UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q/A


AMENDMENT
NO. 1




x
                QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934FOR
      THE QUARTERLY PERIOD ENDED MARCH 31, 2009OR ̈
                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
      Employerincorporation
      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.


YESxNO ̈





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 smaller
      reporting company)





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).YES ̈NOx





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 May 10,
2009.














EXPLANATORY
NOTE


We are
amending our Quarterly Report on Form 10-Q for the quarter ended March 31,
2009, filed with the Securities and Exchange Commission on May 11, 2009,
solely to update Exhibits 32.1 and 32.2 to state that the date for each of
the certifications covers the periodic report for the quarterly period ended
March 31, 2009.All
other items and exhibits contained in the Form 10-Q as filed on May 11, 2009
remain unchanged.
   
  TABLE
OF CONTENTS





PART I –
      FINANCIAL INFORMATION
              
              1Item 1.
              Financial
      Statements
              
              1Item 2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              
              19Item 3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              
              27Item 4T.
              Controls
      and Procedures
              
              27Item 1.
              Legal
      Proceedings
              
              27Item 1A.
              Risk
      Factors
              
              28Item 2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              
              28Item 3.
              Defaults
      Upon Senior Securities
              
              28Item 4.
              Submission
      of Matters to a Vote of Security Holders
              
              28Item 5.
              Other
      Information
              
              28Item 6.
              Exhibits
              
              28SIGNATURES
              
              29








PART
I – FINANCIAL INFORMATION





Item 1.  Financial
Statements




SMARTHEAT,
INC. AND SUBSIDIARIES
 CONSOLIDATED
BALANCE SHEETS
 
 AS OFMARCH 31, 2009
                            
                            
                            AS OFDECEMBER 31, 2008ASSETSCURRENT
      ASSETSCash
      & cash equivalents
                            
                            $
                            737,652
                            
                            
                            $
                            1,435,212Restricted
      cash
                            
                            
                            437,564
                            
                            
                            
                            462,048Accounts
      receivable, net
                            
                            
                            10,144,431
                            
                            
                            
                            11,390,169Retentions
      receivable
                            
                            
                            388,158
                            
                            
                            
                            290,852Advances
      to suppliers
                            
                            
                            1,259,750
                            
                            
                            
                            412,524Other
      receivables, prepayments and deposits
                            
                            
                            661,710
                            
                            
                            
                            698,834Inventories
                            
                            
                            8,150,511
                            
                            
                            
                            6,107,583Note
      and acceptances receivable
                            
                            
                            53,493
                            
                            
                            
                            14,631Total
      current assets
                            
                            
                            21,833,269
                            
                            
                            
                            20,811,853NON-CURRENT
      ASSETSRestricted
      cash
                            
                            
                            196,467
                            
                            
                            
                            219,472Accounts
      receivable, net
                            
                            
                            57,052
                            
                            
                            
                            310,810Retentions
      receivable
                            
                            
                            645,159
                            
                            
                            
                            166,912Intangible
      assets, net
                            
                            
                            1,113,375
                            
                            
                            
                            1,155,131Property
      and equipment, net
                            
                            
                            2,391,418
                            
                            
                            
                            2,436,553Total
      noncurrent assets
                            
                            
                            4,403,471
                            
                            
                            
                            4,288,878TOTAL
      ASSETS
                            
                            $
                            26,236,740
                            
                            
                            $
                            25,100,731LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIESAccounts
      payable
                            
                            $
                            2,450,794
                            
                            
                            $
                            1,210,906Unearned
      revenue
                            
                            
                            1,088,984
                            
                            
                            
                            850,408Taxes
      payable
                            
                            
                            163,020
                            
                            
                            
                            1,327,775Accrued
      liabilities and other payables
                            
                            
                            1,136,028
                            
                            
                            
                            1,330,812Due
      to minority shareholder
                            
                            
                            -
                            
                            
                            
                            5,303Loans
      payable
                            
                            
                            2,442,985
                            
                            
                            
                            2,443,450Total
      current liabilities
                            
                            
                            7,281,811
                            
                            
                            
