prepaid
      VAT on purchases
                            
                            
                            867,788
                            
                            
                            
                            378,543Prepaid
      expenses and other
                            
                            
                            83,550
                            
                            
                            
                            213,835Total
      Current Assets
                            
                            
                            14,409,057
                            
                            
                            
                            11,929,701PROPERTY
      AND EQUIPMENT - net
                            
                            
                            39,227,276
                            
                            
                            
                            36,863,501OTHER
      ASSETS:Land
      use rights, net
                            
                            
                            3,708,409
                            
                            
                            
                            3,729,427Total
      Assets
                            
                            $
                            57,344,742
                            
                            
                            $
                            52,522,629LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Loans
      payable
                            
                            $
                            1,755,387
                            
                            
                            $
                            2,040,111Accounts
      payable
                            
                            
                            4,546,631
                            
                            
                            
                            3,404,521Accrued
      expenses
                            
                            
                            476,165
                            
                            
                            
                            556,662VAT
      and service taxes payable
                            
                            
                            104,282
                            
                            
                            
                            25,284Advances
      from customers
                            
                            
                            328,799
                            
                            
                            
                            143,261Income
      taxes payable
                            
                            
                            951,605
                            
                            
                            
                            1,018,514Total
      Current Liabilities
                            
                            
                            8,162,869
                            
                            
                            
                            7,188,353STOCKHOLDERS'
      EQUITY:Preferred
      stock $0.001 par value;(March
      31, 2010 and December 31, 2009 - 60,000,000 shares authorized, all ofwhich
      were designated as series A convertible preferred, 15,534,264 and15,419,088
      shares issued and outstanding; at March 31, 2010 and December
      31,2009,
      respectively)
                            
                            
                            15,534
                            
                            
                            
                            15,419Common
      stock ($0.001 par value; 150,000,000 shares authorized;17,382,037
      and 16,402,204 shares issued and outstandingat
      March 31, 2010 and December 31, 2009, respectively)
                            
                            
                            17,382
                            
                            
                            
                            16,402Additional
      paid-in capital
                            
                            
                            24,225,451
                            
                            
                            
                            22,332,756Retained
      earnings
                            
                            
                            20,541,574
                            
                            
                            
                            18,595,037Statutory
      reserve
                            
                            
                            1,252,980
                            
                            
                            
                            1,252,980Accumulated
      other comprehensive gain - foreign currency translation
      adjustment
                            
                            
                            3,128,952
                            
                            
                            
                            3,121,682Total
      Stockholders' Equity
                            
                            
                            49,181,873
                            
                            
                            
                            45,334,276Total
      Liabilities and Stockholders' Equity
                            
                            $
                            57,344,742
                            
                            
                            $
                            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 EndedMarch
      31,2010
                
                
                2009(Unaudited)
                
                
                (Unaudited)NET
      REVENUES
                
                $
                16,840,682
                
                
                $
                7,860,867COST
      OF SALES
                
                
                12,423,987
                
                
                
                6,264,218GROSS
      PROFIT
                
                
                4,416,695
                
                
                
                1,596,649OPERATING
      EXPENSES:Depreciation
                
                
                82,955
                
                
                
                77,530Selling,
      general and administrative
                
                
                1,401,376
                
                
                
                500,948Total
      Operating Expenses
                
                
                1,484,331
                
                
                
                578,478INCOME
      FROM OPERATIONS
                
                
                2,932,364
                
                
                
                1,018,171OTHER
      INCOME (EXPENSE):Interest
      income
                
                
                1,244
                
                
                
                230Interest
      expense
                
                
                (74,919
                )
                
                
                (23,671
                )Foreign
      currency loss
                
                
                (1,859
                )
                
                
                (11
                )Debt
      issuance costs
                
                
                -
                
                
                
                (12,000
                )Total
      Other Income (Expense)
                
                
                (75,534
                )
                
                
                (35,452
                )INCOME
      BEFORE INCOME TAXES
                
                
                2,856,830
                
                
                
                982,719INCOME
      TAXES
                
                
                910,293
                
                
                
                336,661NET
      INCOME
                
                $
                1,946,537
                
                
                $
                646,058COMPREHENSIVE
      INCOME:NET
      INCOME
                
                $
                1,946,537
                
                
                $
                646,058OTHER
      COMPREHENSIVE INCOME:Unrealized
      foreign currency translation gain
                
                
                7,270
                
                
                
                41,540COMPREHENSIVE
      INCOME
                
                $
                1,953,807
                
                
                $
                687,598NET
      INCOME PER COMMON SHARE:Basic
                
                $
                0.11
                
                
                $
                0.04Diluted
                
                $
                0.08
                
                
                $
                0.03WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING:Basic
                
                
                17,252,799
                
                
                
                14,988,280Diluted
                
                
                25,395,026
                
                
                
                19,664,343





See notes
to unaudited consolidated financial statements


4





CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





For
      the Three Months EndedMarch
      31,2010
                
                
                2009(Unaudited)
                
                
                (Unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                
                $
                1,946,537
                
                
                $
                646,058Adjustments
      to reconcile net income from operations to net cash provided by operating
      activities:Depreciation
                
                
                584,646
                
                
                
                175,113Amortization
      of debt discount to interest expense
                
                
                44,993
                
                
                
                1,500Amortization
      of land use rights
                
                
                21,618
                
                
                
                21,585Increase
      in allowance for doubtful accounts
                
                
                251,496
                
                
                
                1,109Stock-based
      compensation expense
                
                
                286,320
                
                
                
                42,031Changes
      in assets and liabilities:Notes
      receivable
                
                
                102,808
                
                
                
                70,041Accounts
      receivable
                
                
                (1,075,263
                )
                
                
                (377,183
                )Inventories
                
                
                (1,095,615
                )
                
                
                (515,182
                )Prepaid
      value-added taxes on purchases
                
                
                (489,189
                )
                
                
                -Prepaid
      and other current assets
                
                
                137,756
                
                
                
                (57,485
                )Advances
      to suppliers
                
                
                (110,779
                )
                
                
                16,025Due
      from related party
                
                
                -
                
                
                
                438,174Accounts
      payable
                
                
                1,141,572
                
                
                
                (42,397
                )Accrued
      expenses
                
                
                (212,230
                )
                
                
                45,669VAT
      and service taxes payable
                
                
                78,994
                
                
                
                (97,450
                )Income
      taxes payable
                
                
                (67,074
                )
                
                
                (233,343
                )Advances
      from customers
                
                
                185,517
                
                
                
                54,282NET
      CASH PROVIDED BY OPERATING ACTIVITIES
                
                
                1,732,107
                
                
                
                188,547CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
                
                
                (2,810,860
                )
                
                
                (951,736
                )NET
      CASH USED IN INVESTING ACTIVITIES
                
                
                (2,810,860
                )
                
                
                (951,736
                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from loans payable
                
                
                -
                
                
                
                542,116Repayment
      of loans payable
                
                
                (330,000
                )
                
                
                -Proceeds
      from exercise of warrants
                
                
                1,600,000
                
                
                
                -NET
      CASH PROVIDED BY FINANCING ACTIVITIES
                
                
                1,270,000
                
                
                
                542,116EFFECT
      OF EXCHANGE RATE ON CASH AND CASH EQUIVALENTS
                
                
                360
                
                
                
                369NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                
                
                191,607
                
                
                
                (220,704
                )CASH
      AND CASH EQUILAVENTS - beginning of year
                
                
                2,278,638
                
                
                
                328,614CASH
      AND CASH EQUIVALENTS - end of period
                
                $
                2,470,245
                
                
                $
                107,910SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash
      paid for:Interest
                
                $
                32,069
                
                
                $
                21,264Income
      taxes
                
                $
                977,367
                
                
                $
                580,004NON-CASH
      INVESTING AND FINANCING ACTIVITIES:Debt
      discount for grant of warrants
                
                $
                -
                
                
                $
                92,985Common
      stock issued for future service
                
                $
                7,470
                
                
                $
                -





See notes
to unaudited consolidated financial statements.


