**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM
        10-Q**
 
 **x**
              **QUARTERLY
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934****FOR
                  THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008****OR**** ̈**
              **TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
 
 **Commission
        file number 000-53052**
 
 **SMARTHEAT
        INC.**
 *(Exact
        name of registrant as specified in its charter)*
 
 **NEVADA**
              
              **98-0514768***(State
                  or other jurisdiction of*
              
              *(IRS
                  Employer**incorporation
                  or organization)*
              
              *Identification
                  No.)*
 
 **A-1,
        10, Street 7**
 **Shenyang
        Economic and Technological Development Zone**
 **Shenyang,
        China**
 **110027**
 *(Address
        of principal executive offices, including zip code.)*
 
 **+86
        (24) 2519-7699**
 *(telephone
        number, including area code)*
 
 (Former
        name or former address, if changed since last report)
 
 Check
        whether the issuer (1) filed all reports required to be filed by Section
        13 or
        15(d) of the Exchange Act during the past 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 last 90 days.
 **YES** **x** **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,”
“non-accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the
        Exchange Act.
 
 **Large accelerated filer**** ̈**
              
              **Accelerated filer**** ̈****Non-accelerated filer**** ̈**
              
              **Smaller reporting company****x**(do not check if a smallerreporting company)
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act). **YES** ** ̈** **NO** **x**
 
 State
        the
        number of shares outstanding of each of the issuer’s classes of common equity,
        as of the latest practicable date: 24,179,900 shares as of November 3,
        2008.
  
 
 **TABLE
        OF CONTENTS**
 
 PART I –
FINANCIAL
                  INFORMATION
              
              1Item 1.
              Financial
                  Statements
              
              1**13.
                  DEFFERED TAX LIABILITY**
              
              13Deferred
                  tax liability represented differences between the tax bases and
                  book bases
                  of property and equipment and intangible assets arising from the
                  acquisition of SanDeKe.
              
              13Item 2.
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              
              18Item 3.
              Quantitative
                  and Qualitative Disclosures About Market Risk
              
              26Item 4T.
              Controls
                  and Procedures
              
              26Item 1.
              Legal
                  Proceedings
              
              27Item 1A.
              Risk
                  Factors
              
              27Item 2.
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              
              27Item 3.
              Defaults
                  Upon Senior Securities
              
              27Item 4.
              Submission
                  of Matters to a Vote of Security Holders
              
              27Item 5.
              Other
                  Information
              
              27Item 6.
              Exhibits
              
              27SIGNATURES
              
              28
  
 **SMARTHEAT
          INC. AND SUBSIDIARIES**
 **CONSOLIDATED
          BALANCE SHEETS**
  **PART
        I – FINANCIAL INFORMATION**
  **Item
        1.**  **Financial
        Statements**
  AS OF SEPTEMBER 30, 2008
              
              AS OF DECEMBER 31, 2007(Unaudited)**ASSETS**CURRENT
                  ASSETSCash
                  & cash equivalents
              
              $
              1,702,938
              
              $
              393,147Restricted
                  cash
              
              
              678,642
              
              
              537,098Accounts
                  receivable, net
              
              
              11,797,010
              
              
              4,762,822Retentions
                  receivable
              
              
              271,173
              
              
              191,319Prepaid
                  expenses
              
              
              8,316
              
              
              -Advances
                  to suppliers
              
              
              154,290
              
              
              158,750Other
                  receivables
              
              
              3,351,498
              
              
              766,231Inventories
              
              
              8,454,000
              
              
              7,928,408Due
                  from related party
              
              
              251,547
              
              
              118,560Notes
                  receivable
              
              
              203,696
              
              
              -Total
                  current assets
              
              
              26,873,110
              
              
              14,856,335NON-CURRENT
                  ASSETSAccounts
                  receivable, net
              
              
              -
              
              
              949,998Retentions
                  receivable
              
              
              -
              
              
              169,309Intangible
                  assets, net
              
              
              1,176,351
              
              
              534,208Property
                  and equipment, net
              
              
              2,349,147
              
              
              2,040,809Construction
                  in progress
              
              
              85,036
              
              
              -Total
                  noncurrent assets
              
              
              3,610,534
              
              
              3,694,324TOTAL
                  ASSETS
              
              **$**
              **30,483,644**
              
              **$**
              **18,550,659****LIABILITIES
                  AND STOCKHOLDERS' EQUITY**CURRENT
                  LIABILITIESAccounts
                  payable
              
              $
              4,635,664
              
              $
              3,128,585Unearned
                  revenue
              
              
              2,282,353
              
              
              3,125,406Taxes
                  payable
              
              
              1,423,528
              
              
              503,010Accrued
                  liabilities and other payables
              
              
              1,398,402
              
              
              807,700Due
                  to related party
              
              
              -
              
              
              445,990Due
                  to minority shareholder
              
              
              5,274
              
              
              -Loans
                  payable
              
              
              3,548,746
              
              
              4,619,856Total
                  current liabilities
              
              
              13,293,967
              
              
              12,630,547DEFERRED
                  TAX LIABILITY
              
              
              39,112
              
              
              -COMMITMENTS
                  AND CONTINGENCIESMINORITY
                  INTEREST
              
              
              -
              
              
              -STOCKHOLDERS'
                  EQUITYCommon
                  stock, $0.001 par value; 75,000,000shares
                  authorized, 24,179,900 and 18,500,000shares
                  issued and outstanding at September 30,2008
                  and December 31, 2007, respectively
              
              
              24,180
              
              
              18,500Paid
                  in capital
              
              
              8,219,898
              
              
              3,102,132Statutory
                  reserve
              
              
              1,064,768
              
              
              506,532Accumulated
                  other comprehensive income
              
              
              1,052,529
              
              
              473,859Retained
                  earnings
              
              
              6,789,190
              
              
              1,819,089Total
                  stockholders' equity
              
              
              17,150,565
              
              
              5,920,112TOTAL
                  LIABILITIES AND STOCKHOLDERS' EQUITY
              
              **$**
              **30,483,644**
              
              **$**
              **18,550,659**
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements
  1
 
 **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF INCOME AND OTHER**
 **COMPREHENSIVE
        INCOME**
 **(Unaudited)**
 
 **FOR THE NINE MONTHS ENDED SEPTEMBER 30,**
              
              **FOR THE THREE MONTHS ENDED SEPTEMBER 30,****2008**
              
              **2007**
              
              **2008**
              
              **2007**Net
                  sales
              
              $
              29,345,571
              
              $
              5,473,573
              
              $
              20,708,288
              
              $
              3,015,606Cost
                  of goods sold
              
              
              19,502,070
              
              
              3,679,507
              
              
              13,273,914
              
              
              2,080,718Gross
                  profit
              
              
              9,843,501
              
              
              1,794,066
              
              
              7,434,374
              
              
              934,888Operating
                  expensesSelling
                  expenses
              
              
              1,664,882
              
              
              805,099
              
              
              1,056,854
              
              
              320,206General
                  and administrative expenses
              
              
              1,470,577
              
              
              528,215
              
              
              1,024,107
              
              
              229,373Total
                  operating expenses
              
              
              3,135,459
              
              
              1,333,314
              
              
              2,080,961
              
              
              549,579Income
                  from operations
              
              
              6,708,042
              
              
              460,752
              
              
              5,353,413
              
              
              385,309Non-operating
                  income (expenses)Interest
                  income
              
              
              318,070
              
              
              142,583
              
              
              57,387
              
              
              -Interest
                  expense
              
              
              (257,116
              )
              
              (170,985
              )
              
              (94,076
              )
              
              (104,857
              )Investment
                  expense
              
              
              (1,628
              )
              
              -
              
              
              (1,628
              )
              
              -Non-operating
                  income
              
              
              9,744
              
              
              22,110
              
              
              9,744
              
              
              22,110Non-operating
                  expense
              
              
              (2,990
              )
              
              (6,285
              )
              
              (11,280
              )
              
              (18,285
              )Exchange
                  loss
              
              
              (9,058
              )
              
              (11,855
              )
              
              (9,058
              )
              
              (11,855
              )Subsidy
                  income
              
              
              16,141
              
              
              52,193
              
              
              7,000
              
              
              363Total
                  non-operating income (expenses)
              
              
              73,163
              
              
              27,761
              
              
              (41,911
              )
              
              (112,524
              )Income
                  before income tax
              
              
              6,781,205
              
              
              488,513
              
              
              5,311,502
              
              
              272,785Income
                  tax expense
              
              
              1,246,935
              
              
              105,256
              
              
              980,907
              
              
              52,770Income
                  after income tax
              
              
              5,534,270
              
              
              383,257
              
              
              4,330,595
              
              
              220,015Less:
                  minority interest
              
              
              5,934
              
              
              (1,859
              )
              
              5,934
              
              
              (13
              )Net
                  income
              
              
              5,528,336
              
              
              385,116
              
              
              4,324,661
              
              
              220,028Other
                  comprehensive itemForeign
                  currency translation
              
              
              578,670
              
              
              147,335
              
              
              167,774
              
              
              70,081Comprehensive
                  Income
              
              $
              6,107,006
              
              $
              532,451
              
              $
              4,492,435
              
              $
              290,109Basic
                  weighted average shares outstanding
              
              
              21,503,588
              
              
              18,500,000
              
              
              24,055,878
              
              
              18,500,000Diluted
                  weighted average shares outstanding
              
              
              21,503,647
              
              
              18,500,000
              
              
              24,056,054
              
              
              18,500,000Basic
                  earnings per share
              
              $
              0.26
              
              $
              0.02
              
              $
              0.18
              
              $
              0.01Diluted
                  earnings per share
              
              $
              0.26
              
              $
              0.02
              
              $
              0.18
              
              $
              0.01
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements
  2
 
 **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 **(Unaudited)**
 
 **FOR THE NINE MONTHS ENDED SEPTEMBER 30,****2008**
              
              **2007**CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  income
              
              $
              5,528,336
              
              $
              385,116Adjustments
                  to reconcile net income to net cashprovided
                  by operating activities:Depreciation
                  and amortization
              
              
              173,821
              
              
              90,888Unearned
                  interest on accounts receivable
              
              
              (71,804
              )
              
              (91,645
              )Stock
                  option compensation expense
              
              
              1,270
              
              
              -Minority
                  interest
              
              
              5,934
              
              
              (1,859
              )(Increase)
                  decrease in current assets:Accounts
                  receivable
              
              
              (4,995,840
              )
              
              2,234,468Retentions
                  receivable
              
              
              107,279
              
              
              376,944Advances
                  to suppliers
              
              
              320,260
              
              
              (1,186,901
              )Other
                  receivables
              
              
              (2,346,526
              )
              
              (94,544
              )Inventory
              
              
              118,223
              
              
              (3,696,182
              )Other
                  assets
              
              
              -
              
              
              (1,433,510
              )Increase
                  (decrease) in current liabilities:Accounts
                  payable
              
              
              928,337
              
              
              648,667Unearned
                  revenue
              
              
              (1,581,803
              )
              
              1,938,100Taxes
                  payable
              
              
              864,934
              
              
              (518,038
              )Accrued
                  liabilities and other payables
              
              
              (266,072
              )
              
              267,750Net
                  cash used in operating activities
              
              
              (1,213,651
              )
              
              (1,080,746
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Restricted
                  cash
              
              
              (101,542
              )
              
              (71,483
              )Acquisition
                  of property & equipment
              
              
              (287,398
              )
              
              (184,535
              )Construction
                  in progress
              
              
              (83,027
              )
              
              (401,961
              )Net
                  cash used in investing activities
              
              
              (471,967
              )
              
              (657,979
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Due
                  to minority shareholders
              
              
              (660
              )
              
              -Due
                  from / (to) shareholder
              
              
              (587,644
              )
              
              (201,173
              )Notes
                  receivable
              
              
              (201,118
              )
              
              (6,524
              )Short
                  term loans
              
              
              (1,361,113
              )
              
              2,314,795Capital
                  contribution, shares issued
              
              
              5,100,000
              
              
              -Net
                  cash provided by financing activities
              
              
              2,949,465
              
              
              2,107,098EFFECT
                  OF EXCHANGE RATE CHANGE ON CASH & CASH EQUIVALENTS
              
              
              (9,482
              )
              
              16,811NET
                  INCREASE IN CASH & CASH EQUIVALENTS
              
              
              1,254,365
              
              
              385,184CASH
                  & CASH EQUIVALENTS, BEGINNING OF PERIOD
              
              
              448,573
              
              
              202,295CASH
                  & CASH EQUIVALENTS, END OF PERIOD
              
              $
              1,702,938
              
              $
              587,479Supplemental
                  Cash flow data:Income
                  tax paid
              
              $
              426,809
              
              $
              95,082Interest
                  paid
              
              $
              201,269
              
              $
              180,265
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements
  3
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 **1.
        ORGANIZATION AND DESCRIPTION OF BUSINESS**
 
 SmartHeat
        Inc., formerly known as Pacific Goldrim Resources, Inc. (the “Company” or
“SmartHeat”), was incorporated on August 4, 2006 in the State of Nevada. The
        Company is engaged in the manufacturing and sale of plate heat exchangers
        and
        various packages, thermometer testing devices and heat usage calculators
        through
        its wholly owned operating subsidiary in China.
 