                            7,168,654DEFERRED
      TAX LIABILITY
                            
                            
                            38,725
                            
                            
                            
                            38,854COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITYCommon
      stock, $0.001 par value; 75,000,000 shares authorized, 24,179,900 shares
      issued and outstanding at March 31, 2009 and December 31, 2008,
      respectively
                            
                            
                            24,180
                            
                            
                            
                            24,180Paid
      in capital
                            
                            
                            8,223,453
                            
                            
                            
                            8,223,453Statutory
      reserve
                            
                            
                            1,267,058
                            
                            
                            
                            1,150,542Accumulated
      other comprehensive income
                            
                            
                            986,339
                            
                            
                            
                            984,629Retained
      earnings
                            
                            
                            8,415,174
                            
                            
                            
                            7,510,419Total
      stockholders' equity
                            
                            
                            18,916,204
                            
                            
                            
                            17,893,223TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                            
                            $
                            26,236,740
                            
                            
                            $
                            25,100,731
 
 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
 
 FOR THE THREE MONTHSENDED MARCH 31,2009
                    
                    
                    2008Net
      sales
                    
                    $
                    6,207,503
                    
                    
                    $
                    3,079,051Cost
      of goods sold
                    
                    
                    3,900,947
                    
                    
                    
                    2,112,956Gross
      profit
                    
                    
                    2,306,556
                    
                    
                    
                    966,095Operating
      expensesSelling
      expenses
                    
                    
                    460,913
                    
                    
                    
                    197,421General
      and administrative expenses
                    
                    
                    569,522
                    
                    
                    
                    284,145Total
      operating expenses
                    
                    
                    1,030,435
                    
                    
                    
                    481,566Income
      from operations
                    
                    
                    1,276,121
                    
                    
                    
                    484,529Non-operating
      income (expenses)Interest
      income
                    
                    
                    16,681
                    
                    
                    
                    147,138Interest
      expense
                    
                    
                    (52,852
                    )
                    
                    
                    (66,628
                    )Financial
      expense
                    
                    
                    (1,840
                    )
                    
                    
                    -Other
      income
                    
                    
                    760
                    
                    
                    
                    11,181Total
      non-operating income (expenses)
                    
                    
                    (37,251
                    )
                    
                    
                    91,691Income
      before income tax
                    
                    
                    1,238,870
                    
                    
                    
                    576,220Income
      tax expense
                    
                    
                    217,601
                    
                    
                    
                    104,957Net
      income
                    
                    
                    1,021,269
                    
                    
                    
                    471,263Other
      comprehensive itemForeign
      currency translation
                    
                    
                    1,710
                    
                    
                    
                    242,094Comprehensive
      Income
                    
                    $
                    1,022,979
                    
                    
                    $
                    713,357Basic
      weighted average shares outstanding
                    
                    
                    24,179,900
                    
                    
                    
                    18,500,000Diluted
      weighted average shares outstanding
                    
                    
                    24,184,174
                    
                    
                    
                    18,500,000Basic
      earnings per share
                    
                    $
                    0.04
                    
                    
                    $
                    0.03Diluted
      earnings per share
                    
                    $
                    0.04
                    
                    
                    $
                    0.03
 
 The
accompanying notes are an integral part of these consolidated financial
statements
  2
 
 SMARTHEAT,
INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 
 FOR THE THREE MONTHSENDED MARCH 31,2009
                        
                        
                        2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                        
                        $
                        1,021,269
                        
                        
                        $
                        471,263Adjustments
      to reconcile net income to net cash used in operating
      activities:Depreciation
      and amortization
                        
                        
                        96,684
                        
                        
                        
                        48,875Unearned
      interest on accounts receivable
                        
                        
                        28,854
                        
                        
                        
                        (143,793
                        )Decrease
      in deferred tax liability
                        
                        
                        (122
                        )
                        
                        
                        -(Increase)
      decrease in current assets:Accounts
      receivable
                        
                        
                        1,073,545
                        
                        
                        