5


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
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.


6


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





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





These
consolidated financial statements should be read in conjunction with the summary
of significant accounting policies and notes to consolidated financial
statements included in the Company’s Form 10-K annual report for the year ended
December 31, 2009.





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 fee 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


March 31,
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 convertible debt and 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


March 31,
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 March 31,
2010 and December 31, 2009, the Company’s cash balances by geographic area were
as follows:





March
      31, 2010
                    
                    
                    December 31, 2009Country:United
      States
                    
                    $
                    519,989
                    
                    
                    
                    21.1
                    %
                    
                    $
                    506,777
                    
                    
                    
                    22.2
                    %China
                    
                    
                    1,950,256
                    
                    
                    
                    78.9
                    %
                    
                    
                    1,771,861
                    
                    
                    
                    77.8
                    %Total
      cash and cash equivalents
                    
                    $
                    2,470,245
                    
                    
                    
                    100.0
                    %
                    
                    $
                    2,278,638
                    
                    
                    
                    100.0
                    %


9




CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
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 $226,737 and $329,492
at March 31, 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 March 31, 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 $1,009,711 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 $160,658 and $160,632 at March 31, 2010 and
December 31, 2009, respectively.





Advances to
suppliers




Advances
to suppliers represent the cash paid in advance for purchasing of inventory
items from suppliers. The advance payments are meant to ensure preferential
pricing and delivery. The amounts advanced under such arrangements totaled
$561,357 and $450,507 as of March 31, 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


March 31,
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 three months ended March 31, 2010 and
2009.





Advances from
customers





Advances
from customers at March 31, 2010 and December 31, 2009 amounted to $328,799
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, and
electric equipment upon shipment and transfer of title. The other elements may
include installation and, generally, a one-year warranty. Equipment installation
revenue is valued based on estimated service person hours to complete
installation and is recognized when the labor has been completed and the
equipment has been accepted by the customer, which is generally within a couple
days of the delivery of the equipment. 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 three months ended March 31, 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


March 31,
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 FASB Accounting Standards Codification also requires measurement of
the cost of employee and director services received in exchange for an award
based on the grant-date fair value of the award.





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 $398,091 and $66,432 for the
three months ended March 31, 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 statement of operations and was not
material.





Research and
development





Research
and development costs are expensed as incurred. For the three months ended March
31, 2010 and 2009, research and development costs were not
material.


12


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
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 three months ended March 31, 2010 and 2009 was $360 and $369,
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.
The Company does not enter any material transaction in foreign currencies and,
accordingly, transaction gains or losses have not had, and are not expected to
have, a material effect on the results of operations of the
Company.





Asset and
liability accounts at March 31, 2010 and December 31, 2009 were translated at
6.8361 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 three months ended March 31, 2010 and 2009 were 6.83603 RMB and
6.84659 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


March 31,
2010





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





Income per share of common
stock(continued)


Three
      Months Ended March 31,2010
                  
                  
                  2009Net
      income available to common shareholders for basic and diluted net income
      per common share
                  
                  $
                  1,946,537
                  
                  
                  $
                  646,058Weighted
      average common shares outstanding - basic
                  
                  
                  17,252,799
                  
                  
                  
                  14,988,280Effect
      of dilutive securities:Series
      A convertible preferred stock
                  
                  
                  5,178,088
                  
                  
                  
                  4,676,063Warrants
                  
                  
                  2,964,139
                  
                  
                  
                  -Weighted
      average common shares outstanding - diluted
                  
                  
                  25,395,026
                  
                  
                  
                  19,664,343Net
      income per common share - basic
                  
                  $
                  0.11
                  
                  
                  $
                  0.04Net
      income per common share - diluted
                  
                  $
                  0.08
                  
                  
                  $
                  0.03





The
Company's aggregate common stock equivalents at March 31, 2010 and 2009 include
the following:





March
      31, 2010
                      
                      
                      March
      31, 2009Warrants
                      
                      
                      3,974,773
                      
                      
                      
                      5,523,667Series
      A preferred stock
                      
                      
                      5,178,088
                      
                      
                      
                      4,676,063Total
                      
                      
                      9,152,861
                      
                      
                      
                      10,199,730





Deemed preferred stock
dividend





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





Accumulated other
comprehensive income




Comprehensive
income is comprised of net income and all changes to the statements of
stockholders' equity, except those due to investments by stockholders, changes
in paid-in capital and distributions to stockholders. For the Company,
comprehensive income for the three months ended March 31, 2010 and 2009 included
net income and unrealized gains from foreign currency translation
adjustments.





Related
parties





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


14


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





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





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 March 31, 2010, subsequent events were evaluated by the Company as of May
14, 2010, 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 Company is currently evaluating this new
ASU.





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





In
November 2009, the FASB issued an ASU regarding accounting for stock dividends,
including distributions to shareholders with components of stock and cash. This
ASU clarifies that the stock portion of a distribution to shareholders that
contains components of cash and stock and allows shareholders to select their
preferred form of the distribution (with a limit on the amount of cash that will
be distributed in total) should be considered a stock dividend and included in
EPS calculations as a share issuance. The adoption of this guidance did not
have a material impact on the Company’s consolidated financial
statements





In
December 2009, FASB issued ASU No. 2009-16, Accounting for Transfers of
Financial Assets. This Accounting Standards Update amends the FASB Accounting
Standards Codification for the issuance of FASB Statement No. 166,Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No. 140. The amendments
in this Accounting Standards Update improve financial reporting by eliminating
the exceptions for qualifying special-purpose entities from the consolidation
guidance and the exception that permitted sale accounting for certain mortgage
securitizations when a transferor has not surrendered control over the
transferred financial assets. In addition, the amendments require enhanced
disclosures about the risks that a transferor continues to be exposed to because
of its continuing involvement in transferred financial assets. Comparability and
consistency in accounting for transferred financial assets will also be improved
through clarifications of the requirements for isolation and limitations on
portions of financial assets that are eligible for sale accounting. The Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.


15


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





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





Recent accounting
pronouncements (continued)





In
December 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167,Amendments to FASB Interpretation
No. 46(R). The amendments in this Accounting Standards Update replace the
quantitative-based risks and rewards calculation for determining which reporting
entity, if any, has a controlling financial interest in a variable interest
entity with an approach focused on identifying which reporting entity has the
power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance and (1) the obligation to
absorb losses of the entity or (2) the right to receive benefits from the
entity. An approach that is expected to be primarily qualitative will be more
effective for identifying which reporting entity has a controlling
financial interest in a variable interest entity. The amendments in this Update
also require additional disclosures about a reporting entity’s involvement in
variable interest entities, which will enhance the information provided to users
of financial statements. The Company is currently evaluating the impact of
this ASU, however, the Company does not expect the adoption of this ASU to have
a material impact on its 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 Update
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 EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update 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.