 On
        April
        14, 2008, the Company entered into a Share Exchange Agreement with Shenyang
        Taiyu Machinery and Electronic Equipment Co., Ltd. ("Taiyu") and the Taiyu
        Shareholders. The Company issued 18,500,000 shares of its common stock to
        the
        shareholder of Taiyu in exchange for all of the equitable and legal rights,
        title and interests in and to Taiyu's share capital in the amount of RMB
        25,000,000. Concurrent with the share exchange, one of SmartHeat’s shareholders
        cancelled 2,500,000 shares out of 6,549,900 of total issued and outstanding
        shares of SmartHeat pursuant to the Split-Off Agreement dated April 14, 2008.
        As
        a result of the share exchange and the cancellation of the 2,500,000 shares
        of
        the Company's common stock, there are 22,549,900 shares of the Company's
        common
        stock issued and outstanding, approximately 82.04% of which are held by the
        former Taiyu Shareholders.  The shareholders of the Company
        immediately prior to the completion of these transactions hold the remaining
        17.96% of the issued and outstanding share capital of SmartHeat. Taiyu became
        a
        wholly-owned subsidiary of SmartHeat.
 
 Prior
        to
        the acquisition of Taiyu, the Company was a non-operating public shell
        corporation. Pursuant to Securities and Exchange Commission ("SEC") rules,
        the
        merger or acquisition of a private operating company into a non-operating
        public
        shell corporation with nominal net assets is considered a capital transaction
        in
        substance, rather than a business combination. Accordingly, for accounting
        purposes, the transaction has been treated as a reverse acquisition and a
        recapitalization, and pro-forma information is not presented. Transaction
        costs
        incurred in the reverse acquisition have been charged to expense.
 
 Taiyu
        was
        incorporated in the Liaoning Province, People’s Republic of China (“PRC” or
        "China") in July, 2002. Taiyu is engaged in the manufacturing and sale of
        plate
        heat exchangers and various packages, thermo meter testing devices and heat
        usage calculators. The Company is an authorized dealer of the SONDEX brand;
        SONDEX is the second largest plate heat exchanger manufacturer in the
        world.
 
 On
        September 25, 2008, the Company entered into the Share Exchange Agreement
        (the
        "Agreement") between Asialink (Far East) Limited ("Asialink") and the Company
        providing for the acquisition by the Company from Asialink of all of the
        outstanding capital stock of San De Ke Co., Ltd., a Shanghai based manufacturer
        of heat plate exchangers ("SanDeKe"). The purchase price for the SanDeKe
        shares
        was $741,516, of which $222,455 was payable within 15 days after the signature
        date of the Agreement, $370,758 is payable within 15 days after all necessary
        documents have been filed with government agencies, and $148,303 of which
        is
        payable within 15 days after the purchase has been approved and registered
        by
        the government agencies. Under the terms of the Agreement, two of the
        shareholders of SanDeKe have agreed not to compete with the business of SanDeKe
        for a period of four years after the completion of the purchase.
 
 The
        unaudited financial statements have been prepared by the Company,
        pursuant to the rules and regulations of the SEC.  The information
        furnished herein reflects all adjustments (consisting of normal recurring
        accruals and adjustments) which are, in the opinion of management, necessary
        to
        fairly present the operating results for the respective periods. Certain
        information and footnote disclosures normally present in annual financial
        statements prepared in accordance with accounting principles generally accepted
        in the United States of America have been omitted pursuant to such rules
        and
        regulations. These financial statements should be read in conjunction with
        the 2007 audited financial statements and footnotes included in the
        Company’s audited financial statements.  The results for the nine
        months ended September 30, 2008 are not necessarily indicative of the results
        to
        be expected for the full year ending December 31, 2008.
 
 **2.
        SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**
  **Principles
        of Consolidation**
 
 The
        accompanying consolidated financial statements include the accounts of
        SmartHeat, SanDeKe, Taiyu, and Taiyu’s 55% owned subsidiary, Qingdao Yushi Heat
        Power Equipment Co., Ltd ("Yushi"). Yushi is engaged in manufacturing and
        selling of heat power equipment. For purposes of this Quarterly Report, the
        "Company" refers collectively to SmartHeat, SanDeKe, Taiyu and Yushi. All
        significant inter-company accounts and transactions have been eliminated
        in
        consolidation.
  4
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 **Use
        of Estimates**
 
 In
        preparing the financial statements in conformity with accounting principles
        generally accepted in the United States of America, management makes estimates
        and assumptions that affect the reported amounts of assets and liabilities
        and
        disclosures of contingent assets and liabilities at the dates of the financial
        statements, as well as the reported amounts of revenues and expenses during
        the
        reporting year. Significant estimates, required by management, include the
        recoverability of long-lived assets and the valuation of inventories. Actual
        results could differ from those estimates.
  **Cash
        and Cash Equivalents**
 
 For
        purposes of the statement of cash flows, the Company considers all highly
        liquid
        investments with an original maturity of three months or less to be cash
        equivalents. As of September 30, 2008 and December 31, 2007, the Company
        maintained restricted cash of $678,642 and $537,098, respectively, in several
        bank accounts, which was pledged for the guarantee of certain contracts
        execution and completion.
 
 **Accounts
        and Retentions Receivable**
  The
        Company’s policy is to maintain reserves for potential credit losses on accounts
        receivable. Management reviews the composition of accounts receivable and
        analyzes historical bad debts, customer concentrations, customer credit
        worthiness, current economic trends and changes in customer payment patterns
        to
        evaluate the adequacy of these reserves. Based on historical collection
        activity, the Company had allowances of $353,621 and $330,518 at September
        30,
        2008 and December 31, 2007, respectively.
 
 At
        September 30, 2008 and December 31, 2007, the Company had retentions receivable
        from customers for product quality assurance in the amount of $271,173 and
        $360,628, respectively. The retention rate varies from 5% to 20% of the sales
        price with variable terms from 3 months to two years.
 
 Accounts
        receivable is net of unearned interest of $85,254 and $148,421 at September
        30,
        2008 and December 31, 2007, respectively. Unearned interest represents imputed
        interest on accounts receivable with due dates over one year from the invoice
        date discounted at the Company's borrowing rate which was 7.04% in 2008 and
        2007.
 
 **Inventories**
 
 Inventories
        are valued at the lower of cost or market with cost determined on a moving
        weighted average basis. Cost of work in progress and finished goods comprises
        direct material, direct production cost and an allocated portion of production
        overheads.
  **Property
        and Equipment**
 
 Property
        and equipment are stated at cost, net of accumulated depreciation. Expenditures
        for maintenance and repairs are expensed as incurred; additions, renewals
        and
        betterments are capitalized. When property and equipment are retired or
        otherwise disposed of, the related cost and accumulated depreciation are
        removed
        from the respective accounts, and any gain or loss is included in operations.
        Depreciation of property and equipment is provided using the straight-line
        method with a 10% salvage value and estimated lives ranging from 5 to 20
        years
        as follows:
 
 Building
              
              
              20 yearsVehicle
              
              
              5 yearsOffice
                  Equipment
              
              
              5 yearsProduction
                  Equipment
              
              
              5-10 years
  5
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 **Land
        Use Right**
  Right
        to
        use land is stated at cost less accumulated amortization. Amortization is
        provided using the straight-line method over 50 years.
  **Impairment
        of Long-Lived Assets**
  Long-lived
        assets, which include property, plant and equipment and intangible assets,
        are
        reviewed for impairment whenever events or changes in circumstances indicate
        that the carrying amount of an asset may not be recoverable.
  Recoverability
        of long-lived assets to be held and used is measured by a comparison of the
        carrying amount of an asset to the estimated undiscounted future cash flows
        expected to be generated by the asset. If the carrying amount of an asset
        exceeds its estimated undiscounted future cash flows, an impairment charge
        is
        recognized by the amount by which the carrying amount of the asset exceeds
        the
        fair value of the assets. Fair value is generally determined using the asset’s
        expected future discounted cash flows or market value, if readily determinable.
        Based on its review, the Company believes that, as of September 30, 2008
        and
        December 31, 2007, there were no significant impairments of its long-lived
        assets.
  **Income
        Taxes**
 
 The
        Company utilizes Statement of Financial Accounting Standards ("SFAS") No.
        109,
“Accounting for Income Taxes,” which requires the recognition of deferred tax
        assets and liabilities for the expected future tax consequences of events
        that
        have been included in the financial statements or tax returns. Under this
        method, deferred income taxes are recognized for the tax consequences in
        future
        years of differences between the tax bases of assets and liabilities and
        their
        financial reporting amounts at each period end based on enacted tax laws
        and
        statutory tax rates applicable to the periods in which the differences are
        expected to affect taxable income. Valuation allowances are established,
        when
        necessary, to reduce deferred tax assets to the amount expected to be
        realized.
 
 The
        Company does not have any significant deferred tax asset or liability that
        relates to tax jurisdictions not covered by the tax holiday.
 
 The
        Company adopted the provisions of the Financial Accounting Standards Board's
        ("FASB") Interpretation No. 48, Accounting for Uncertainty in Income Taxes,
        on
        January 1, 2007. As a result of the implementation of FIN 48, the Company
        made a
        comprehensive review of its portfolio of tax positions in accordance with
        recognition standards established by FIN 48. As a result of the implementation
        of Interpretation 48, the Company recognized no material adjustments to
        liabilities or shareholders’ equity. When tax returns are filed, it is highly
        certain that some positions taken would be sustained upon examination by
        the
        taxing authorities, while others are subject to uncertainty about the merits
        of
        the position taken or the amount of the position that would be ultimately
        sustained. The benefit of a tax position is recognized in the financial
        statements in the period during which, based on all available evidence,
        management believes it is more likely than not that the position will be
        sustained upon examination, including the resolution of appeals or litigation
        processes, if any. Tax positions taken are not offset or aggregated with
        other
        positions. Tax positions that meet the more-likely-than-not recognition
        threshold are measured as the largest amount of tax benefit that is more
        than 50
        percent likely of being realized upon settlement with the applicable taxing
        authority. The portion of the benefits associated with tax positions taken
        that
        exceeds the amount measured as described above is reflected as a liability
        for
        unrecognized tax benefits in the accompanying balance sheets along with any
        associated interest and penalties that would be payable to the taxing
        authorities upon examination.
 
 Interest
        associated with unrecognized tax benefits is classified as interest expense
        and
        penalties are classified as selling, general and administrative expense in
        the
        statements of income. The adoption of FIN 48 did not have a material impact
        on
        the Company’s financial statements.
 