                        (47,140
                        )Retentions
      receivable
                        
                        
                        (575,657
                        )
                        
                        
                        (275,347
                        )Advances
      to suppliers
                        
                        
                        (838,551
                        )
                        
                        
                        (907,320
                        )Other
      receivables, prepayments and deposits
                        
                        
                        (608,803
                        )
                        
                        
                        (220,372
                        )Inventories
                        
                        
                        (2,044,149
                        )
                        
                        
                        589,796Increase
      (decrease) in current liabilities:Accounts
      payable
                        
                        
                        1,596,204
                        
                        
                        
                        719,555Unearned
      revenue
                        
                        
                        238,745
                        
                        
                        
                        385,532Taxes
      payable
                        
                        
                        (1,164,537
                        )
                        
                        
                        (693,038
                        )Accrued
      liabilities and other payables
                        
                        
                        442,319
                        
                        
                        
                        (97,128
                        )Net
      cash used in operating activities
                        
                        
                        (734,199
                        )
                        
                        
                        (169,117
                        )CASH
      FLOWS FROM INVESTING ACTIVITIES:Increase
      in restricted cash
                        
                        
                        47,361
                        
                        
                        
                        116,033Acquisition
      of property & equipment
                        
                        
                        (10,474
                        )
                        
                        
                        (37,761
                        )Net
      cash provided by investing activities
                        
                        
                        36,887
                        
                        
                        
                        78,272CASH
      FLOWS FROM FINANCING ACTIVITIES:Repayment
      to shareholder
                        
                        
                        -
                        
                        
                        
                        (25,890
                        )Loans
      payable
                        
                        
                        -
                        
                        
                        
                        (172,563
                        )Net
      cash used in financing activities
                        
                        
                        -
                        
                        
                        
                        (198,453
                        )EFFECT
      OF EXCHANGE RATE CHANGE ON CASH & CASH EQUIVALENTS
                        
                        
                        (248
                        )
                        
                        
                        9,517NET
      DECREASE IN CASH & CASH EQUIVALENTS
                        
                        
                        (697,560
                        )
                        
                        
                        (279,781
                        )CASH
      & CASH EQUIVALENTS, BEGINNING OF PERIOD
                        
                        
                        1,435,212
                        
                        
                        
                        393,147CASH
      & CASH EQUIVALENTS, END OF PERIOD
                        
                        $
                        737,652
                        
                        
                        $
                        113,366Supplemental
      Cash flow data:Income
      tax paid
                        
                        $
                        777,627
                        
                        
                        $
                        104,957Interest
      paid
                        
                        $
                        60,316
                        
                        
                        $
                        40,498
 
 The
accompanying notes are an integral part of these consolidated financial
statements
  3




SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





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 subsidiaries 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 were 22,549,900 shares of the Company's common
stock issued and outstanding, approximately 82.04% of which was held by the
former Taiyu Shareholders.  The shareholders of the Company
immediately prior to the completion of these transactions held 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. Pursuant
to Securities and Exchange Commission ("SEC") rules, the merger or acquisition
of a private operating company into a non-operating public shell with nominal
net assets is considered a capital transaction in substance, rather than a
business combination. Accordingly, for accounting purposes, the transaction was
treated as a reverse acquisition and a recapitalization, and pro-forma
information is not presented. Transaction costs incurred in the reverse
acquisition were 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 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 a 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 SanDeKe 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 was 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 agreed not to compete with the business of SanDeKe for a
period of four years after the completion of the purchase.  At March
31, 2009, the Company has paid $593,213; the balance of $148,303 will be paid
once the title is officially transferred to the Company.





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 2008 audited financial statements and footnotes included in the
Company’s audited financial statements.  The results for the three
months ended March 31, 2009 are not necessarily indicative of the results to be
expected for the full year ending December 31, 2009.





2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Principles
of Consolidation





The
accompanying consolidated financial statements include the accounts of
SmartHeat, Taiyu and SanDeKe. For purposes of this Quarterly Report, the
"Company" refers collectively to SmartHeat, SanDeKe, and Taiyu. All significant
inter-company accounts and transactions have been eliminated in
consolidation.