In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity.  The amendments in this update are
effective beginning in the period that an entity adopts SFAS No. 160,
“Non-controlling Interests in Consolidated Financial Statements – An Amendment
of ARB No. 51.” If an entity has previously adopted SFAS No. 160 as of the
date the amendments in this update are included in the Accounting Standards
Codification, the amendments in this update are effective beginning in the first
interim or annual reporting period ending on or after December 15, 2009. The
amendments in this update should be applied retrospectively to the first period
that an entity adopted SFAS No. 160. The adoption of this ASU did not have any
material impact on the Company’s consolidated financial statements.





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. These disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. The
Company is currently evaluating the impact of this ASU, however, the Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.


16


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





NOTE 2 –
ACCOUNTS
RECEIVABLE





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





2010
                  
                  
                  2009Accounts
      receivable
                  
                  $
                  7,880,865
                  
                  
                  $
                  6,804,518Less:
      allowance for doubtful accounts
                  
                  
                  (1,009,711
                  )
                  
                  
                  (758,096
                  )$
                  6,871,154
                  
                  
                  $
                  6,046,422





NOTE 3 -
INVENTORIES





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





2010
                  
                  
                  2009Raw
      materials
                  
                  $
                  2,586,919
                  
                  
                  $
                  1,366,220Work
      in process
                  
                  
                  135,180
                  
                  
                  
                  288,811Finished
      goods
                  
                  
                  766,785
                  
                  
                  
                  737,8653,488,884
                  
                  
                  
                  2,392,896Less:
      reserve for obsolete inventory
                  
                  
                  (160,658
                  )
                  
                  
                  (160,632
                  )$
                  3,328,226
                  
                  
                  $
                  2,232,264





NOTE 4 -
PROPERTY AND
EQUIPMENT





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




Useful
      Life
                          
                          
                          2010
                          
                          
                          2009Office
      equipment and furniture
                          
                          5
      Years
                          
                          
                          $
                          103,337
                          
                          
                          $
                          103,320Manufacturing
      equipment
                          
                          5 –
      10 Years
                          
                          
                          
                          21,973,201
                          
                          
                          
                          17,405,814Vehicles
                          
                          5
      Years
                          
                          
                          
                          115,646
                          
                          
                          
                          79,570Construction
      in progress
                          
                          -
                          
                          
                          
                          7,889,570
                          
                          
                          
                          9,546,200Building
      and building improvements
                          
                          20
      Years
                          
                          
                          
                          15,155,484
                          
                          
                          
                          15,153,04645,237,238
                          
                          
                          
                          42,287,950Less:
      accumulated depreciation
                          
                          
                          
                          
                          
                          (6,009,962
                          )
                          
                          
                          (5,424,449
                          )$
                          39,227,276
                          
                          
                          $
                          36,863,501





For the
three months ended March 31, 2010 and 2009, depreciation expense amounted to
$584,646 and $175,113, of which $501,691 and $97,583 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


March 31,
2010







NOTE 5 –
LAND USE
RIGHTS




There is noprivate 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 three months ended March 31, 2010 and 2009,
amortization of land use rights amounted to $21,618 and $21,585,
respectively.





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


Useful
      Life
                          
                          2010
                          
                          
                          2009Land
      Use Rights
                          
                          45
      - 50 years
                          
                          $
                          3,949,737
                          
                          
                          $
                          3,949,101Less:
      Accumulated Amortization
                          
                          
                          
                          
                          (241,328
                          )
                          
                          
                          (219,674
                          )$
                          3,708,409
                          
                          
                          $
                          3,729,427




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





Years
      ending December 31:2010
                  
                  $
                  86,4732011
                  
                  
                  86,4732012
                  
                  
                  86,4732013
                  
                  
                  86,4732014
                  
                  
                  86,473Thereafter
                  
                  
                  3,276,044$
                  3,708,409





NOTE 6 –
STOCKHOLDERS’
EQUITY





(a)           Common
stock





On
January 31, 2010, the Company issued 1,500 shares of common stock to our Chief
Financial Officer for services rendered and will be rendered pursuant to an
employment agreement. The shares were valued at fair value on the date of grant
and the Company recorded stock-based compensation of $3,400 and prepaid expense
of $4,250.





On
February 10, 2010, the Company issued 28,000 shares of common stock to our Chief
Executive Officer and 20,000 shares of common stock to two other key employees
who are not executive officers pursuant to our 2010 long-term incentive plan.
The shares were valued at fair value on the date of grant and the Company
recorded stock-based compensation of $276,480.





On March
31, 2010, the Company issued 2,000 shares of common stock to our vice president
of financial reporting for services rendered and will be rendered pursuant to an
engagement agreement. The shares were valued at fair value on the date of grant
and the Company recorded stock-based compensation of $6,440 and prepaid expense
of $3,220.





During
the three months ended March 31, 2010, the Company issued 755,000 shares of
common stock upon the conversion of 2,265,000 shares of series A preferred
stock.


18


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





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 stock warrants for which the Company received cash proceeds of
$1,600,000.  In connection with the issuance of the 2,380,177 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.





(b)  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.





(c)           Series A Preferred
Stock





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




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





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





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


19


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(c)         Series A Preferred Stock
(continued)





·
            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.





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





(d)    November 2007 Securities
Purchase Agreement





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




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




20


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





(d)         November 2007 Securities
Purchase Agreement (continued)





·
            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.





(e)  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 three months ended March 31, 2010
and 2009, amortization of debt discount to interest expense was $44,993 and
$1,500, respectively.





Warrant
activities for the three months ended March 31, 2010 are summarized as
follows:





Three Months Ended March 31, 2010Number of
                      Warrants
                    
                    
                    Weighted Average
                      Exercise PriceBalance
      at beginning of year
                    
                    
                    4,941,499
                    
                    
                    $
                    1.49Granted
                    
                    
                    -
                    
                    
                    
                    -Exercised
                    
                    
                    (966,725
                    )
                    
                    
                    1.66Forfeited
                    
                    
                    -
                    
                    
                    
                    -Balance
      at end of period
                    
                    
                    3,974,773
                    
                    
                    $
                    1.45Warrants
      exercisable at end of period
                    
                    
                    3,974,773
                    
                    
                    $
                    1.45


21


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





NOTE 6 –
STOCKHOLDERS’ EQUITY
(continued)





The
following table summarizes the shares of the Company's common stock issuable
upon exercise of warrants outstanding at March 31, 2010:




Warrants Outstanding
                          
                          
                          Warrants ExercisableRange of
                            Exercise
                            Price
                          
                          
                          Number
                            Outstanding at
                            March 31, 2010
                          
                          
                          Weighted
                            Average
                            Remaining
                            Contractual
                            Life (Years)
                          
                          
                          Weighted
                            Average
                            Exercise
                            Price
                          
                          
                          Number
                            Exercisable at
                            March 31,
                            2010
                          
                          
                          Weighted
                            Average
                            Exercise
                            Price$
                          1.698
                          
                          
                          
                          1,985,681
                          
                          
                          
                          2.62
                          
                          
                          $
                          1.698
                          
                          
                          
                          1,985,681
                          
                          
                          
                          1.698$
                          1.200
                          
                          
                          
                          1,989,092
                          
                          
                          
                          2.72
                          
                          
                          
                          1.200
                          
                          
                          
                          1,989,092
                          
                          
                          
                          1.2003,974,773
                          
                          
                          
                          2.67
                          
                          
                          $
                          1.45
                          
                          
                          
                          3,974,773
                          
                          
                          $
                          1.45





(e) 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. grantee.  As of March 31, 2009, the
Company had issued a total of 51,500 shares of common stock, for which it
expensed compensation in the amount of $286,320.