 **Revenue
        Recognition**
 
 The
        Company's revenue recognition policies are in compliance with SEC Staff
        Accounting Bulletin 104. Sales revenue is recognized at the date of shipment
        to
        customers when a formal arrangement exists, the price is fixed or determinable,
        the delivery is completed, no other significant obligations of the Company
        exist
        and collectability is reasonably assured. Payments received before all of
        the
        relevant criteria for revenue recognition are recorded as unearned
        revenue.
  6
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 Sales
        revenue represents the invoiced value of goods, net of value-added tax ("VAT").
        All of the Company’s products that are sold in the PRC are subject to Chinese
        value-added tax of 17% of the gross sales price. This VAT may be offset by
        VAT
        paid by the Company on raw materials and other materials included in the
        cost of
        producing their finished product. The Company recorded VAT payable and VAT
        receivable net of payments in the financial statements. The VAT tax return
        is
        filed offsetting the payables against the receivables.
 
 Sales
        and
        purchases are recorded net of VAT collected and paid as the Company acts
        as an
        agent for the government. VAT taxes are not affected by the income tax
        holiday.
 
 Sales
        returns and allowances were $0 for both the nine and three months ended
        September 30, 2008 and 2007. The Company does not provide unconditional right
        of
        return, price protection or any other concessions to its customers. The Company
        provides free after-sale service for a period of one year. After-sale expense
        was $61,106 and $232,581 for the nine months ended September 30, 2008 and
        2007;
        and $28,783 and $185,584 for the three months ended September 30, 2008 and
        2007,
        respectively.
 
 **Cost
        of Goods Sold**
  Cost
        of
        goods sold consists primarily of material costs, direct labor, and manufacturing
        overhead which are directly attributable to the production of products. 
Write-down of inventories to lower of cost or market is also recorded in
        cost of
        goods sold.
 
 **Concentration
        of Credit Risk**
 
 Financial
        instruments that potentially subject the Company to credit risk consist
        primarily of accounts receivable and other receivables. The Company does
        not
        require collateral or other security to support these receivables. The Company
        conducts periodic reviews of its clients' financial condition and customer
        payment practices to minimize collection risk on accounts
        receivable.
 
 The
        operations of the Company are located in the PRC. Accordingly, the Company's
        business, financial condition, and results of operations may be influenced
        by
        the political, economic, and legal environments in the PRC, as well as by
        the
        general state of the PRC economy.
 
 **Statement
        of Cash Flows**
 
 In
        accordance with SFAS No. 95, “Statement of Cash Flows,” cash flows from the
        Company's operations is calculated based upon the local currencies. As a
        result,
        amounts related to assets and liabilities reported on the statement of cash
        flows may not necessarily agree with changes in the corresponding balances
        on
        the balance sheet. Cash flows from operating, investing and financing activities
        exclude the effect of the acquisition of SanDeKe.
 
 **Basic
        and Diluted Earnings per Share (EPS)**
  Basic
        EPS
        is computed by dividing income available to common shareholders by the weighted
        average number of common shares outstanding for the period. Diluted EPS is
        similarly computed, except that the denominator is increased to include the
        number of additional common shares that would have been outstanding if the
        potential common shares had been issued and if the additional common shares
        were
        dilutive. Diluted net earnings per share are based on the assumption that
        all
        dilutive convertible shares and stock options were converted or exercised.
        Dilution is computed by applying the treasury stock method. Under this method,
        options and warrants are assumed to have been exercised at the beginning
        of the
        period (or at the time of issuance, if later), and as if funds obtained thereby
        were used to purchase common stock at the average market price during the
        period.
  7
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 The
        following table presents a reconciliation of basic and diluted earnings per
        share:
 
 For the Nine
                Months Ended September 30
                (Unaudited)
              
              For the Three Months
                Ended September 30
                (Unaudited)2008
              
              2007
              
              2008
              
              2007Net
                  income
              
              $
              5,528,336
              
              $
              385,116
              
              $
              4,324,661
              
              $
              220,028Weighted
                  average shares outstanding - basic
              
              
              21,503,588
              
              
              18,500,000
              
              
              24,055,878
              
              
              18,500,000Effect
                  of dilutive securities:Unexercised
                  warrants and options
              
              
              59
              
              
              —
              
              
              176
              
              
              —Weighted
                  average shares outstanding - diluted
              
              
              21,503,647
              
              
              18,500,000
              
              
              24,056,054
              
              
              18,500,000Earnings
                  per share - basic
              
              $
              0.26
              
              $
              0.02
              
              
              0.18
              
              
              0.01Earnings
                  per share - diluted
              
              $
              0.26
              
              $
              0.02
              
              
              0.18
              
              
              0.01
 
 **Fair
        Value of Financial Instruments**
 
 SFAS
        No.
        107, “Disclosures about Fair Value of Financial Instruments,” requires that the
        Company disclose estimated fair values of financial instruments. The carrying
        amounts reported in the statements of financial position for current assets
        and
        current liabilities qualifying as financial instruments are a reasonable
        estimate of fair value.
  **Foreign
        Currency Translation and Comprehensive Income (Loss)**
  The
        Company’s functional currency is the RMB (RMB). For financial reporting
        purposes, RMB has been translated into United States dollars (USD) as the
        reporting currency. Assets and liabilities are translated at the exchange
        rate
        in effect at the balance sheet date. Revenues and expenses are translated
        at the
        average rate of exchange prevailing during the reporting period. Translation
        adjustments arising from the use of different exchange rates from period
        to
        period are included as a component of shareholders' equity as "Accumulated
        other
        comprehensive income". Gains and losses resulting from foreign currency
        transactions are included in income. There has been no significant fluctuation
        in exchange rate for the conversion of RMB to USD after the balance sheet
        date.
 
 The
        Company uses SFAS No. 130, “Reporting Comprehensive Income.” Comprehensive
        income is comprised of net income and all changes to the statements of
        shareholders’ equity, except those due to investments by shareholders, changes
        in paid-in capital and distributions to shareholders.
 
 **Segment
        Reporting**
 
 SFAS
        No.
        131, "Disclosures about Segments of an Enterprise and Related Information"
        requires use of the “management approach” model for segment reporting. The
        management approach model is based on the way a company's management organizes
        segments within the company for making operating decisions and assessing
        performance. Reportable segments are based on products and services, geography,
        legal structure, management structure, or any other manner in which management
        disaggregates a company.
 
 SFAS
        131
        has no effect on the Company's financial statements as substantially all
        of the
        Company's operations are conducted in one industry segment. All of the Company's
        assets are located in the PRC.
 
 **New
        Accounting Pronouncements**
 
 **Accounting
        for Financial Guarantee Insurance Contracts**
 
 In
        May
        2008, FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance
        Contracts, an interpretation of FASB
        Statement No. 60 .” 
        The scope of this Statement is limited to financial guarantee insurance (and
        reinsurance) contracts, as described in this Statement, issued by enterprises
        included within the scope of Statement 60. Accordingly, this Statement does
        not
        apply to financial guarantee contracts issued by enterprises excluded from
        the
        scope of Statement 60 or to some insurance contracts that seem similar to
        financial guarantee insurance contracts issued by insurance enterprises (such
        as
        mortgage guaranty insurance or credit insurance on trade receivables). This
        Statement also does not apply to financial guarantee insurance contracts
        that
        are derivative instruments included within the scope of FASB
        Statement No. 133 ,
        “Accounting for Derivative Instruments and Hedging Activities.” This Statement
        will not have an impact on the Company’s financial statements.
  8
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 **The
        Hierarchy of Generally Accepted Accounting Principles**
 
 In
        May
        2008, FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting
        Principles.”  SFAS 162 identifies the sources of accounting principles and
        the framework for selecting the principles to be used in the preparation
        of
        financial statements of nongovernmental entities that are presented in
        conformity with generally accepted accounting principles (GAAP) in the United
        States (the GAAP hierarchy).  SFAS 162 will not have an impact on the
        Company’s financial statements.
 
 **Disclosures
        about Derivative Instruments and Hedging Activities**
 
 In
        March
        2008, FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and
        Hedging Activities an amendment of FASB Statement No. 133.”  SFAS 161
        changes the disclosure requirements for derivative instruments and hedging
        activities. Entities are required to provide enhanced disclosures about (a)
        how
        and why an entity uses derivative instruments, (b) how derivative instruments
        and related hedged items are accounted for under Statement 133 and its related
        interpretations, and (c) how derivative instruments and related hedged items
        affect an entity’s financial position, financial performance, and cash
        flows.  Based on current conditions, the Company does not expect the
        adoption of SFAS 161 to have a significant impact on its results of operations
        or financial position.
  **Non-Controlling
        Interests in Consolidated Financial Statements - An Amendment of ARB No.
        51**
 
 In
        December 2007, FASB issued SFAS No. 160, "Non-controlling Interests in
        Consolidated Financial Statements - An Amendment of ARB No. 51." SFAS 160
        establishes new accounting and reporting standards for the non-controlling
        interest in a subsidiary and for the deconsolidation of a subsidiary.
        Specifically, this statement requires the recognition of a non-controlling
        interest (minority interest) as equity in the consolidated financial statements
        and separate from the parent’s equity. The amount of net income attributable to
        the non-controlling interest will be included in consolidated net income
        on the
        face of the income statement. SFAS 160 clarifies that changes in a parent’s
        ownership interest in a subsidiary that do not result in deconsolidation
        are
        equity transactions if the parent retains its controlling financial interest.
        In
        addition, this statement requires that a parent recognize a gain or loss
        in net
        income when a subsidiary is deconsolidated. Such gain or loss will be measured
        using the fair value of the non-controlling equity investment on the
        deconsolidation date. SFAS 160 also includes expanded disclosure requirements
        regarding the interests of the parent and its non-controlling interest. SFAS
        160
        are effective for fiscal years, and interim periods within those fiscal years,
        beginning on or after December 15, 2008. Based on current conditions, the
        Company does not expect the adoption of SFAS 160 to have a significant impact
        on
        its results of operations or financial position.
  **Business
        Combinations**
  In
        December 2007, FASB issued SFAS No. 141 (Revised 2007), "Business
        Combinations." SFAS 141R will significantly change the accounting for business
        combinations. Under SFAS 141R, an acquiring entity will be required to recognize
        all the assets acquired and liabilities assumed in a transaction at the
        acquisition-date fair value with limited exceptions. SFAS 141R will change
        the
        accounting treatment for certain specific items, including:
 
 ·
              Acquisition
                  costs will be generally expensed as
                  incurred;
 ·
              Non-controlling
                  interests (formerly known as “minority interests” - see SFAS 160
                  discussion above) will be valued at fair value at the acquisition
                  date;
 ·
              Acquired
                  contingent liabilities will be recorded at fair value at the acquisition
                  date and subsequently measured at either the higher of such amount
                  or the
                  amount determined under existing guidance for non-acquired
                  contingencies;
 ·
              In-process
                  research and development will be recorded at fair value as an
                  indefinite-lived intangible asset at the acquisition
                  date;
 ·
              Restructuring
                  costs associated with a business combination will be generally
                  expensed
                  subsequent to the acquisition date;
                  and
  9
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 ·
              Changes
                  in deferred tax asset valuation allowances and income tax uncertainties
                  after the acquisition date generally will affect income tax
                  expense.
 
 SFAS
        141R
        also includes a substantial number of new disclosure requirements. SFAS 141R
        applies prospectively to business combinations for which the acquisition
        date is
        on or after the beginning of the first annual reporting period beginning
        on or
        after December 15, 2008. Earlier adoption is prohibited. Accordingly, since
        we are a calendar year-end company we will continue to record and disclose
        business combinations following existing GAAP until January 1, 2009. The
        Company expects SFAS 141R will have an impact on accounting for business
        combinations once adopted but the effect is dependent upon acquisitions at
        that
        time.
 