4


SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





Use
of Estimates





In
preparing the financial statements in conformity with accounting principles
generally accepted in the United States of America (“US GAAP”), 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, allowance for
doubtful accounts, and the reserve for obsolete and slow-moving 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 March 31, 2009 and December 31, 2008, the Company maintained
total restricted cash of $634,031 and $681,520, respectively, in several bank
accounts, representing cash deposits from customers for securing payment from
customers that occurs no later than the warranty period expires, of which,
$437,564 and $462,048 was the cash that will be released to the Company within
one year. Restricted cash is held in an interest bearing bank
account.




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 $629,568 and $629,687 at March 31, 2009
and December 31, 2008, respectively.





At March
31, 2009 and December 31, 2008, the Company had retentions receivable from
customers for product quality assurance of $1,033,317 and $457,764,
respectively. The retention rate varies from 5% to 20% of the sales price with
variable terms from three months to two years depending on the shipping date of
the products and the number of heating seasons that the warranty period
covers.





Accounts
receivable is net of unearned interest of $57,374 and $28,526 at March 31, 2009
and December 31, 2008, 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, currently 7.16%, and it was
7.04% in 2008.





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
      yearsVehicles
            5
      yearsOffice
      Equipment
            5
      yearsProduction
      Equipment
            5-10
      years





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.


5


SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





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 March 31, 2009 and
December 31, 2008, there were no significant impairments of its long-lived
assets.




Warranties





The
Company offers warranty to all customers on its products for a period of one or
two heating seasons depending on the contract terms negotiated with the
customers. The Company accrues for warranty costs based on estimates of the
costs that may be incurred under its warranty obligations. The warranty expense
and related accrual is included in the Company's selling expenses and other
payable respectively, and is recorded at the time revenue is recognized. Factors
that affect the Company's warranty liability include the number of sold units,
its estimates of anticipated rates of warranty claims, costs per claim and
estimated support labor costs and the associated overhead.  The
Company periodically assesses the adequacy of its recorded warranty liabilities
and adjusts the amounts as necessary.





The
Company's warranty reserve at March 31, 2009 and December 31, 2008 are as
follows:





March 31, 2009
                            
                            
                            December 31, 2008Beginning
      balance
                            
                            $
                            -
                            
                            
                            $
                            -Provisions
      made
                            
                            
                            76,570
                            
                            
                            
                            95,000Changes
      in estimates
                            
                            
                            -
                            
                            
                            
                            -Actual
      costs incurred
                            
                            
                            (12,906
                            )
                            
                            
                            (95,000
                            )Ending
      balance
                            
                            $
                            63,664
                            
                            
                            
                            -Warranty
      reserve in current liabilities
                            
                            $
                            63,664
                            
                            
                            
                            -




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 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.


6





SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





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 (“SAB”) 104. Sales revenue is recognized when products are
delivered and for PHE and PHE units, when customer acceptance occurs, the price
is fixed or determinable, no other significant obligations of the Company exist
and collectibility is reasonably assured. Payments received before all of the
relevant criteria for revenue recognition are recorded as unearned
revenue.





The
Company’s sales contracts with the customers generally provide that 30% of the
purchase price is due upon the placement of an order, 30% is due on delivery,
30% is due upon installation and acceptance of the equipment after customer
testing, the final 10% of the purchase price is due on a date that is no later
than the termination date of the standard warranty period.





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 three months ended March 31, 2009
and 2008. The Company does not provide right of return, price protection or any
other concessions to its customers.





The
standard warranty of the Company is provided to all customers and is not
considered an additional service; rather it is considered an integral part of
the product’s sale. The Company believes that the existence of its standard
product warranty in a sales contract does not constitute a deliverable in the
arrangement and thus there is no need to apply the EITF 00-21 separation
and allocation model for a multiple deliverable arrangement. FAS 5 specifically
address the accounting for standard warranties and neither SAB 104 nor EITF
00-21 supersedes FAS 5. The Company believes that accounting for its standard
warranty pursuant to FAS 5 does not impact revenue recognition because the cost
of honoring the warranty can be reliably estimated.