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.


22


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





NOTE 8 –
LOANS
PAYABLE





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





March31,
                
                
                December31,2010
                
                
                2009Loan
      payable to Industrial and Commercial Bank of China, due on September 24,
      2010 with annual interest at March 31, 2010 and December 31, 2009 of 5.84%
      and 5.84%, respectively, secured by assets of the Company.
                
                
                146,282
                
                
                $
                146,259Loan
      payable to Industrial and Commercial Bank of China, due on September 15,
      2010 with annual interest at March 31, 2010 and December 31, 2009 of 5.58%
      and 5.58%, respectively, secured by assets of the Company.
                
                
                146,282
                
                
                
                146,259Loan
      payable to Industrial and Commercial Bank of China, due on September 22,
      2010 with annual interest at March 31, 2010 and December 31, 2009 of 5.58%
      and 5.58%, respectively, secured by assets of the Company.
                
                
                146,282
                
                
                
                146,259Loan
      payable to Bank of Communications, due on June 8, 2010 with annual
      interest at March 31, 2010 and December 31, 2009 of 5.84% and 5.84%,
      respectively, the rate being adjusted quarterly based on People’s Bank of
      China’s base rate times 120%.
                
                
                438,847
                
                
                
                438,775Loan
      payable to Bank of Communications, due on June 14, 2010 with annual
      interest at March 31, 2010 and December 31, 2009 of 5.84% and 5.84%,
      respectively, the rate being adjusted quarterly based on People’s Bank of
      China’s base rate times 120%.
                
                
                292,565
                
                
                
                292,517Loan
      payable to Agricultural and Commercial Bank, due on March 30, 2011
      with annual interest at March 31, 2010 and December 31, 2009 of 6.90% and
      6.90%, respectively, secured by certain assets of the
    Company.
                
                
                585,129
                
                
                
                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
                
                
                1,755,387
                
                
                
                2,085,104Less:
      long-term portion of loans payable
                
                
                -
                
                
                
                -Current
      portion of loans payable
                
                
                1,755,387
                
                
                
                2,085,104Less:
      debt discount (a)
                
                
                -
                
                
                
                (44,993
                )Current
      portion of loans payable – net
                
                $
                1,755,387
                
                
                $
                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(e)).


23


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010




NOTE 9 -
SEGMENT
INFORMATION





For the
three months ended March 31, 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 months ended March 31,
2009, electric power auxiliary apparatuses (including coking equipment). The
Company's reportable segments are strategic business units that offer different
products. They are managed separately based on the fundamental differences in
their operations. All of the Company’s operations are conducted in the PRC.
Information with respect to these reportable business segments for the three
months ended March 31, 2010 and 2009 is as follows:





2010
                  
                  
                  2009Revenues:Dyeing
      and finishing equipment
                  
                  $
                  4,993,233
                  
                  
                  $
                  3,529,441Forged
      rolled rings and related components
                  
                  
                  11,847,449
                  
                  
                  
                  4,331,42616,840,682
                  
                  
                  
                  7,860,867Depreciation:Dyeing
      and finishing equipment
                  
                  
                  110,210
                  
                  
                  
                  100,107Forged
      rolled rings and related components
                  
                  
                  474,436
                  
                  
                  
                  75,006584,646
                  
                  
                  
                  175,113Interest
      expense:Dyeing
      and finishing equipment
                  
                  
                  -
                  
                  
                  
                  -Forged
      rolled rings and related components
                  
                  
                  26,976
                  
                  
                  
                  21,264Other
      (a)
                  
                  
                  47,943
                  
                  
                  
                  2,40774,919
                  
                  
                  
                  23,671Net
      income (loss):Dyeing
      and finishing equipment
                  
                  
                  499,978
                  
                  
                  
                  464,503Forged
      rolled rings and related components
                  
                  
                  1,971,425
                  
                  
                  
                  424,036Other
      (a)
                  
                  
                  (524,866
                  )
                  
                  
                  (242,481
                  )1,946,537
                  
                  
                  
                  646,058Identifiable
      long-lived tangible assets at March 31, 2010 and December 31, 2009 by
      segment:Dyeing
      and finishing equipment
                  
                  $
                  6,154,976
                  
                  
                  $
                  5,728,590Forged
      rolled rings and related components
                  
                  
                  33,072,300
                  
                  
                  
                  31,134,911$
                  39,227,276
                  
                  
                  $
                  36,863,501Identifiable
      long-lived tangible assets at March 31, 2010 and December 31, 2009 by
      geographical location:China
                  
                  $
                  39,227,276
                  
                  
                  $
                  36,863,501United
      States
                  
                  
                  -
                  
                  
                  
                  -$
                  39,227,276
                  
                  
                  $
                  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.


24


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





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.





For the
three months ended March 31, 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
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Balance
      – March 31, 2010
                  
                  $
                  72,407
                  
                  
                  $
                  1,168,796
                  
                  
                  $
                  11,777
                  
                  
                  $
                  1,252,980





NOTE 11 –
CONCENTRATIONS





Customers





During
the three months ended March 31, 2010, one customer accounted for 23% of the
Company’s total sales. No customer accounted for more than 10% of the Company’s
total sales for the three months ended March 31, 2009.





Suppliers





Two major
suppliers provided approximately 67% of the Company’s purchases of raw materials
for the three months ended March 31, 2010. No supplier provided more than 10% of
the Company’s purchases of raw materials for the three months ended March 31,
2009.





NOTE 12 –
RESTRICTED NET
ASSETS





Regulations
in the PRC permit payments of dividends by the Company’s PRC VIEs only out of
their 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. As a result of these PRC laws and
regulations, the Company’s PRC VIE’s and subsidiary are restricted in their
abilities to transfer a portion of their net assets to the Company. Foreign
exchange and other regulation in PRC may further restrict the Company’s PRC VIEs
and subsidiary from transferring funds to the Company in the form of loans
and/or advances.





As of
March 31, 2010 and December 31, 2009, substantially all of the Company’s net
assets are attributable to the PRC VIE’s and subsidiary. Accordingly, the
Company’s restricted net assets were approximately $56,582,000 and $51,652,000,
respectively.


25


CHINA
WIND SYSTEMS, INC. AND SUBSIDIARIES


NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


March 31,
2010





NOTE 13 –
SUBSEQUENT
EVENTS





On April
7, 2010, the Company issued 133,333 shares of common stock upon the conversion
of 400,000 shares of series A preferred stock.





On May 4,
2010, we issued 43,750 shares of common stock in connection with the cashless
exercise of 58,333 warrants.





On May 7,
2010, we issued 7,000 shares of common stock to our Chief Executive Officer and
5,000 shares of common stock to two other key employees who are not executive
officers pursuant to our 2010 long-term incentive plan.


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 other 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.




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
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 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.  Electro-slag re-melted technology 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 expect to begin to test manufacture
products at this plant in the second quarter of 2010.