 **Employers’
        Accounting for Defined Benefit Pension and Other Postretirement Plans, an
        Amendment of FASB Statements No. 87, 88, 106, and 132R**
  In
        September 2006, FASB issued SFAS, No. 158, “Employers’ Accounting for Defined
        Benefit Pension and Other Postretirement Plans, an Amendment of FASB Statements
        No. 87, 88, 106, and 132R,” which requires employers to recognize the
        underfunded or overfunded status of a defined benefit postretirement plan
        as an
        asset or liability in its statement of financial position and to recognize
        changes in the funded status in the year in which the changes occur through
        accumulated other comprehensive income. Additionally, SFAS 158 requires
        employers to measure the funded status of a plan as of the date of its year-end
        statement of financial position. The new reporting requirements and related
        new
        footnote disclosure rules of SFAS 158 are effective for fiscal years ending
        after December 15, 2006. The Company adopted the provisions of SFAS 158 for
        the
        year end 2006, and the effect of recognizing the funded status in accumulated
        other comprehensive income was not significant. The new measurement date
        requirement applies for fiscal years ending after December 15,
        2008.
 
 **Accounting
        for Non-Refundable Advance Payments for Goods or Services Received for Use
        in
        Future Research and Development Activities**
 
 In
        June
        2007, FASB issued FASB Staff Position No. EITF 07-3, “Accounting for
        Nonrefundable Advance Payments for Goods or Services Received for use in
        Future
        Research and Development Activities,” which addresses whether non-refundable
        advance payments for goods or services that used or rendered for research
        and
        development activities should be expensed when the advance payment is made
        or
        when the research and development activity has been
        performed.  Management is currently evaluating the effect of this
        pronouncement on our financial statements.
  **3.
        INVENTORIES**
 
 Inventories
        at September 30, 2008 and December 31, 2007 were as follows:
 
 September
                30,
                2008
              
              December
                  31,
                2007Raw
                  materials
              
              $
              6,774,332
              
              $
              3,865,575Work
                  in process
              
              
              543,019
              
              
              48,627Finished
                  Goods
              
              
              1,136,649
              
              
              4,014,206Total
              
              $
              8,454,000
              
              $
              7,928,408
  10
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 **4.
        PROPERTY AND EQUIPMENT, NET**
 
 Property
        and equipment consisted of the following at September 30, 2008 and December
        31,
        2007:
 
 September 30,
                2008
              
              December 31,
                2007Building
              
              $
              1,738,219
              
              $
              1,624,651Production
                  equipment
              
              
              420,789
              
              
              298,242Office
                  equipment
              
              
              223,078
              
              
              156,368Vehicles
              
              
              274,940
              
              
              134,7242,657,026
              
              
              2,213,985Less:
                  Accumulated depreciation
              
              
              (307,879
              )
              
              (173,176
              )$
              2,349,147
              
              $
              2,040,809
 
 Depreciation
        expense for the nine months ended September 30, 2008 and 2007 was approximately
        $119,000 and $45,000; approximately $42,000 and $16,000 for the three months
        ended September 30, 2008 and 2007, respectively.
 
 **5.
        CONSTRUCTION IN PROGRESS**
 
 Construction
        in progress represented the amount the Company has paid for constructing
        a
        manufacturing workshop.
 
 **6.
        OTHER RECEIVABLES**
 
 Other
        receivables at September 30, 2008 consisted of cash advances to some customers
        in the amount of approximately $1,870,000, guarantee deposits for public
        bidding
        of approximately $510,000, prepayment and deposits for freight insurance
        expense
        of approximately $155,000, receivables for consulting and installation service
        provided in the amount of approximately $230,000, and cash advances to employees
        for normal business purposes such as travel expenses, etc.
  **7.
        NOTES RECEIVABLE**
 
 Notes
        receivable consisted of several notes that were due from third parties or
        the
        Company’s customers. These notes receivable were interest-free and due within
        3-6 months.
 
 **8.
        RELATED PARTY TRANSACTIONS**
 
 **Due
        from related party**
 
 Due
        from
        related party consisted of purchase deposits and a short term advance to
        one of
        the Company’s shareholders of $251,547 and $118,560 at September 30, 2008 and
        December 31, 2007, respectively.
 
 **Due
        to Related Party**
 
 Due
        to
        related party represented advance from the same shareholder with variable
        interest rate tied to the bank interest rate, currently at 8.591% per annum
        and
        6.903% per annum as of December 31, 2007, principal and interest are payable
        on
        demand, this advance was paid of by September 30, 2008.
 
 **9.
        INTANGIBLE ASSETS**
 
 Intangible
        assets mainly consisted of land use rights, computer software, know-how
        technology, customer list and covenant not to compete. All land in the PRC
        is
        government owned and cannot be sold to any individual or company. However,
        the
        government grants the user a “land use right” to use the land. The Company
        acquired land use rights during 2005 for $439,850 (RMB 3,549,682). The Company
        has the right to use the land for 50 years and is amortizing such rights
        on a
        straight-line basis for 50 years.
  11
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 Intangible
        assets consisted of the following at September 30, 2008 and December 31,
        2007:
 
 September 30,
                2008
              
              December 31,
                2007Land
                  use right
              
              $
              520,634
              
              $
              486,618Know-how
                  technology
              
              
              267,457
              
              
              -Customer
                  list
              
              
              192,119
              
              
              -Covenant
                  not to compete
              
              
              104,512
              
              
              -Software
              
              
              184,086
              
              
              140,4761,268,808
              
              
              627,094Less:
                  accumulated amortization
              
              
              (92,457
              )
              
              (92,886
              )$
              1,176,351
              
              $
              534,208
  Amortization
        expense for the nine months ended September 30, 2008 and 2007 were approximately
        $38,000 and $34,000, approximately $11,000 and $23,000 for the three months
        ended September 30, 2008 and 2007, respectively. Annual amortization expense
        for
        the next five years is expected to be as follows: $51,000, $51,000, $51,000,
        $21,000 and $21,000.
 
 **10.
        TAXES PAYABLE**
 
 Taxes
        payable consisted of the following at September 30, 2008 and December 31,
        2007:
 
 September 30,
                2008
              
              December 31,
                2007Income
                  tax payable
              
              $
              934,558
              
              $
              74,981Value
                  added tax payable
              
              
              502,026
              
              
              421,009Other
                  taxes payable (receivable)
              
              
              (13,056
              )
              
              7,020$
              1,423,528
              
              $
              503,010
 
 **11.
        ACCRUED LIABILITIES AND OTHER PAYABLES**
 
 Accrued
        liabilities at September 30, 2008 mainly consisted of accrued interest, utility
        and employee benefits in the aggregate of approximately $60,000. Other payables
        mainly consisted of short term, non interest bearing advances from third
        parties
        and payables for the Company’s miscellaneous expenses in the aggregate of
        approximately $590,000, and payable for the purchase consideration of SanDeKe
        for approximately $741,000.
  **12.
        LOANS PAYABLE - SHORT TERM**
 
 The
        Company is obligated for the following short term loans payable as of September
        30, 2008 and December 31, 2007:
 
 Balance at
                September 30,
                2008
              
              Balance at
                December 31,
                2007Short
                  term loan with a commercial bank in the PRC for 6,000,000 RMB,
                  or
                  $822,526. This loan was entered into on Apr 28, 2007 and is due
                  on Apr 12,
                  2008. This loan bears interest at 7.029% per annum. This loan was
                  renewed
                  on Apr 12, 2008 with new maturity date on June 13, 2009.
              
              $
              880,023
              
              $
              822,526Short
                  term loan with a foreign commercial bank with branch in the PRC
                  for
                  10,200,000 RMB, or $1,398,295. This loan was entered into on Jun
                  25, 2007
                  and is due on Jun 24, 2008. This loan born interest at 5.265% per
                  annum.
                  This loan was repaid in June, 2008.
              
              
              —
              
              
              1,302,333The
                  Company entered into a series of short term loans during 2006 and
                  2007
                  with a third party company in the PRC for total of 10, 300,000
                  RMB or
                  $1,412,003. Some of the loans will mature on various dates in year
                  2008
                  and some of the loans are payable on demand. These loans bear variable
                  interest at 8.591% per annum for 2008 and 6.903% per annum for
                  2007.
              
              
              1,129,363
              
              
              1,412,003The
                  Company entered into a series of short term loans during 2006 with
                  another
                  third party company in the PRC for total of 2,850,000 RMB, or $390,700.
                  These loans are due on various dates in year 2008. These loans
                  bear
                  variable interest at 8.591% per annum for 2008 and 6.903% per annum
                  for
                  2007.
              
              
              358,661
              
              
              390,701The
                  Company entered into a short term loan with another third party
                  company in
                  the PRC for 5,050,000 RMB or $625,759. This loan was entered into
                  on Aug
                  31, 2005 and was due on Aug 31, 2006. This loan bears no interest.
                  Imputed
                  interest on the loan was immaterial. This loan became payable on
                  demand
                  after Aug 31, 2006.
              
              
              740,686
              
              
              692,293The
                  Company entered into a one year loan on July 1, 2008 with another
                  third
                  party company in the PRC for total of 3,000,000 RMB, or $440,000.
                  This
                  loan is due on June 30, 2009 with interest rate of 8.591% per
                  annum.
              
              
              440,013
              
              
              —$
              3,548,746
              
              $
              4,619,856
  12
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 **13.
        DEFFERED TAX LIABILITY**
 
 Deferred
        tax liability represented differences between the tax bases and book bases
        of
        property and equipment and intangible assets arising from the acquisition
        of
        SanDeKe.
 
 **14.
        MINORITY INTEREST AND DUE TO MINORITY SHAREHOLDER**
 
 Minority
        interest represented 45% interest in Yushi. At August 31, 2008, the Company
        liquidated Yushi and planned to distribute the remaining assets of $5,274
        to its
        minority shareholders. At September 30, 2008, minority interest was zero
        due to
        the liquidation of Yushi; at December 31, 2007, minority interest was zero
        as
        minority’s share of cumulative losses exceeded its equity interest in Yushi.
        Minority’s share of income for the nine months ended September 30, 2008 was
        $5,934 as the forgiveness of the accounts payable by Taiyu, minority’s share of
        loss for the nine months ended December 31, 2007 were limited to
        $1,859.
 
 **15.
        INCOME TAXES**
 
 The
        Company is governed by the Income Tax Law of the PRC concerning privately-run
        enterprises, which are generally subject to tax at a statutory rate of 25%
        on
        income reported in the statutory financial statements after appropriated
        tax
        adjustments.
  The
        Company, as a manufacturing business, is subject to a 15% income tax rate.
        Taiyu
        was exempted from income tax for two years starting from the 1st profitable
        year
        since incorporation, and was entitled to a 50% discount on the 15% income
        tax
        rate for 2005 through 2007. According to the new income tax law that became
        effective January 1, 2008, for those enterprises to which the 15% tax rate
        was
        applicable previously, the applicable rates shall be gradually increase over
        a
        five-year period as follows:
 
 Year
              
              
              Tax Rate2007
              
              
              15
              %2008
              
              
              18
              %2009
              
              
              20
              %2010
              
              
              22
              %2011
              
              
              24
              %2012
              
              
              25
              %
  13
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 SanDeKe
        is subject to an 18% income tax rate after 7% reduction in federal income
        tax
        rate given by federal government, is also exempted from income tax for two
        years
        starting from the 1st profitable year, and was entitled to a 50% discount
        on the
        18% income tax rate for 2010 through 2012. SanDeKe’s net income will be lowered
        by approximately $17,000 for the period from acquisition date to September
        30,
        2008 if it is not exempted from income tax.
 
 For
        the
        nine and three months ended September 30, 2008 and 2007, the Company’s effective
        income tax rate differs from US statutory rate due to the effect of tax holiday.
 
 **16.
        STATUTORY RESERVES**
 
 Pursuant
        to the new corporate law of the PRC effective January 1, 2006, the Company
        is
        now only required to maintain one statutory reserve by appropriating from
        its
        after-tax profit before declaration or payment of dividends. The statutory
        reserve represents restricted retained earnings.
 