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 are 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.


7





SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





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.





The
following table presents a reconciliation of basic and diluted earnings per
share:





For the Three
      Months
                      Ended March 312009
                    
                    
                    2008Net
      income
                    
                    $
                    1,021,269
                    
                    
                    $
                    471,263Weighted
      average shares outstanding – basic
                    
                    
                    24,179,900
                    
                    
                    
                    18,500,000Effect
      of dilutive securities:Unexercised
      warrants and options
                    
                    
                    4,274
                    
                    
                    
                    —Weighted
      average shares outstanding – diluted
                    
                    
                    24,184,174
                    
                    
                    
                    18,500,000Earnings
      per share – basic
                    
                    $
                    0.04
                    
                    
                    $
                    0.03Earnings
      per share – diluted
                    
                    $
                    0.04
                    
                    
                    $
                    0.03





Fair
Value of Financial Instruments





SFAS No.
107, “Disclosures about Fair Value of Financial Instruments,” requires 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
accounts of the Company’s Chinese subsidiaries are maintained in the Chinese
Yuan Renminbi (RMB) and the accounts of the U.S. parent company are maintained
in the U.S. Dollar (USD). The accounts of the Chinese subsidiaries were
translated into USD in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 52, "Foreign Currency Translation," with the RMB as the
functional currency for the Chinese subsidiaries. According to the Statement,
all assets and liabilities were translated at the exchange rate on the balance
sheet date, stockholders’ equity are translated at the historical rates and
statement of operations items are translated at the weighted average exchange
rate for the year. The resulting translation adjustments are reported under
other comprehensive income in accordance with SFAS No. 130, "Reporting
Comprehensive Income”.


Stock-Based
Compensation




The
Company accounts for its stock-based compensation in accordance with SFAS No.
123R, “Share-Based Payment, an Amendment of FASB Statement No. 123.”  The
Company recognizes in the statement of operations the grant-date fair value of
stock options and other equity-based compensation issued to employees and
non-employees.





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.


8





SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008








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.





Registration
Rights Agreement




The
Company accounts for payment arrangements under registration rights agreement in
accordance with FASB Staff Position EITF 00-19-2, which requires that the
contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement, whether issued as a
separate agreement or included as a provision of a financial instrument or other
agreement, be separately recognized and measured in accordance with FASB
Statement No. 5, Accounting for Contingencies.





The
Company is required to file the Registration Statement with the SEC within 60
days of the closing of the private placement offering. The Registration
Statement must be declared effective by the SEC within 180 days of the final
closing of the offering. Subject to certain grace periods, the Registration
Statement must remain effective and available for use until the Investors can
sell all of the securities covered by the Registration Statement without
restriction pursuant to Rule 144. If the Company fails to meet the filing or
effectiveness requirements of the Registration Statement, the Company is
required to pay liquidated damages of 2% of the aggregate purchase price paid by
such Investor for any Registrable Securities then held by such Investor on the
date of such failure and on each anniversary of the date of such failure until
such failure is cured.  The last closing under the private
placement occurred on September 24, 2008 and the 180 day period for
effectiveness of the registration statement under the Registration Rights
Agreement ended on March 23, 2009.  At March 31, 2009, the Company became
liable to pay approximately $110,000 liquidated damages to our investors as a
result of failure to declare the effectiveness of the Registration Statement
within 180 days of the final closing of the offering.  The liquidated
damages have been recorded as the Company’s expense with charging corresponding
account to accrued liabilities.




New
Accounting Pronouncements




Employer’s
Disclosures about Postretirement Benefit Plan Assets





In
December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures
about Postretirement Benefit Plan Assets” (“FSP FAS 132(R)-1”). FSP
FAS 132(R)-1 applies to an employer that is subject to the disclosure
requirements of SFAS No. 132 (revised 2003), “Employers’ Disclosures
about Pensions and Other Postretirement Benefits” (“SFAS 132R”) and amends
SFAS 132R to provide guidance on an employer’s disclosures about
plan assets of a defined benefit pension or other postretirement plan. The
disclosures about plan assets required by FSP FAS 132(R)-1 shall be
provided for fiscal years ending after December 15, 2009. Earlier
application is permitted. The adoption of FSP FAS 132(R)-1 did not have a
material impact on its financial statements.