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.




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




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.  We believe that there is
a shortage of wind components in China’s wind energy supply chain. The shortage
is caused by the lack of forged products including rolled rings, shafts, and
gear rims which are used in the gearbox, and rolled rings used in yaw
bearings.




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


27


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





Three Months Ended March 31,2010
                  
                  
                  2009Dollars
                  
                  
                  %
                  
                  
                  Dollars
                  
                  
                  %Dyeing
      and finishing equipment
                  
                  $
                  4,993
                  
                  
                  
                  29.6
                  %
                  
                  $
                  3,530
                  
                  
                  
                  44.9
                  %Forged
      rolled rings - wind power industry
                  
                  
                  6,953
                  
                  
                  
                  41.3
                  %
                  
                  
                  2,724
                  
                  
                  
                  34.7
                  %Forged
      rolled rings – other industries
                  
                  
                  4,895
                  
                  
                  
                  29.1
                  %
                  
                  
                  1,607
                  
                  
                  
                  20.4
                  %Total
                  
                  $
                  16,841
                  
                  
                  
                  100.0
                  %
                  
                  $
                  7,861
                  
                  
                  
                  100.0
                  %





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




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




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





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.


28


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 its assets and
liabilities are included in our consolidated balance sheet. The VIEs do not have
any non-controlling interest and accordingly, did not subtract any net income in
calculating the net income attributable to us. Because of the contractual
arrangements, we have pecuniary interest in the Huayang Companies that require
consolidation of the Huayang Companies financial statements with our financial
statements.





Accounts
receivable





We have a
policy of reserving for uncollectible accounts based on our best estimate of the
amount of probable credit losses in our existing accounts receivable. We
periodically review our accounts receivable 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.


29


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 three months ended
March 31, 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 did not incur any research
and development expenses in the three months ended March 31, 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.





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.


30


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 Company is currently evaluating this new
ASU.





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





In
November 2009, the FASB issued an ASU regarding accounting for stock dividends,
including distributions to shareholders with components of stock and cash. This
ASU clarifies that the stock portion of a distribution to shareholders that
contains components of cash and stock and allows shareholders to select their
preferred form of the distribution (with a limit on the amount of cash that will
be distributed in total) should be considered a stock dividend and included in
EPS calculations as a share issuance. The adoption of this guidance did not
have a material impact on the Company’s consolidated financial
statements





In
December 2009, FASB issued ASU No. 2009-16, Accounting for Transfers of
Financial Assets. This Accounting Standards Update amends the FASB Accounting
Standards Codification for the issuance of FASB Statement No. 166,Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No. 140. The amendments
in this Accounting Standards Update improve financial reporting by eliminating
the exceptions for qualifying special-purpose entities from the consolidation
guidance and the exception that permitted sale accounting for certain mortgage
securitizations when a transferor has not surrendered control over the
transferred financial assets. In addition, the amendments require enhanced
disclosures about the risks that a transferor continues to be exposed to because
of its continuing involvement in transferred financial assets. Comparability and
consistency in accounting for transferred financial assets will also be improved
through clarifications of the requirements for isolation and limitations on
portions of financial assets that are eligible for sale accounting. The Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.




In
December 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167,Amendments to FASB Interpretation
No. 46(R). The amendments in this Accounting Standards Update replace the
quantitative-based risks and rewards calculation for determining which reporting
entity, if any, has a controlling financial interest in a variable interest
entity with an approach focused on identifying which reporting entity has the
power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance and (1) the obligation to
absorb losses of the entity or (2) the right to receive benefits from the
entity. An approach that is expected to be primarily qualitative will be more
effective for identifying which reporting entity has a controlling
financial interest in a variable interest entity. The amendments in this Update
also require additional disclosures about a reporting entity’s involvement in
variable interest entities, which will enhance the information provided to users
of financial statements. The Company is currently evaluating the impact of
this ASU, however, the Company does not expect the adoption of this ASU to have
a material impact on its consolidated financial statements.


31


In
January 2010, FASB issued ASU No. 2010-01- Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this Update
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 EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update 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.





In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity.  The amendments in this update are
effective beginning in the period that an entity adopts SFAS No. 160,
“Non-controlling Interests in Consolidated Financial Statements – An Amendment
of ARB No. 51.” If an entity has previously adopted SFAS No. 160 as of the
date the amendments in this update are included in the Accounting Standards
Codification, the amendments in this update are effective beginning in the first
interim or annual reporting period ending on or after December 15, 2009. The
amendments in this update should be applied retrospectively to the first period
that an entity adopted SFAS No. 160. The adoption of this ASU did not have a
material impact on our consolidated financial statements.





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. These disclosures
are effective for fiscal years beginning after December 15, 2010, and for
interim periods within those fiscal years. The adoption of this ASU did not have
a material impact on our consolidated financial statements.




Currency
Exchange Rates





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





Our
exposure to foreign exchange risk primarily relates to currency gains or losses
resulting from timing differences between signing of sales contracts and
settling of these contracts. Furthermore, we translate monetary assets and
liabilities denominated in other currencies into RMB, the functional currency of
our operating business. Our results of operations and cash flow are translated
at average exchange rates during the 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. As our sales
denominated in foreign currencies, such as RMB, continue to grow, we will
consider using arrangements to hedge our exposure to foreign currency exchange
risk.





Our
financial statements are expressed in U.S. dollars and the functional
currency of our parent company is U.S. dollars, but 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.


32


RESULTS
OF OPERATIONS





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




ThreeMonthsEndedMarch31,2010
                                                    
                                                    
                                                    2009Dollars
                                                    
                                                    
                                                    Percent
                                                    
                                                    
                                                    Dollars
                                                    
                                                    
                                                    PercentNet
      revenues
                                                    
                                                    $
                                                    16,841
                                                    
                                                    
                                                    
                                                    100.0
                                                    %
                                                    
                                                    $
                                                    7,861
                                                    
                                                    
                                                    
                                                    100.0
                                                    %Cost
      of revenues
                                                    
                                                    
                                                    12,424
                                                    
                                                    
                                                    
                                                    73.8
                                                    %
                                                    
                                                    
                                                    6,264
                                                    
                                                    
                                                    
                                                    79.7
                                                    %Gross
      profit
                                                    
                                                    
                                                    4,417
                                                    
                                                    
                                                    
                                                    26.2
                                                    %
                                                    
                                                    
                                                    1,597
                                                    
                                                    
                                                    
                                                    20.3
                                                    %Operating
      expenses
                                                    
                                                    
                                                    1,484
                                                    
                                                    
                                                    
                                                    8.8
                                                    %
                                                    
                                                    
                                                    579
                                                    
                                                    
                                                    
                                                    7.4
                                                    %Income
      from operations
                                                    
                                                    
                                                    2,933
                                                    
                                                    
                                                    
                                                    17.4
                                                    %
                                                    
                                                    
                                                    1,018
                                                    
                                                    
                                                    
                                                    13.0
                                                    %Other
      income (expenses)
                                                    
                                                    
                                                    (76
                                                    )
                                                    
                                                    
                                                    (0.4
                                                    )%
                                                    
                                                    
                                                    (35
                                                    )
                                                    
                                                    
                                                    (0.5
                                                    )%Income
      before provision for income taxes
                                                    
                                                    
                                                    2,857
                                                    
                                                    
                                                    