 **Surplus
        Reserve Fund**
 
 The
        Company is now only required to transfer 10% of its net income, as determined
        under PRC accounting rules and regulations, to a statutory surplus reserve
        fund
        until such reserve balance reaches 50% of the Company’s registered capital.
 
 The
        surplus reserve fund is non-distributable other than during liquidation and
        can
        be used to fund previous years’ losses, if any, and may be utilized for business
        expansion or converted into share capital by issuing new shares to existing
        shareholders in proportion to their shareholding or by increasing the par
        value
        of the shares currently held by them, provided that the remaining reserve
        balance after such issue is not less than 25% of the registered
        capital.
 
 **Common
        Welfare Fund**
 
 The
        common welfare fund is a voluntary fund that provides that the Company can
        elect
        to transfer 5% to 10% of its net income to this fund. This fund can only
        be
        utilized on capital items for the collective benefit of the Company’s employees,
        such as construction of dormitories, cafeteria facilities, and other staff
        welfare facilities. This fund is non-distributable other than upon liquidation.
 
 **17.
        STOCKHOLDERS’ EQUITY**
 
 **Common
        Stock with Warrants Issued for Cash**
 
 In
        August
        2008, the Company closed a private placement offering of Units pursuant to
        which
        SmartHeat sold an aggregate of 1,630,000 Units at an offering price of $3.50
        per
        Unit for aggregate gross proceeds of approximately $5.7 million. Each "Unit"
        consists of one share of SmartHeat's common stock and a three year warrant
        to
        purchase 15% of one share of common stock at an exercise price of $6.00 per
        share. The Units sold represent an aggregate of 1,630,000 million shares
        of
        common stock and warrants to purchase 244,500 shares of Common Stock. In
        connection with the private placement offering, the Company paid commission
        of
        approximately $340,000 and issued warrants to purchase 148,500 shares of
        common
        stock to its placement agents. The warrants are immediately exercisable and
        expire on the third anniversary of their issuance. Net proceeds of approximately
        $5.1 million have been received by the Company. The value of warrants was
        determined by using the Black-Scholes pricing model with the following
        assumptions:  discount rate **–** 2.76%;
        dividend yield **–** 0%;
        expected volatility **–** 15% and
        term of 3 years. There were no warrants exercised from the grant date to
        September 30, 2008.
 
 **Stock
        Options to Independent Directors**
 
 On
        July
        17, 2008, the Company granted non-statutory stock options to each of its
        two
        independent US directors. The terms of each option are: 10,000 shares at
        an
        exercise price per share of $4.60, with a life of five years and vesting
        over
        three years as follows: 3,333 shares shall vest on July 17, 2009; 3,333 shares
        shall vest on July 17, 2010; and 3,334 shares shall vest on July 17, 2011,
        subject in each case to the director continuing to be associated with the
        Company as a director.
  14
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 Based
        on
        the fair value method under SFAS No. 123 (Revised) “Share Based Payment” (“SFAS
        123(R)”), the fair value of each stock option granted is estimated on the date
        of the grant using the Black-Scholes option pricing model. The Black-Scholes
        option pricing model has assumptions for risk free interest rates, dividends,
        stock volatility and expected life of an option grant. The risk free interest
        rate is based upon market yields for United States Treasury debt securities
        at a
        maturity near the term remaining on the option. Dividend rates are based
        on the
        Company’s dividend history. The stock volatility factor is based on the
        historical volatility of the Company’s stock price. The expected life of an
        option grant is based on management’s estimate. The fair value of each option
        grant to independent directors is calculated by the Black-Scholes method
        and is
        recognized as compensation expense over the vesting period of each stock
        option
        award. For stock options issued, the fair value was estimated at the date
        of
        grant using the following range of assumptions:
  The
        options vest over a period of three years and have a life of 5 years, volatility
        of 15%, risk free interest rate of 2.76%, and dividend yield of 0%. No estimate
        of forfeitures was made as the Company has a short history of granting
        options.
 
 The
        Company recorded $1,270 of compensation expense for stock options to its
        independent directors for the nine months ended September 30, 2008. There
        were
        no options exercised for the nine months ended September 30, 2008.
 
 **18.
        COMMITMENTS**
 
 The
        Company leased several offices for its sales representative in different
        cities
        under various one-year, non-cancellable, and renewable operating lease
        agreements.
 
 Future
        minimum rental payments required under these operating leases are as
        follows:
 
 Year
                  Ending September 30,
              
              
              Amount2009
              
              $
              46,0002010
              
              
              21,000Total
              
              $
              67,000
  Total
        rental expense for the nine months ended September 30, 2008 and 2007 was
        approximately $71,000 and $39,000, and approximately $39,000 and $20,000
        for the
        three months ended September 30, 2008 and 2007, respectively.
 
 **19.
        CONTINGENCIES**
 
 The
        Company sold goods to its customers and received Commercial Notes (Bank
        Acceptance) from the customers in lieu of the payments for accounts receivable.
        The Company discounted the Notes with the bank or endorsed the Notes to vendors,
        which could be for payment of their own obligations or get cash from the
        third
        parties. Most of the Commercial Notes have maturity of less than six months.
        At
        September 30, 2008, the Company is contingently liable to vendors and third
        parties for endorsed bank acceptance amounting to $358,227.
  The
        Company’s operations in the PRC are subject to specific considerations and
        significant risks not typically associated with companies in North America
        and
        Western Europe. These include risks associated with, among others, the
        political, economic and legal environments and foreign currency exchange.
        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.
  The
        Company’s sales, purchases and expense transactions are denominated in RMB and
        all of the Company’s assets and liabilities are also denominated in RMB. The RMB
        is not freely convertible into foreign currencies under the current law.
        In
        China, foreign exchange transactions are required by law to be transacted
        only
        by authorized financial institutions. Remittances in currencies other than
        RMB
        may require certain supporting documentation in order to affect the
        remittance.
  15
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 **20.
        ACQUISITION OF SAN DE KE CO., LTD.**
 
 On
        September 25, 2008, the Company entered into a Share Exchange Agreement
        ("Agreement") for the acquisition by the Company of all of the outstanding
        capital stock of SanDeKe. The purchase price for the SanDeKe shares was
        $741,516, of which $222,455 was payable within 15 days after the signature
        date
        of the Agreement, $370,758 is payable within 15 days after all necessary
        documents have been filed with government agencies, and $148,303 of which
        is
        payable within 15 days after the purchase has been approved and registered
        by
        the government agencies. Under the terms of the Agreement, two of the
        shareholders of SanDeKe have agreed not to compete with the business of SanDeKe
        for a period of four years after the completion of the purchase.
 
 The
        operating results of SanDeKe are included in the accompanying consolidated
        statements of income from the acquisition date. For convenience of reporting
        the
        acquisition for accounting purposes, September 1, 2008 has been designated
        as
        the acquisition date.
 
 The
        following table summarizes the fair values of the assets acquired and
        liabilities assumed at the date of acquisition.   The fair value of
        the net assets acquired exceeded the total consideration for the acquisition
        by
        approximately $117,000 (RMB 800,000). The excess (negative goodwill) was
        allocated on a pro rata basis to long-lived assets.
 
 Cash
              
              $
              59,245Accounts
                  receivable
              
              
              489,527Advance
                  to suppliers
              
              
              329,951Other
                  receivables
              
              
              128,646Inventory
              
              
              92,370Property
                  and equipment
              
              
              73,324Intangible
                  assets
              
              
              563,567Accounts
                  payable
              
              
              (332,276
              )Advance
                  from customers
              
              
              (557,216
              )Deferred
                  tax liability
              
              
              (39,076
              )Other
                  current liabilities
              
              
              (66,546
              )Purchase
                  price
              
              $
              741,516
 
 The
        intangible asset consisted of know-how technology being amortized over 5
        years,
        customer list being amortized over 5 years and covenants not to compete,
        being
        amortized over 4 years.
 
 The
        pro
        forma financial information of the consolidated operations of the Company
        as if
        the acquisition of SanDeKe had occurred as of the beginning of the year is
        presented below:
 
 For the nine months ended
                September 30, 2008
              
              SmartHeat
              
              Taiyu
              
              SanDeKe
              
              Pro forma
                Adjustments
              
              Pro forma
                ConsolidatedNet
                  revenue
              
              $
              -
              
              
              28,958,383
              
              
              2,541,234
              
              
              -
              
              
              31,499,617Cost
                  of revenue
              
              
              -
              
              
              (19,252,126
              )
              
              (2,012,066
              )
              
              -
              
              
              (21,264,191
              )Gross
                  profit
              
              
              -
              
              
              9,706,257
              
              
              529,168
              
              
              -
              
              
              10,235,425Selling
                  expense
              
              
              -
              
              
              (1,664,882
              )
              
              -
              
              
              -
              
              
              (1,664,882
              )General
                  & administrative expense
              
              
              (107,195
              )
              
              (1,297,666
              )
              
              (384,526
              )
              
              (87,898
              )
              
              (1,877,286
              )Total
                  operating expenses
              
              
              (107,195
              )
              
              (2,962,549
              )
              
              (384,526
              )
              
              (87,898
              )
              
              (3,542,168
              )Income
                  (loss) from operations
              
              
              (107,195
              )
              
              6,743,708
              
              
              144,642
              
              
              (87,898
              )
              
              6,693,257Non-operating
                  income (expenses), net
              
              
              -
              
              
              75,806
              
              
              (870
              )
              
              -
              
              
              74,936Income
                  (loss) before income tax
              
              
              (107,195
              )
              
              6,819,514
              
              
              143,773
              
              
              (87,898
              )
              
              6,768,193Income
                  tax
              
              
              -
              
              
              (1,246,935
              )
              
              -
              
              
              -
              
              
              (1,246,935
              )Minority
                  interest
              
              
              -
              
              
              5,934
              
              
              -
              
              
              -
              
              
              5,934Net
                  income (loss)
              
              $
              (107,195
              )
              
              5,566,645
              
              
              143,773
              
              
              (87,898
              )
              
              5,515,324
 
 a)
              Pro
                  forma adjustment is to record additional amortization expense of
                  $86,440
                  and depreciation expense of $1,458 for the increase in basis of
                  the
                  intangible assets and slight decrease in basis of the fixed assets
                  as a
                  result of the purchase.
  16
  **SMARTHEAT
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **SEPTEMBER
        30, 2008 (UNAUDITED) AND DECEMBER 31, 2007**
 
 For the nine months ended
                September 30, 2007
              
              SmartHeat
              
              Taiyu
              
              SanDeKe
              
              Pro forma
                Adjustments
              
              Pro forma
                ConsolidatedNet
                  revenue
              
              $
              -
              
              
              5,473,573
              
              
              1,750,129
              
              
              -
              
              
              7,223,702Cost
                  of revenue
              
              
              -
              
              
              (3,679,507
              )
              
              (1,504,957
              )
              
              -
              
              
              (5,184,465
              )Gross
                  profit
              
              
              -
              
              
              1,794,065
              
              
              245,171
              
              
              -
              
              
              2,039,237Selling
                  expense
              
              
              -
              
              
              (805,099
              )
              
              -
              
              
              -
              
              
              (805,099
              )General
                  & administrative expense
              
              
              –
              
              
              (528,215
              )
              
              (168,431
              )
              
              (80,770
              )
              
              (777,416
              )Total
                  operating expenses
              
              
              -
              
              
              (1,333,314
              )
              
              (168,431
              )
              
              (80,770
              )
              
              (1,582,515
              )Income
                  from operations
              
              
              -
              
              
              460,752
              
              
              76,740
              
              
              (80,770
              )
              
              456,722Non-operating
                  income, net
              
              
              -
              
              
              27,760
              
              
              451
              
              
              -
              
              
              28,211Income
                  before income tax
              
              
              -
              
              
              488,512
              
              
              77,191
              
              
              (80,770
              )
              
              484,932Income
                  tax
              
              
              -
              
              
              (105,256
              )
              
              -
              
              
              -
              
              
              (105,256
              )Minority
                  interest
              
              
              -
              
              
              (1,859
              )
              
              -
              
              
              -
              
              
              (1,859
              )Net
                  income
              
              $
              -
              
              
              385,115
              
              
              77,191
              
              
              (80,770
              )
              
              381,536
 
 a)
              Pro
                  forma adjustment is to record additional amortization expense of
                  $78,759
                  and depreciation expense of $2,011 for the increase in basis of
                  the
                  intangible assets and slight decrease in basis of the fixed assets
                  as a
                  result of the purchase.