Accounting
for Defensive Intangible Assets





In
November 2008, the FASB issued EITF Issue No. 08-7, “Accounting for
Defensive Intangible Assets” (“EITF 08-7”). EITF 08-7 applies to all
acquired intangible assets in situations in which the acquirer does not intend
to actively use the asset but intends to hold the asset to prevent its
competitors from obtaining access to the asset (a defensive intangible
asset). Defensive intangible assets could include assets that the acquirer will
never actively use, as well as assets that will be used by the acquirer during a
transition period when the intention of the acquirer is to discontinue the use
of those assets. EITF 08-7 concluded that a defensive intangible asset
should be accounted for as a separate unit of accounting and should be amortized
over the period that the defensive intangible asset directly or indirectly
contributes to the future cash flows of the entity. EITF 08-7 is effective
prospectively for intangible assets acquired on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008.
Earlier application is not permitted.  The adoption of EITF 08-7 did
not have a material impact on its financial statements.





9


SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





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.” The
adoption of SFAS No. 163 did not have a material impact on its financial
statements.




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 adoption did not have an impact on
the Company’s financial statements.




Determination
of the Useful Life of Intangible Assets





In
April 2008, the FASB issued FASB Staff Position FAS 142-3, “Determination
of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends
the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”),
and requires additional disclosures. The objective of FSP FAS 142-3 is to
improve the consistency between the useful life of a recognized intangible asset
under SFAS 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141 (R), “Business Combinations” (“SFAS
141(R)”), and other accounting principles generally accepted in the United
States of America. FSP FAS 142-3 applies to all intangible assets, whether
acquired in a business combination or otherwise and shall be effective for
financial statements issued for fiscal years beginning after December 15,
2008, and interim periods within those fiscal years. The guidance for
determining the useful life of intangible assets shall be applied prospectively
to intangible assets acquired after the effective date. The disclosure
requirements apply prospectively to all intangible assets recognized as of, and
subsequent to, the effective date. Early adoption is prohibited. The adoption of
FSP FAS 142-3 did not have a material impact on its 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.  SFAS 161 is effective for fiscal years, and interim periods within
those fiscal years, beginning on or after November 15, 2008, the
adoption of SFAS 161 did not have a significant impact on its results of
operations or financial position.





Fair
value of measurements




On
January 1, 2008, the Company adopted SFAS No. 157, “Fair Value
Measurements,” SFAS 157 defines fair value, establishes a three-level
valuation hierarchy for disclosures of fair value measurement and enhances
disclosures requirements for fair value measurements. The three levels are
defined as follow:




·
            Level
      1 inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active
  markets.




·
            Level
      2 inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the asset or liability, either directly or indirectly, for
      substantially the full term of the financial
  instrument.




·
            Level
      3 inputs to the valuation methodology are unobservable and significant to
      the fair value measurement.




As of
March 31, 2009, the Company did not identify any assets and liabilities that are
required to be presented on the balance sheet at fair value.


10





SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





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. The Company expects SFAS 160 will
have an impact on accounting for business combinations, but the effect is
dependent upon acquisitions at that time.The Company adopted the
provisions of SFAS 160 on January 1, 2009.