                                                    17.0
                                                    %
                                                    
                                                    
                                                    983
                                                    
                                                    
                                                    
                                                    12.5
                                                    %Provision
      for income taxes
                                                    
                                                    
                                                    910
                                                    
                                                    
                                                    
                                                    5.4
                                                    %
                                                    
                                                    
                                                    337
                                                    
                                                    
                                                    
                                                    4.3
                                                    %Net
      income
                                                    
                                                    
                                                    1,947
                                                    
                                                    
                                                    
                                                    11.6
                                                    %
                                                    
                                                    
                                                    646
                                                    
                                                    
                                                    
                                                    8.2
                                                    %Other
      comprehensive income:Foreign
      currency translation adjustment
                                                    
                                                    
                                                    7
                                                    
                                                    
                                                    
                                                    0.0
                                                    %
                                                    
                                                    
                                                    42
                                                    
                                                    
                                                    
                                                    0.5
                                                    %Comprehensive
      income
                                                    
                                                    $
                                                    1,954
                                                    
                                                    
                                                    
                                                    11.6
                                                    %
                                                    
                                                    $
                                                    688
                                                    
                                                    
                                                    
                                                    8.7
                                                    %




The
following table sets forth information as to the gross margin for our two lines
of business and for the electrical power equipment product line, which was
included in the forged rolled rings and related products segment for the three
months ended March 31, 2010 and 2009 (dollars in thousands).




Dyeing and
              finishing
              equipment
            
            
            Forged rolled
              rings and
              related
              products
            
            
            TotalThree Months Ended March 31, 2010Revenue
            
            $
            4,993
            
            
            $
            11,848
            
            
            $
            16,841Cost
      of sales
            
            $
            3,984
            
            
            $
            8,440
            
            
            $
            12,424Gross
      profit
            
            $
            1,009
            
            
            $
            3,408
            
            
            $
            4,417Gross
      margin %
            
            
            20.2
            %
            
            
            28.8
            %
            
            
            26.2
            %Three Months Ended March 31, 2009Revenue
            
            $
            3,530
            
            
            $
            4,331
            
            
            $
            7,861Cost
      of sales
            
            $
            2,778
            
            
            $
            3,486
            
            
            $
            6,264Gross
      profit
            
            $
            752
            
            
            $
            845
            
            
            $
            1,597Gross
      margin %
            
            
            21.3
            %
            
            
            19.5
            %
            
            
            20.3
            %




Revenues. For the three
months ended March 31, 2010, we had revenues of $16,841,000, as compared to
revenues of $7,861,000 for the three months ended march 31, 2009, an increase of
approximately 114.2%. The increase in total revenue was attributable to the
increases in revenue from forged rolled rings and revenue from dyeing and
finishing equipment, and is summarized as follows (dollars in
thousands):




For the Three
                      Months Ended
                      March 31, 2010
                    
                    
                    For the Three
                      Months Ended
                      March 31, 2009
                    
                    
                    Increase
                      (Decrease)
                    
                    
                    Percentage
                      ChangeDyeing
      and finishing equipment
                    
                    $
                    4,993
                    
                    
                    $
                    3,530
                    
                    
                    $
                    1,463
                    
                    
                    
                    41.5
                    %Forged
      rolled rings - wind power industry
                    
                    
                    6,953
                    
                    
                    
                    2,724
                    
                    
                    
                    4,229
                    
                    
                    
                    155.2
                    %Forged
      rolled rings – other industries
                    
                    
                    4,895
                    
                    
                    
                    1,607
                    
                    
                    
                    3,288
                    
                    
                    
                    204.6
                    %Total
      net revenues
                    
                    $
                    16,841
                    
                    
                    $
                    7,861
                    
                    
                    $
                    8,980
                    
                    
                    
                    114.2
                    %





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.


33


Revenues
from forging of rolled rings totaled $11,848,000 for the three months ended
March 31, 2010, with revenues from the wind power industry amounting to
$6,953,000 and revenues from other forging operations amounting to $4,895,000.
Due to the deliberate shift in focus of our sales effort to the wind segment, we
increased sales of forged rolled rings to the wind power industry by 155.2% for
the three months ended March 31, 2010 compared to the three months ended March
31, 2009. We also experienced a 204.6% increase in forging revenues from other
industries, such as the railway, heavy machinery manufacturing, petrochemical,
metallurgical, sea port machinery, and defense and radar industries.





Cost of sales. Cost of sales
for the three months ended March 31, 2010 increased $6,160,000 or 98.3%, from
$6,264,000 for the three months ended March 31, 2009 to $12,424,000 for the
three months ended March 31, 2010. Cost of goods sold for Dyeing was $3,984,000
for the three months ended March 31, 2010, as compared to $2,778,000 for the
three months ended March 31, 2009. Cost of sales related to the manufacture of
forged rolled rings and related products was $8,440,000 for the three months
ended March 31, 2010 as compared to $3,486,000 for the three months ended March
31, 2009.





Gross profit and gross
margin. Our gross profit was $4,417,000 for the three months ended March
31, 2010 as compared to $1,597,000 for the three months ended March 31, 2009,
representing gross margins of 26.2% and 20.3%, respectively. Gross profit for
Dyeing was $1,009,000 for the three months ended March 31, 2010 as compared to
$752,000 for the three months ended March 31, 2009, representing gross margins
of approximately 20.2% and 21.3%, respectively. The decrease in our gross margin
for Dyeing was attributable to an increase in the cost of raw materials, such as
steel and other metals, which could not be passed on to our customers during the
first quarter of fiscal 2010 as well as a reduction of our sales price due to
stronger competition resulting from the downturn in the textile industry in
China. Gross profit from forged rolled rings and related products segment was
$3,408,000 for the three months ended March 31, 2010 as compared to $845,000 for
the three months ended March 31, 2009, representing gross margins of
approximately 28.8% and 19.5%, respectively. The increase in our gross margin
was mainly attributed to operational efficiencies from the increase in our
production in the first quarter of fiscal 2010 as compared to the 2009 period.
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 $585,000 for the three months ended March 31, 2010 and $175,000 for the
three months ended March 31, 2009, of which $502,000 for the three months ended
March 31, 2010 and $97,000 for the three months ended March 31, 2009 is included
in cost of sales and $83,000 for the three months ended March 31, 2010 and
$78,000 for the three months ended March 31, 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. Beginning in the second quarter of 2009, our
new facility was placed in service and we began to generate revenues and,
accordingly, we began to depreciate the property and equipment associated with
the new facility.





Selling, general and administrative
expenses. Selling, general and administrative expenses totaled $1,401,000
for the three months ended March 31, 2010, as compared to $501,000 for the three
months ended March 31, 2009, an increase of $900,000 or approximately 179.7%.
Selling, general and administrative expenses consisted of the following (dollars
in thousands):





Three Months Ended
                    March 31, 2010
                  
                  
                  Three Months Ended
                    March 31, 2009Professional
      fees
                  
                  $
                  76
                  
                  
                  $
                  148Bad
      debt expense
                  
                  
                  251
                  
                  
                  
                  1Payroll
      and related benefits
                  
                  
                  427
                  
                  
                  
                  103Travel
                  
                  
                  90
                  
                  
                  
                  38Other
                  
                  
                  557
                  
                  
                  
                  211$
                  1,401
                  
                  
                  $
                  501





•
            Professional fees decreased for
      the three months ended March 31, 2010 by $72,000, or 48.6%, as compared to
      the three months ended March 31, 2009. The decrease is primarily
      attributed to a decrease in accounting expense of approximately $64,000, a
      decrease in investor relations expenses of approximately $34,000 offset by
      an increase in legal fees of approximately $2,000, an increase in stock
      transfer fees of approximately $12,000 and an increase in consulting
      expenses of approximately
$12,000.