17




**CAUTIONARY
      STATEMENT FOR FORWARD-LOOKING STATEMENTS**




*This
      Quarterly Report on Form 10-Q includes forward-looking statements within the
      meaning of Section 27A of the Securities Act of 1933, as amended (the
      "Securities Act"), and Section 21E of the Securities Exchange Act of 1934,
      as
      amended (the "Exchange Act"). We have based these forward-looking statements
      on
      our current expectations and projections about future events. These
      forward-looking statements are subject to known and unknown risks, uncertainties
      and assumptions about us that may cause our actual results, levels of activity,
      performance or achievements to be materially different from any future results,
      levels of activity, performance or achievements expressed or implied by such
      forward-looking statements. In some cases, you can identify forward-looking
      statements by terminology such as “may,” “will,” “should,” “could,” “would,”
“expect,” “plan,” anticipate,” believe,” estimate,” continue,” or the negative
      of such terms or other similar expressions. Factors that might cause or
      contribute to such a discrepancy include, but are not limited to, those listed
      under the heading “Risk Factors” and those listed in our other SEC filings. The
      following discussion should be read in conjunction with our Financial Statements
      and related Notes thereto included elsewhere in this report. Throughout this
      Quarterly Report we will refer to SmartHeat Inc., together with its
      subsidiaries, as "SmartHeat," the "Company," "we," "us," and
      "our."*




**Item
      2.****Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations**




**Overview**




We
      are a
      leading provider of plate heat exchanger products to China's industrial,
      residential and commercial markets. We design, manufacture, sell, and service
      plate heat exchangers ("PHEs"), units which combine plate heat exchangers with
      various pumps, temperature sensors, valves, and automated control systems ("PHE
      Units"), and heat meters for a broad range of industries, including petroleum
      refining, petrochemicals, power generation, metallurgy, food & beverage and
      chemical processing. We sell PHEs under the Sondex brand and PHE Units designed
      by our engineers and assembled with Sondex plates under our Taiyu brand name.
      We
      are one of three authorized dealers of Sondex PHEs for the industrial and energy
      sectors in China. Our Sondex distribution territory is North China.




Our
      revenue is subject to fluctuations due to the timing of sales of high-value
      products, the impact of seasonal spending patterns, the timing and size of
      projects our customers perform, changes in overall spending levels in the
      industry and other unpredictable factors that may affect customer ordering
      patterns.  Any significant delays in the commercial launch or any lack
      or delay of commercial acceptance of new products, unfavorable sales trends
      in
      existing product lines, or impacts from the other factors mentioned above,
      could
      adversely affect our revenue growth or cause a sequential decline in quarterly
      revenue.  Due to the possibility of fluctuations in our revenue and
      net income or loss, we believe that quarterly comparisons of our operating
      results are not a good indication of future performance.




**Recent
      Developments**




*Share
      Exchange and Related Transactions*




On
      April
      14, 2008, the Company entered into and consummated a series of agreements which
      resulted in the acquisition of all of share capital of Shenyang Taiyu Machinery
      & Electronic Equipment Co., Ltd ("Taiyu"), a plate heat exchange products
      company organized under the laws of the People's Republic of China, the
      divestiture of the Company's prior exploration business, and the change of
      the
      Company's name to SmartHeat Inc. The acquisition of Taiyu's share capital was
      accomplished pursuant to the terms of a Share Exchange Agreement dated April
      14,
      2008 (the "Share Exchange Agreement") by and among the Company's wholly owned
      subsidiary SmartHeat Inc., a Nevada corporation, Taiyu and all of the
      shareholders of Taiyu (the "Taiyu Shareholders").  At the closing
      under the Share Exchange Agreement all of the equitable and legal rights, title
      and interests in and to Taiyu's share capital in the amount of RMB25,000,000
      was
      exchanged for an aggregate of 18,500,000 shares of SmartHeat common stock (the
      "Share Exchange").  As a result of the Share Exchange, Taiyu became a
      wholly-owned subsidiary of SmartHeat. SmartHeat was thereafter immediately
      merged into the Company.




In
      addition, the following actions occurred under the terms of the Share Exchange
      Agreement:


18




·
            Immediately
                following the closing of the Share Exchange, the Company transferred
                all
                of its pre-closing assets and liabilities (other than the obligation
                to
                pay a $10,000 fee to the Company's audit firm) to a wholly owned
                subsidiary, PGR Holdings, Inc., a Nevada corporation ("SplitCo"),
                under
                the terms of an Agreement of Conveyance, Transfer and Assignment
                of Assets
                and Assumption of Obligations dated April 14, 2008.  The Company
                also sold all of the outstanding capital stock of SplitCo to Jason
                Schlombs (the former director and officer, and a major shareholder,
                of the
                Company) pursuant to a Stock Purchase Agreement dated April 14, 2008
                in
                exchange for the surrender of 2,500,000 shares of the Company's common
                stock held by Mr. Schlombs.




·
            As
                a condition to the closing of the Share Exchange, Mr. Jun Wang, the
                Chairman and Chief Executive Officer of Taiyu was appointed to the
                board
                of directors of the Company. Mr. Wang is the sole member of the board
                of
                directors as of the date hereof; Mr. Schlombs, having resigned effective
                as of the close of business on April 15,
                2008.




·
            Also
                as a condition to the closing of the Share Exchange, Mr. Schlombs
                resigned
                as the President, Chief Executive Officer, Secretary and Treasurer
                of the
                Company and Mr. Jun Wang was appointed as President and Chief Executive
                Officer, Ms. Zhijuan Guo was appointed as Chief Financial Officer
                and Ms.
                Huajun Ai was appointed as Corporate
                Secretary.




*Private
      Placement*





On
      July
      7, 2008, the Company completed a closing of a private placement offering (the
      "Offering") of Units pursuant to which SmartHeat sold an aggregate of 1,620,000
      Units at an offering price of $3.50 per Unit for aggregate gross proceeds of
      approximately $5.67 million. An additional 10,000 Units were sold in a second
      closing of the Offering on August 12, 2008 for aggregate gross proceeds of
      approximately $35,000. Each "Unit" consists of one share of SmartHeat's common
      stock and a three year warrant to purchase 15% of one share of common stock
      at
      an exercise price of $6.00 per share. The Units sold represent an aggregate
      of
      1,630,000 million shares of common stock and warrants to purchase 244,500 shares
      of Common Stock. The warrants are immediately exercisable and expire on the
      third anniversary of their issuance. In connection with the Offering, the
      Company paid commissions and fees approximately $340,000 and issued warrants
      to
      purchase 148,500 shares of common stock.





*Option
      Grants*





On
      July
      17, 2008, the Company granted non-statutory stock options to each of its two
      independent US directors. The terms of each option are: 10,000 shares at an
      exercise price per share of $4.60, with a life of five years and vesting over
      three years as follows: 3,333 shares shall vest on July 17, 2009; 3,333 shares
      shall vest on July 17, 2010; and 3,334 shares shall vest on July 17, 2011,
      subject in each case to the director continuing to be associated with the
      Company as a director.





*San
      De Ke Transaction*





On
      September 25, 2008, the Company entered into the Share Exchange Agreement (the
      "Purchase Agreement") between Asialink (Far East) Limited ("Asialink") and
      the
      Company providing for the acquisition by the Company from Asialink of all of
      the
      outstanding capital stock of San De Ke Co., Ltd., a Shanghai - based
      manufacturer of heat plate exchangers ("SanDeKe"). The purchase price for the
      SanDeKe shares was $741,516. SanDeKe has an annual production capacity of
      approximately 4,000 plate heat exchangers. SanDeKe was founded in October 2004
      to capitalize and expand on the increasing need for energy saving and
      environmentally friendly products within China. Its client base spans a wide
      range of industries including manufacturing, consumer, chemical, and energy.





Under
      the
      terms of the Purchase Agreement, two of the shareholders of SanDeKe have agreed
      not to compete with the business of SanDeKe for a period of four years after
      the
      completion of the purchase.


19





**Critical
      Accounting Policies**




Basis
      of Presentation





Our
      financial statements are prepared in accordance with GAAP and the requirements
      of Regulation S-X promulgated by the SEC.





Principle
      of Consolidation




The
      accompanying consolidated financial statements include the accounts of the
      Company and its direct and indirect subsidiaries. All significant inter-company
      accounts and transactions have been eliminated in consolidation.





Use
      of
      Estimates




In
      preparing the financial statements in conformity with accounting principles
      generally accepted in the United States of America, management makes estimates
      and assumptions that affect the reported amounts of assets and liabilities
      and
      disclosures of contingent assets and liabilities at the dates of the financial
      statements, as well as the reported amounts of revenues and expenses during
      the
      reporting year.  Significant estimates, required by management,
      include the recoverability of long-lived assets and the valuation of
      inventories.  Actual results could differ from those
      estimates.




Accounts
      and Retentions Receivable




The
      Company’s policy is to maintain reserves for potential credit losses on accounts
      receivable.  Management reviews the composition of accounts receivable
      and analyzes historical bad debts, customer concentrations, customer credit
      worthiness, current economic trends and changes in customer payment patterns
      to
      evaluate the adequacy of these reserves.




Accounts
      receivable is net of unearned interest.  Unearned interest represents
      imputed interest on accounts receivable with due dates over one year from the
      invoice date discounted at the Company's borrowing rate for the
      year.




Inventories




Inventories
      are valued at the lower of cost or market with cost determined on a moving
      weighted average basis.  Cost of work in progress and finished goods
      comprises direct material, direct production cost and an allocated portion
      of
      production overheads.




**Property
      and Equipment**




Property
      and equipment are stated at cost, net of accumulated
      depreciation.  Expenditures for maintenance and repairs are expensed
      as incurred; additions, renewals and betterments are
      capitalized.  When property and equipment are retired or otherwise
      disposed of, the related cost and accumulated depreciation are removed from
      the
      respective accounts, and any gain or loss is included in
      operations.  Depreciation of property and equipment is provided using
      the straight-line method with a 10% salvage value and estimated lives ranging
      from 5 to 20 years as follows:




Building
            
            
            20
                yearsVehicle
            
            
            5
                yearsOffice
                Equipment
            
            
            5
                yearsProduction
                Equipment
            
            
            5
                -
                10 years




Revenue
      Recognition




Our
      revenue recognition policies are in compliance with SEC Staff Accounting
      Bulletin No. 104.  Sales revenue is recognized at the date of shipment
      to customers when a formal arrangement exists, the price is fixed or
      determinable, the delivery is completed, no other significant obligations of
      the
      Company exist and collectability is reasonably assured.  Payments
      received before all of the relevant criteria for revenue recognition are
      recorded as unearned revenue.


20





**Foreign
      Currency Translation and Comprehensive Income (Loss)**




The
      Company’s functional currency is the Renminbi (“RMB”).  For financial
      reporting purposes, RMB has been translated into United States dollars ("USD")
      as the reporting currency.  Assets and liabilities are translated at
      the exchange rate in effect at the balance sheet date.  Revenues and
      expenses are translated at the average rate of exchange prevailing during the
      reporting period.  Translation adjustments arising from the use of
      different exchange rates from period to period are included as a component
      of
      shareholders' equity as "Accumulated other comprehensive
      income."  Gains and losses resulting from foreign currency
      transactions are included in income.  There has been no significant
      fluctuation in the exchange rate for the conversion of RMB to USD after the
      balance sheet date.