Business
Combinations




SFAS 141
(Revised 2007), Business Combinations (SFAS 141(R)), is effective for the
Company for business combinations for which the acquisition date is on or after
January 1, 2009. SFAS 141(R) changes how the acquisition method is applied in
accordance with SFAS 141. The primary revisions to this Statement require an
acquirer in a business combination to measure assets acquired, liabilities
assumed, and any noncontrolling interest in the acquiree at the acquisition
date, at their fair values as of that date, with limited exceptions specified in
the Statement. This Statement also requires the acquirer in a business
combination achieved in stages to recognize the identifiable assets and
liabilities, as well as the noncontrolling interest in the acquiree, at the full
amounts of their fair values (or other amounts determined in accordance with the
Statement). Assets acquired and liabilities assumed arising from contractual
contingencies as of the acquisition date are to be measured at their
acquisition-date fair values, and assets or liabilities arising from all other
contingencies as of the acquisition date are to be measured at their
acquisition-date fair value, only if it is more likely than not that they meet
the definition of an asset or a liability in FASB Concepts Statement No. 6,
Elements of Financial Statements. This Statement significantly amends other
Statements and authoritative guidance, including FASB Interpretation No. 4,
Applicability of FASB Statement No. 2 to Business Combinations Accounted for by
the Purchase Method, and now requires the capitalization of research and
development assets acquired in a business combination at their acquisition-date
fair values, separately from goodwill. FASB Statement No. 109, Accounting for
Income Taxes, was also amended by this Statement to require the acquirer to
recognize changes in the amount of its deferred tax benefits that are
recognizable because of a business combination either in income from continuing
operations in the period of the combination or directly in contributed capital,
depending on the circumstances. The Company expects SFAS 141R will have a
significant impact on accounting for business combinations, but the effect is
dependent upon acquisitions at that time.The Company adopted the
provisions of SFAS 160 on January 1, 2009.





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. EITF 07-03
is effective for fiscal years beginning after December 15, 2008.  The
adoption of EITF 07-03 did not have a significant impact on the Company’s
financial statements.





3.
INVENTORIES





Inventories
at March 31, 2009 and December 31, 2008 were as follows:





March 31,
                    
                    
                    December 31,2009
                    
                    
                    2008Raw
      materials
                    
                    $
                    5,527,347
                    
                    
                    $
                    4,411,298Work
      in process
                    
                    
                    550,020
                    
                    
                    
                    652,472Finished
      Goods
                    
                    
                    2,073,144
                    
                    
                    
                    1,043,813Total
                    
                    $
                    8,150,511
                    
                    
                    $
                    6,107,583


11


SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





4.
PROPERTY AND EQUIPMENT, NET





Property
and equipment consisted of the following at March 31, 2009 and December 31,2008:





March 31,
                    2009
                  
                  
                  December 31,
                    2008Building
                  
                  $
                  1,818,481
                  
                  
                  $
                  1,818,827Production
      equipment
                  
                  
                  440,982
                  
                  
                  
                  441,065Office
      equipment
                  
                  
                  242,403
                  
                  
                  
                  231,975Vehicles
                  
                  
                  300,899
                  
                  
                  
                  300,9562,802,765
                  
                  
                  
                  2,792,823Less:
      Accumulated depreciation
                  
                  
                  (411,347
                  )
                  
                  
                  (356,270
                  )$
                  2,391,418
                  
                  
                  $
                  2,436,553





Depreciation
expense for the three months ended March 31, 2009 and 2008 was approximately
$55,000 and $38,000, respectively.





5.
OTHER RECEIVABLES, PREPAYMENTS AND DEPOSITS





Other
receivables, prepayments and deposits consisted of the following at March 31,
2009 and December 31, 2008, respectively:





March 31,
                        2009
                      
                      
                      December 31,
                        2008Cash
      advance to third parties
                      
                      $
                      129,391
                      
                      
                      $
                      89,628Deposit
      for public bids
                      
                      
                      238,634
                      
                      
                      
                      353,399Prepayment
      for freight and related insurance expenses
                      
                      
                      98,387
                      
                      
                      
                      95,888Deposits
                      
                      
                      7,652
                      
                      
                      
                      42,783Advance
      to employees
                      
                      
                      187,646
                      
                      
                      
                      117,136Total
                      
                      $
                      661,710
                      
                      
                      $
                      698,834





Cash
advance to third parties was the short term cash advances to customers and
vendors with repayment usually within three to six months.  Deposits
for public bidding represented the deposits for bidding expected contracts,
which will be returned to the Company after the bidding process is completed
unusually within three to four months from the payment
date.  Prepayment for freight and /or related insurance expenses
represented prepaid shipping and freight insurance expenses for customers and is
generally repaid upon customer receipt of products.  Deposits mainly
consisted of deposits for rents and utilities. Cash advance to employees mainly
represented short term loan to employees and advance to employees for business
trip and related expenses. Other receivables, prepayments and deposits are
reimbursed or settled within 12 months.