•
            Bad debt expense increased for
      the three months ended March 31, 2010 by $250,000. 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 March 31, 2010 by $324,000, or
      316.0%, as compared to the three months ended March 31, 2009. The increase
      was mainly attributable to an increase in stock-based compensation for our
      management of approximately $312,000 and an increase in compensation and
      related benefits of approximately $12,000 in our forged rolled rings and
      related products segment resulting from increased
      operations.





•
            Travel expense for the three
      months ended March 31, 2010 increased by $51,000, or 134.2%, as compared
      to the three months ended March 31, 2009. The increase is related to an
      increase in travel for investor road shows and
      conferences.


34


•
            Other selling, general and
      administrative expenses increased by $346,000, or 164.6%, for the three
      months ended March 31, 2010 as compared with the three months ended March
      31, 2009. The increase was primarily attributed to an increase in shipping
      fees paid for our customers of approximately $332,000 and an increase in
      entertainment expenses of approximately
  $14,000.





Income from operations.For
the three months ended March 31, 2010, income from operations amounted to
$2,932,000, as compared to $1,018,000 for the three months ended March 31, 2009,
an increase of $1,914,000 or 188.0%.





Other income (expenses). For
the three months ended March 31, 2010, other expenses amounted to $76,000 as
compared to $35,000 for the three months ended March 31, 2009. For the three
months ended March 31, 2010, other expenses included:




•
            interest expense of $75,000,
      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 $30,000 incurred on our outstanding
    loans;





•
            foreign currency losses of
      $2,000; and





•
            interest income of
      $1,000.




For the
three months ended March 31, 2009, other expenses included:




•
            interest expense of $24,000,
      consisting of non-cash interest expense of $2,000 from the amortization of
      debt discount arising from our March 2009 financing and interest expense
      of $22,000 incurred on our outstanding
  loans;





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





•
            nominal foreign currency losses
      and interest income.





Income tax expense. Income
tax expense totaled $910,000 for the three months ended March 31, 2010, as
compared to $337,000 for the three months ended March 31, 2009, an increase of
$574,000, or approximately 170.4% 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 for the three months ended March 31, 2010 was
$1,947,000, or $0.11 per share (basic) and $0.08 per share (diluted). Net
income for the three months ended March 31, 2009 was $646,000, or $0.04 per
share (basic) and $0.03 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. As a result of these translations, which
are a non-cash adjustment, we reported a foreign currency translation gain of
$7,000 for the three months ended March 31, 2010 as compared to $42,000 for the
three months ended March 31, 2009. 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 March 31, 2010 of $1,954,000, compared with $688,000
for the three months ended March 31, 2009.





Liquidity
and Capital Resources





Liquidity
is the ability of a company to generate funds to support its current and future
operations, satisfy its obligations and otherwise operate on an ongoing basis.
At March 31, 2010 and December 31, 2009, we had cash balances of $2,470,245 and
$2,278,638, respectively. These funds are located in financial institutions
located as follows (dollars in thousands):





March 31, 2010
                  
                  
                  December 31, 2009Country:United
      States
                  
                  $
                  520
                  
                  
                  
                  21.1
                  %
                  
                  $
                  507
                  
                  
                  
                  22.2
                  %China
                  
                  
                  1,950
                  
                  
                  
                  78.9
                  %
                  
                  
                  1,772
                  
                  
                  
                  77.8
                  %Total
      cash and cash equivalents
                  
                  $
                  2,470
                  
                  
                  
                  100.0
                  %
                  
                  $
                  2,279
                  
                  
                  
                  100.0
                  %


35


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


December 31, 2009 to
                                      March 31, 2010Category
                                    
                                    2010
                                    
                                    
                                    2009
                                    
                                    
                                    Change
                                    
                                    
                                    Percent ChangeCurrent
      assets:Cash
      and cash equivalents
                                    
                                    $
                                    2,470
                                    
                                    
                                    $
                                    2,279
                                    
                                    
                                    
                                    191
                                    
                                    
                                    
                                    8.4
                                    %Notes
      receivable
                                    
                                    
                                    227
                                    
                                    
                                    
                                    329
                                    
                                    
                                    
                                    (102
                                    )
                                    
                                    
                                    (31.2
                                    )%Accounts
      receivable, net of allowance for doubtful accounts
                                    
                                    
                                    6,871
                                    
                                    
                                    
                                    6,046
                                    
                                    
                                    
                                    825
                                    
                                    
                                    
                                    13.6
                                    %Inventories,
      net of reserve for obsolete inventory
                                    
                                    
                                    3,328
                                    
                                    
                                    
                                    2,232
                                    
                                    
                                    
                                    1,096
                                    
                                    
                                    
                                    49.1
                                    %Advances
      to suppliers
                                    
                                    
                                    561
                                    
                                    
                                    
                                    451
                                    
                                    
                                    
                                    110
                                    
                                    
                                    
                                    24.6
                                    %Prepaid
      value-added taxes on purchase
                                    
                                    
                                    868
                                    
                                    
                                    
                                    379
                                    
                                    
                                    
                                    489
                                    
                                    
                                    
                                    129.2
                                    %Prepaid
      expenses and other current assets
                                    
                                    
                                    84
                                    
                                    
                                    
                                    214
                                    
                                    
                                    
                                    (130
                                    )
                                    
                                    
                                    (60.9
                                    )%Current
      liabilities:Loans
      payable
                                    
                                    
                                    1,755
                                    
                                    
                                    
                                    2,040
                                    
                                    
                                    
                                    (285
                                    )
                                    
                                    
                                    (14.0
                                    )%Accounts
      payable
                                    
                                    
                                    4,547
                                    
                                    
                                    
                                    3,405
                                    
                                    
                                    
                                    1,142
                                    
                                    
                                    
                                    33.5
                                    %Accrued
      expenses
                                    
                                    
                                    476
                                    
                                    
                                    
                                    557
                                    
                                    
                                    
                                    (81
                                    )
                                    
                                    
                                    (14.5
                                    )%VAT
      and service taxes payable
                                    
                                    
                                    104
                                    
                                    
                                    
                                    25
                                    
                                    
                                    
                                    79
                                    
                                    
                                    
                                    312.4
                                    %Advances
      from customers
                                    
                                    
                                    329
                                    
                                    
                                    
                                    143
                                    
                                    
                                    
                                    186
                                    
                                    
                                    
                                    129.5
                                    %Income
      tax payable
                                    
                                    
                                    952
                                    
                                    
                                    
                                    1,019
                                    
                                    
                                    
                                    (67
                                    )
                                    
                                    
                                    (6.6
                                    )%Working
      capital:Total
      current assets
                                    
                                    
                                    14,409
                                    
                                    
                                    
                                    11,930
                                    
                                    
                                    
                                    2,479
                                    
                                    
                                    
                                    20.8
                                    %Total
      current liabilities
                                    
                                    
                                    8,163
                                    
                                    
                                    
                                    7,189
                                    
                                    
                                    
                                    974
                                    
                                    
                                    
                                    13.6
                                    %Working
      capital
                                    
                                    
                                    6,246
                                    
                                    
                                    
                                    4,741
                                    
                                    
                                    
                                    1,505
                                    
                                    
                                    
                                    31.7
                                    %





Our
working capital increased $1,505,000 to $6,246,000 at March 31, 2010 from
working capital of $4,741,000 at December 31, 2009. This increase in working
capital is primarily attributable to an increase in cash of $191,000, an
increase in accounts receivable, net of allowance for doubtful accounts of
$825,000, an increase in inventories, net of reserve for obsolete inventory of
$1,096,000, an increase in advances to suppliers of $110,000, an increase in
prepaid value-added taxes on purchase of $489,000, a decrease in loans payable
of $285,000, a decrease in accrued expenses of $81,000 and a decrease in income
tax payable of $67,000 offset by a decrease in notes receivable of $102,000, a
decrease in prepaid expenses and other current assets of $130,000, an increase
in accounts payable of $1,142,000, an increase in VAT and service taxes payable
of $79,000 and an increase in advances from customers of $186,000.