The
      Company uses SFAS 130, “Reporting Comprehensive
      Income.”  Comprehensive income is comprised of net income and all
      changes to the statements of shareholders’ equity, except those due to
      investments by shareholders, changes in paid-in capital and distributions to
      shareholders.




**Results
      of Operations**




***Quarter
      Ended September 30, 2008 Compared to the Quarter Ended September 30,
      2007***




The
      following table sets forth the results of our operations for the periods
      indicated as a percentage of net sales:




For
                the Quarter Ended September 30,2008
            
            2007$
            
            %
                of sales
            
            $
            
            %
                of salesSales
            
            
            20,708,288
            
            
            
            
            
            3,015,606Cost
                of Sales
            
            
            (13,273,914
            )
            
            64.0
            
            
            (2,080,718
            )
            
            69.0Gross
                Profit
            
            
            7,434,374
            
            
            36.0
            
            
            934,888
            
            
            31.0Operating
                Expenses
            
            
            (2,080,961
            )
            
            10.0
            
            
            (549,579
            )
            
            18.0Income
                from Operations
            
            
            5,353,413
            
            
            26.0
            
            
            385,309
            
            
            13.0Other
                Income (Expenses), net
            
            
            (41,911
            )
            
            (0.2
            )
            
            (112,524
            )
            
            (3.7
            )Net
                Income
            
            
            4,324,661
            
            
            21.0
            
            
            220,028
            
            
            7.3





*Sales.* Our
      net sales for the three months ended September 30, 2008 were approximately
      $20.71 million while our net sales in same period for 2007 were approximately
      $3.02 million, an increase in revenues of $17.69 million, or about
      587%.  The increase was primarily due to the expansion of our sales
      force, growth of our existing sales channels to develop new customers and the
      extension of our customer base into other industries and new regions in China.
      We believe that our sales will continue to grow as we strengthen our sales
      efforts by hiring more sales personnel, expanding sales channels, and improving
      the quality of our products.





*Cost
      of Sales.* Our
      cost of sales for the three months ended September 30, 2008 were approximately
      $13.27 million while our cost of sales for the same period in 2007, were
      approximately $2.08 million, an increase of $11.19 million, or
      538%.  The increase in cost of sales is attributed to increases in our
      production and sales during the period.  Cost of sales as a percentage of
      sales was approximately 64% for the third fiscal quarter of 2008 and 69% for
      the
      same period in 2007. The decrease in cost of sales as a percentage of sales
      for
      the third quarter of 2008 was mainly due to efficient cost control on our
      purchasing, manufacturing and quality control departments.





*Gross
      Profit* .  Gross
      profit was $7.43 million for the quarter ended September 30, 2008 as compared
      to
      $0.93 million for the same period in 2007, representing gross margins of
      approximately 36% and 31% for the third quarter of 2008 and 2007,
      respectively.  The increase in our gross profits was mainly due to the
      significant increase in our sales and decrease in cost of sales. We believe
      our
      gross profit margin will continue to increase due to the economies of scale
      as
      we continue to increase our production, improve efficiency on cost control
      and
      increase the sales on assembled heat exchanger unit.


21





*Operating
      Expenses* .  Operating
      expenses, consisting of selling, general and administrative expenses, totaled
      approximately $2.08 million for the three months ended September 30, 2008 as
      compared to $0.55 million for the same period in 2007, an increase of
      approximately $1.53 million or 279%.  The increase in operating
      expenses was mainly due to proportional increases in after-sale service,
      payroll, insurance and travel expenses, coupled with our increased sales and
      production; as well as the audit, legal, consulting and filing expenses in
      connection with the Company of being public in US since April of
      2008.





*Net
      Income* .  Our
      net income for the three month period ended September 30, 2008 was approximately
      $4.32 million as compared to $0.22 million for the same period in 2007, an
      increase of $4.1 million or 1866%.  This increase is attributable to
      economy of scale combined with rapid growth in revenue and efficiency of
      operations. Our management believes that net income will continue to increase
      as
      we continue to increase our sales, offer better quality products and control
      our
      manufacturing costs.




***Nine
      Months Ended September 30, 2008 Compared to the Nine Months Ended September
      30,
      2007***




The
      following table sets forth the results of our operations for the periods
      indicated as a percentage of net sales:




For
                the Nine Months
              Ended
                September 30,2008
            
            2007$
            
            %
                of Sales
            
            $
            
            %
                of SalesSales
            
            
            29,345,571
            
            
            
            
            
            5,473,573Cost
                of sales
            
            
            (19,502,070
            )
            
            66.5
            
            
            (3,679,507
            )
            
            67.0Gross
                Profit
            
            
            9,843,501
            
            
            33.5
            
            
            1,794,066
            
            
            33.0Operating
                Expenses
            
            
            (3,135,459
            )
            
            10.7
            
            
            (1,333,314
            )
            
            24.4Income
                from Operation
            
            
            6,708,042
            
            
            23.0
            
            
            460,752
            
            
            8.4Other
                Income (Expenses), net
            
            
            73,163
            
            
            0.25
            
            
            27,761
            
            
            0.51Net
                Income
            
            
            5,528,336
            
            
            19.0
            
            
            385,116
            
            
            7.0




*Sales.* Our
      net sales for the nine months ended September 30, 2008 were approximately $29.35
      million while our net sales for the same period in 2007, were approximately
      $5.47 million, an increase in revenues of $23.87 million, or
      436%.  The increase was due to 1) growing demand for our product
      resulting from rapid increase in newly-built residential communities in Shenyang
      City and the surrounding area, 2) increased number of our sales representatives
      to develop new customers in more cities in China, 3) expanding the field of
      applications for our products to industries other than heating providers, such
      as steel, electrical power plants and chemical engineering, etc. We believe
      that
      our sales will continue to grow because we are strengthening our sales efforts
      by hiring more sales personnel, offering incentive rewarding and compensating
      system to our sales representatives, increasing the sales channels, and
      improving the quality of our products.




*Cost
      of Sales.* Our
      cost of sales for the nine months ended September 30, 2008 were approximately
      $19.5 million while our cost of sales for the same period in 2007 were
      approximately $3.68 million, an increase of $15.82 million, or
      430%.  The increase in cost of sales is attributed to the increase of
      production and sales activities in 2008.  Cost of sales as a
      percentage of sales was approximately 66.5% for the nine months ended September
      30, 2008 and 67% for the same period in 2007.  A slight decrease in
      cost of sales as a percentage of sales for nine months ended September 30,
      2008
      was a result of improvement on cost control which benefited from our strictly
      established cost control procedures.




*Gross
      Profit* .  Gross
      profit was $9.84 million for the nine months ended September 30, 2008 as
      compared to $1.79 million for the same period in 2007, representing gross
      margins of approximately 33.5% and 33% for nine months ended September 30,
      2008
      and 2007, respectively.  The increase in our gross profits due to the
      increase of sales activities and decrease in cost of sales which benefited
      from
      our strict cost control procedures. We believe our gross profit margin will
      increase due to the economy of scale as we will increase our production and
      improving our efficiency on cost control.


22





*Operating
      Expenses* .  Operating
      expenses consisted of selling, general and administrative expenses and totaled
      approximately $3.14 million for the nine months ended September 30, 2008 as
      compared to $1.33 million for the same period in 2007, an increase of
      approximately $1.8 million or 136%.  The increased in operating
      expenses was mainly due to increase in rental expense as we leased new offices
      for our representatives in the major cities of China, after-sale service,
      payroll, insurance and travel expenses coupled with our increased sales and
      production; as well as the audit, legal, consulting and filing expenses in
      connection with the Company of being public in the US since April of
      2008.




*Net
      Income* .  Our
      net income for the nine months ended September 30, 2008 was $5.53 million as
      compared to approximately $0.39 million for the same period in 2007, an increase
      of $5.14 million or 1336%.  This increase is attributable to economy
      of scale combined with rapid growth in revenue and efficiency
      of operations. Our management believes that net income will continue to increase
      as we continue to increase our sales, offer better quality products and control
      our manufacturing costs.





**Liquidity
      and Capital Resources**




As
      of
      September 30, 2008, we had cash and cash equivalents of approximately
      $1,702,938. Working capital was approximately $13.58 million at
      September 30, 2008. The ratio of current assets to current liabilities was
      2.02:1 at September 30, 2008.




The
      following is a summary of cash provided by or used in each of the indicated
      types of activities during the nine months ended September 30, 2008 and
      2007:




For
                the Nine Months Ended
              September
                30,2008
            
            2007Cash
                provided by (used in):Operating
                Activities
            
            $
            (1,213,651
            )
            $
            (1,080,746
            )Investing
                Activities
            
            
            (471,967
            )
            
            (657,979
            )Financing
                Activities
            
            
            2,949,465
            
            
            2,107,098




Net
      cash
      flow used in operating activities was $1,213,651 for the nine months ended
      September 30, 2008, as compared to net cash flow used in operating activities
      of
      $1,080,746 for the nine months ended September 30, 2007. The increase in
      net cash flow used in operating activities for the nine months ended September
      30, 2008 was mainly due to an increase in other receivables and decrease in
      customer deposits.  In addition, our net income for nine months ended
      September 30, 2008 has increased rapidly compared to the same period
      of 2007, bringing more cash in to the Company, while at the same time our
      accounts receivables have increased significantly, reducing our cash
      inflows.




Net
      cash
      flow used in investing activities was $471,967 for the nine months ended
      September 30, 2008, as compared to net cash used in investing activities of
      $657,979 in the same period of 2007.  The slight decrease of net cash
      flow used in investing activities in the nine months ended September 30, 2008
      was mainly due to the completion of construction in progress that was commenced
      and paid in 2007.





Net
      cash
      flow provided by financing activities was $2,949,465 for the nine months ended
      September 30, 2008 as compared to net cash provided by financing activities
      of
      $2,107,098 for the same period of 2007. The increase of net cash inflow provided
      by financing activities for the nine months ended September 30, 2008 was mainly
      due to net proceeds of $5,100,000 from the shares issued despite repayments
      of
      $2,149,875 for the loans during the nine months ended September 30,
      2008.





We
      believe we have sufficient cash to continue our current business
      through **** September
      30, 2009 due to expected increased sales revenue and net income from operations.





We
      do not
      believe that inflation had a significant negative impact on our results of
      operations during the year ended September 30, 2009.


23





**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.




**Contractual
      Obligations**





The
      Company is obligated for the following short term loans payable as of September
      30, 2008:


Balance
                at
              September
                30,
              2008Short
                term loan with a commercial bank in the PRC for 6,000,000 RMB, or
                $822,526. This loan was entered into on Apr 28, 2007 and is due on
                Apr 12,
                2008. This loan bears interest at 7.029% per annum. This loan was
                renewed
                on Apr 12, 2008 with new maturity date on June 13, 2009.
            
            $
            880,023The
                Company entered into a series of short term loans during 2006 and
                2007
                with a third party company in the PRC for total of 10, 300,000 RMB
                or
                $1,412,003. Some of the loans will mature on various dates in year
                2008
                and some of the loans are payable on demand. These loans bear variable
                interest at 8.591% per annum for 2008 and 6.903% per annum for 2007.
            
            
            1,129,363The
                Company entered into a series of short term loans during 2006 with
                another
                third party company in the PRC for total of 2,850,000 RMB, or $390,700.
                These loans are due on various dates in year 2008. These loans bear
                variable interest at 8.591% per annum for 2008 and 6.903% per annum
                for
                2007.
            
            
            358,661The
                Company entered into a short term loan with another third party company
                in
                the PRC for 5,050,000 RMB or $625,759. This loan was entered into
                on Aug
                31, 2005 and was due on Aug 31, 2006. This loan bears no interest.
                Imputed
                interest on the loan was immaterial. This loan became payable on
                demand
                after Aug 31, 2006.
            