Net cash
flow provided by operating activities was $1,732,000 for the three months ended
March 31, 2010 as compared to net cash flow provided by operating activities of
$189,000 for the three months ended March 31, 2009, an increase of $1,543,000.
Net cash flow provided by operating activities for the three months ended March
31, 2010 was mainly due to net income of $1,947,000 and the add-back of non-cash
items such as depreciation of $585,000, the amortization of debt discount to
interest expense of $45,000, the amortization of land use rights of $22,000, the
increase in allowance for doubtful accounts of $251,000, and stock-based
compensation of $286,000, and changes in operating assets and liabilities such
as a decrease in notes receivable of $103,000, a decrease in prepaid and other
current assets of $138,000, an increase in accounts payable of $1,142,000, an
increase in VAT and service taxes payable of $79,000 and an increase in advances
from customers of $186,000, offset by an increase in accounts receivable of
$1,075,000, an increase in inventories of $1,096,000, an increase in prepaid
value-added taxes on purchases of $489,000, an increase in advances to suppliers
of $111,000, a decrease in accrued expenses of $212,000 and a decrease in income
taxes payable of $67,000. Net cash flow provided by operating activities for the
three months ended March 31, 2009 was mainly due to net income of $646,000, the
add-back of non cash items such as depreciation of $175,000 the amortization of
debt discount of $1,500, the amortization of land-use rights of $22,000 and
stock-based compensation of $42,000, and changes in operating assets and
liabilities such as a decrease in notes receivable of $70,000, a decrease in due
from related party of $438,000, an increase of accrued expense of $46,000 and an
increase in advances from customers of $54,000, offset by an increase in
inventory of $515,000, a decrease in income tax payable of $233,000 and an
increase in accounts receivable of $377,000.




Net cash
flow used in investing activities was $2,811,000 for the three months ended
March 31, 2010 as compared to net cash used in investing activities of $952,000
for the three months ended March 31, 2009. For the three months ended March 31,
2010, we purchased property and equipment of $2,811,000. In October 2009, we
ordered the initial machinery and began leasehold improvements to expand our
forged products facilities with 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 expect to spend an additional
$2,000,000 in the second quarter of 2010 on equipment and leasehold improvements
related to this expansion. For the three months ended March 31, 2009, we used
cash to purchase of property and equipment of $952,000.





Net cash
flow provided by financing activities was $1,270,000 for the three months ended
March 31, 2010 as compared to net cash provided by financing activities of
$542,000 for the three months ended March 31, 2009. For the three months ended
March 31, 2010, we received $1,600,000 from the exercise of warrants offset by
the repayment of loans payable of $330,000. For the three months ended March 31,
2009, we received gross proceeds from our loans payable of
$542,000.


36


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 March 31, 2010
(dollars in thousands), and the effect these obligations are expected to have on
our liquidity and cash flows in future periods.




Payments Due by PeriodTotal
                    
                    
                    Less than
                      1 year
                    
                    
                    1-3 Years
                    
                    
                    3-5
                      Years
                    
                    
                    5 Years
                      +Contractual Obligations :Bank
      indebtedness (1)
                    
                    $
                    1,755
                    
                    
                    $
                    1,755
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -Total
      Contractual Obligations:
                    
                    $
                    1,755
                    
                    
                    $
                    1,755
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -




(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 three months ended March 31, 2010, we had unrealized
foreign currency translation gain of $7,270, 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 March 31,
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 Messrs. 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 March 31, 2010.


37


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. However,
management believes that these deficiencies do not amount to a material
weakness. Therefore, our internal control over financial reporting was effective
as of March 31, 2010.





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 extensive experience in
      internal control and U.S. GAAP reporting compliance, and, together with
      our chief executive officer, oversee 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 2009.
      However, we will increase our search for qualified candidates with
      assistance from recruiters and through
  referrals.




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




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




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





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





Our
management is not aware of any material weaknesses in our internal control over
financial reporting, and nothing has come to the attention of management that
causes them to believe that any material inaccuracies or errors exist in our
financial statement as of March 31, 2010.  The reportable conditions and
other areas of our internal control over financial reporting identified by us as
needing improvement have not resulted in a material restatement of our financial
statements. We are not aware of any instance where such reportable conditions or
other identified areas of weakness have resulted in a material misstatement of
omission in any report we have filed with or submitted to the SEC. Since
management has concluded that no errors or restatements have occurred and
believes that controls were in place during the 2009 quarters that would detect
or prevent a material misstatement in our consolidated financial statements,
management has concluded that that there was not a material weakness in
controls.





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


38


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
January 31, 2010, we issued 1,500 shares of common stock to our Chief Financial
Officer for services rendered and will be rendered pursuant to an engagement
agreement. The shares were valued at fair value on the date of grant and we
recorded stock-based compensation of $3,400 and prepaid expense of
$4,250.





On
February 10, 2010, we issued 28,000 shares of common stock to our Chief
Executive Officer and 20,000 shares of common stock to two other key employees
who are not executive officers pursuant to our 2010 long-term incentive plan.
The shares were valued at fair value on the date of grant and we recorded
stock-based compensation of $276,480.





On March
31, 2010, we issued 2,000 shares of common stock to our vice president of
financial reporting for services rendered and will be rendered pursuant to an
engagement agreement. The shares were valued at fair value on the date of grant
and we recorded stock-based compensation of $6,440 and prepaid expense of
$3,220.





During
the three months ended March 31, 2010, we issued 755,000 shares of common stock
upon the conversion of 2,265,000 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 stock warrants for which the Company received cash proceeds of
$1,600,000. In connection with the issuance of the 2,380,177 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.





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





ITEM 6. EXHIBITS




31.1
                
                Rule
      13a-14(a)/15d-14(a) certification of Chief Executive
    Officer31.2
                
                Rule
      13a-14(a)/15d-14(a) certificate of Principal Financial
    Officer32.1
                
                Section
      1350 certification of Chief Executive Officer and Chief Financial
      Officer


39


SIGNATURES





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





CHINA
      WIND SYSTEMS, INC.Date:
      May 14, 2010
              By:
              /s/ Jianhua WuJianhua
      Wu, Chief Executive OfficerDate:
      May 14, 2010
              By:
              /s/ Teresa ZhangTeresa
      Zhang, Chief Financial
Officer


40