            
            740,686The
                Company entered into a one year loan on July 1, 2008 with another
                third
                party company in the PRC for total of 3,000,000 RMB, or $440,000.
                This
                loan is due on June 30, 2009 with interest rate of 8.591% per
                annum.
            
            
            440,013$
            3,548,746





**Recent
      Accounting Pronouncements**





**Accounting
      for Financial Guarantee Insurance Contracts**





In
      May
      2008, FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance
      Contracts, an interpretation of FASB
      Statement No. 60 .” 
      The scope of this Statement is limited to financial guarantee insurance (and
      reinsurance) contracts, as described in this Statement, issued by enterprises
      included within the scope of Statement 60. Accordingly, this Statement does
      not
      apply to financial guarantee contracts issued by enterprises excluded from
      the
      scope of Statement 60 or to some insurance contracts that seem similar to
      financial guarantee insurance contracts issued by insurance enterprises (such
      as
      mortgage guaranty insurance or credit insurance on trade receivables). This
      Statement also does not apply to financial guarantee insurance contracts that
      are derivative instruments included within the scope of FASB
      Statement No. 133 ,
      “Accounting for Derivative Instruments and Hedging Activities.” This Statement
      will not have an impact on the Company’s financial statements.


24





**The
      Hierarchy of Generally Accepted Accounting Principles**





In
      May
      2008, FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting
      Principles.”  SFAS 162 identifies the sources of accounting principles and
      the framework for selecting the principles to be used in the preparation of
      financial statements of nongovernmental entities that are presented in
      conformity with GAAP in the United States.  SFAS 162 will not have an
      impact on the Company’s financial statements.





**Disclosures
      about Derivative Instruments and Hedging Activities**





In
      March
      2008, FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and
      Hedging Activities an amendment of FASB
      Statement No. 133 .” 
      SFAS 161 changes the disclosure requirements for derivative instruments and
      hedging activities. Entities are required to provide enhanced disclosures about
      (a) how and why an entity uses derivative instruments, (b) how derivative
      instruments and related hedged items are accounted for under Statement 133
      and
      its related interpretations, and (c) how derivative instruments and related
      hedged items affect an entity’s financial position, financial performance, and
      cash flows.  Based on current conditions, the Company does not expect the
      adoption of SFAS 161 to have a significant impact on its results of operations
      or financial position.




**Non-Controlling
      Interests in Consolidated Financial Statements - An Amendment of ARB No.
      51**





In
      December 2007, FASB issued SFAS No. 160, "Non-controlling Interests in
      Consolidated Financial Statements - An Amendment of ARB No. 51." SFAS 160
      establishes new accounting and reporting standards for the non-controlling
      interest in a subsidiary and for the deconsolidation of a subsidiary.
      Specifically, this statement requires the recognition of a non-controlling
      interest (minority interest) as equity in the consolidated financial statements
      and separate from the parent’s equity. The amount of net income attributable to
      the non-controlling interest will be included in consolidated net income on
      the
      face of the income statement. SFAS 160 clarifies that changes in a parent’s
      ownership interest in a subsidiary that do not result in deconsolidation are
      equity transactions if the parent retains its controlling financial interest.
      In
      addition, this statement requires that a parent recognize a gain or loss in
      net
      income when a subsidiary is deconsolidated. Such gain or loss will be measured
      using the fair value of the non-controlling equity investment on the
      deconsolidation date. SFAS 160 also includes expanded disclosure requirements
      regarding the interests of the parent and its non-controlling interest. SFAS
      160
      is effective for fiscal years, and interim periods within those fiscal years,
      beginning on or after December 15, 2008. Based on current conditions, the
      Company does not expect the adoption of SFAS 160 to have a significant impact
      on
      its results of operations or financial position.





**Business
      Combinations**





In
      December 2007, FASB issued SFAS No. 141 (Revised 2007), "Business
      Combinations." SFAS 141R will significantly change the accounting for business
      combinations. Under SFAS 141R, an acquiring entity will be required to recognize
      all the assets acquired and liabilities assumed in a transaction at the
      acquisition-date fair value with limited exceptions. SFAS 141R will change
      the
      accounting treatment for certain specific items, including:





·
            Acquisition
                costs will be generally expensed as
                incurred;


·
            Non-controlling
                interests (formerly known as “minority interests”**–**see SFAS 160 discussion above) will be valued at fair value at the
                acquisition date;


·
            Acquired
                contingent liabilities will be recorded at fair value at the acquisition
                date and subsequently measured at either the higher of such amount
                or the
                amount determined under existing guidance for non-acquired
                contingencies;


·
            In-process
                research and development will be recorded at fair value as an
                indefinite-lived intangible asset at the acquisition
                date;


·
            Restructuring
                costs associated with a business combination will be generally expensed
                subsequent to the acquisition date;
                and


·
            Changes
                in deferred tax asset valuation allowances and income tax uncertainties
                after the acquisition date generally will affect income tax
                expense.





SFAS
      141R
      also includes a substantial number of new disclosure requirements. SFAS 141R
      applies prospectively to business combinations for which the acquisition date
      is
      on or after the beginning of the first annual reporting period beginning on
      or
      after December 15, 2008. Earlier adoption is prohibited. Accordingly, since
      we are a calendar year-end company we will continue to record and disclose
      business combinations following existing GAAP until January 1, 2009. The
      Company expects SFAS 141R will have an impact on accounting for business
      combinations once adopted but the effect is dependent upon acquisitions at
      that
      time.





25




**Employers’
      Accounting for Defined Benefit Pension and Other Postretirement Plans, an
      Amendment of FASB Statements No. 87, 88, 106, and 132R**




In
      September 2006, FASB issued SFAS, No. 158, “Employers’ Accounting for Defined
      Benefit Pension and Other Postretirement Plans, an Amendment of FASB Statements
      No. 87, 88, 106, and 132R,” which requires employers to recognize the
      underfunded or overfunded status of a defined benefit postretirement plan as
      an
      asset or liability in its statement of financial position and to recognize
      changes in the funded status in the year in which the changes occur through
      accumulated other comprehensive income. Additionally, SFAS 158 requires
      employers to measure the funded status of a plan as of the date of its year-end
      statement of financial position. The new reporting requirements and related
      new
      footnote disclosure rules of SFAS 158 are effective for fiscal years ending
      after December 15, 2006. The Company adopted the provisions of SFAS 158 for
      the
      year end 2006, and the effect of recognizing the funded status in accumulated
      other comprehensive income was not significant. The new measurement date
      requirement applies for fiscal years ending after December 15,
      2008.





**Accounting
      for Non-Refundable Advance Payments for Goods or Services Received for Use
      in
      Future Research and Development Activities**





In
      June
      2007, FASB issued FASB Staff Position No. EITF 07-3, “Accounting for
      Nonrefundable Advance Payments for Goods or Services Received for use in Future
      Research and Development Activities,” which addresses whether non-refundable
      advance payments for goods or services that used or rendered for research and
      development activities should be expensed when the advance payment is made
      or
      when the research and development activity has been
      performed.  Management is currently evaluating the effect of this
      pronouncement on our financial statements.




**Item
      3.**  **Quantitative
      and Qualitative Disclosures About Market Risk**




Not
      required




**Item
      4T. Controls and Procedures**




**Disclosure
      Controls and Procedures**




As
      of
      September 30, 2008, we carried out an evaluation of the effectiveness of the
      design and operation of our “disclosure controls and procedures” (as defined in
      the Exchange Act Rules 13a-15(e) and 15d-15(e)) under the supervision and with
      the participation of our management, including our Chief Executive Officer
      and
      our Chief Financial Officer. Based upon that evaluation, we concluded that
      our
      disclosure controls and procedures are effective.




Disclosure
      controls and procedures are controls and other procedures that are designed
      to
      ensure that information required to be disclosed in our reports filed or
      submitted under the Exchange Act are recorded, processed, summarized and
      reported, within the time periods specified in the SEC’s rules and forms.
      Disclosure controls and procedures include, without limitation, controls and
      procedures designed to ensure that information required to be disclosed in
      our
      reports filed under the Exchange Act is accumulated and communicated to
      management to allow timely decisions regarding required disclosure.




**Changes
      in Internal Controls Over Financial Reporting**




During
      the quarter ended September 30, 2008, there were no changes in our internal
      control over financial reporting that materially affected our internal control
      over financial reporting.


26


**Part
      II.**  **OTHER
      INFORMATION**




**Item
      1.**  **Legal
      Proceedings**




From
      time
      to time, we may become involved in various lawsuits and legal proceedings,
      which
      arise in the ordinary course of business.  However, litigation is
      subject to inherent uncertainties, and an adverse result in these or other
      matters may arise from time to time that may have an adverse affect on our
      business, financial conditions, or operating results.  We are
      currently not aware of any such legal proceedings or claims that will have,
      individually or in the aggregate, a material adverse affect on our business,
      financial condition or operating results.




**Item
      1A.**  **Risk
      Factors**




Not
      required.




**Item
      2.****Unregistered
      Sales of Equity Securities and Use of Proceeds******




On
      July
      7, 2008, the Company completed a closing of a private placement offering (the
      "Offering") of Units pursuant to which SmartHeat sold an aggregate of 1,620,000
      Units at an offering price of $3.50 per Unit for aggregate gross proceeds of
      approximately $5.67 million. An additional 10,000 Units was sold in a second
      closing of the Offering on August 12, 2008 for aggregate gross proceeds of
      approximately $35,000. Each "Unit" consists of one share of SmartHeat's common
      stock and a three year warrant to purchase 15% of one share of common stock
      at
      an exercise price of $6.00 per share. The Units sold represent an aggregate
      of
      1,630,000 million shares of common stock and warrants to purchase 244,500 shares
      of Common Stock. The warrants are immediately exercisable and expire on the
      third anniversary of their issuance. In connection with the Offering, the
      Company paid commissions and fees approximately $340,000 and issued warrants
      to
      purchase 148,500 shares of common stock. The proceeds from the sale of the
      Units
      in the Offering were used for general corporate purposes.





**Item
      3.****Defaults
      Upon Senior Securities**




None.




**Item
      4.**  **Submission
      of Matters to a Vote of Security Holders**




None.




**Item
      5.**  **Other
      Information**




None.





**Item
      6.**  **Exhibits** ****




**Exhibit No.**
            **Document
                Description**31.1
            Certification
                of Chief Executive Officer pursuant to Rule 13a-15(e) and 15d-15(e),
                promulgated under the Securities and Exchange Act of 1934, as
                amended.31.2
            Certification
                of Chief Financial Officer pursuant to Rule13a-15(e) and 15d-15(e),
                promulgated under the Securities and Exchange Act of 1934, as
                amended.32.1
            Certification
                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                906 of
                the
              Sarbanes-Oxley
                Act of 2002 (Chief Executive Officer).32.2
            Certification
                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                906 of
                the
              Sarbanes-Oxley
                Act of 2002 (Chief Financial
                Officer).


27




**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.




**SMARTHEAT
                INC.**
              **(Registrant)**By:
            /s/
                Jun WangNovember
                14, 2008
            
            Jun
                Wang
              President
                and Chief Executive OfficerBy:
            /s/
                Zhijuan GuoNovember
                14, 2008
            
            Zhijuan
                Guo
              Chief
                Financial Officer


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**EXHIBIT
      INDEX**





**Exhibit No.**
            **Document
                Description**31.1
            Certification
                of Chief Executive Officer pursuant to Rule 13a-15(e) and 15d-15(e),
                promulgated under the Securities and Exchange Act of 1934, as
                amended.31.2
            Certification
                of Chief Financial Officer pursuant to Rule13a-15(e) and 15d-15(e),
                promulgated under the Securities and Exchange Act of 1934, as
                amended.32.1
            Certification
                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002 (Chief Executive
                Officer).32.2
            Certification
                pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002 (Chief Financial
                Officer).





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