6.
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 approximately $440,000 (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.





Intangible
assets consisted of the following at March 31, 2009 and December 31, 2008,
respectively:


12


SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





March 31,
                    2009
                  
                  
                  December 31,
                    2008Land
      use right
                  
                  $
                  519,271
                  
                  
                  $
                  519,369Know-how
      technology
                  
                  
                  266,757
                  
                  
                  
                  266,808Customer
      list
                  
                  
                  191,615
                  
                  
                  
                  191,652Covenant
      not to compete
                  
                  
                  104,238
                  
                  
                  
                  104,258Software
                  
                  
                  190,130
                  
                  
                  
                  190,1661,272,011
                  
                  
                  
                  1,272,253Less:
      accumulated amortization
                  
                  
                  (158,636
                  )
                  
                  
                  (117,122
                  )$
                  1,113,375
                  
                  
                  $
                  1,155,131





Amortization
expense of intangible assets for the three month ended March 31, 2009 and 2008
was approximately $42,000 and $10,100, respectively. Annual amortization expense
for the next five years at March 31, 2009 is expected to be: $180,000, $180,000,
$180,000, $180,000 and $140,000.





7.
MAJOR CUSTOMERS AND VENDORS




Four and
three customers accounted for 50% and 59% of the Company’s net revenue for the
three months ended March 31, 2009 and 2008, respectively. For the three months
ended March 31, 2009, each customer accounted for about 18%, 16%, 12%, and 5% of
the sales.  For the three months ended March 31, 2008, each customer
accounted for about 25%, 21% and 14% of the sales.   At March 31, 2009
and 2008, the total receivable balance due from these customers was
approximately $3,319,000 and $1,717,000, respectively.




One major
vendor provided 11% and 9% of the Company’s purchases of raw materials for the
three months ended March 31, 2009 and 2008, respectively.  The Company
had approximately $110,000 and $291,000 in accounts payable to this vendor at
March 31, 2009 and 2008, respectively.





8.
TAXES PAYABLE





Taxes
payable consisted of the following at March 31, 2009 and December 31,
2008:





March 31,
                    2009
                  
                  
                  December 31,
                    2008Income
      tax payable
                  
                  $
                  163,932
                  
                  
                  $
                  723,958Value
      added tax payable (receivable)
                  
                  
                  (10,014
                  )
                  
                  
                  597,676Other
      taxes payable
                  
                  
                  9,102
                  
                  
                  
                  6,141$
                  163,020
                  
                  
                  $
                  1,327,775





9.
ACCRUED LIABILITIES AND OTHER PAYABLES





Accrued
liabilities and other payables consisted of the following at March 31, 2009 and
December 31, 2008:





March 31,
                        2009
                      
                      
                      December 31,
                        2008Advance
      from third parties
                      
                      $
                      449,914
                      
                      
                      $
                      453,625Payable
      for purchase of SanDeKe
                      
                      
                      148,303
                      
                      
                      
                      741,516Other
      payables
                      
                      
                      261,886
                      
                      
                      
                      99,418Warranty
      reserve
                      
                      
                      63,664
                      
                      
                      
                      -Accrued
      liabilities
                      
                      
                      212,261
                      
                      
                      
                      36,253Total
                      
                      $
                      1,136,028
                      
                      
                      $
                      1,330,812





Advance
from third parties represented short term, non interest bearing advances from
third parties. Other payables consisted of payables for the Company’s
miscellaneous expenses including postage, business insurance, employee benefits,
bidding fee, etc. Accrued liabilities mainly consisted of accrued interest,
payroll, utility, and liquidated damages for failure to declare the
effectiveness of the Registration Statement within 180 days of the final closing
of the offering.




10.
LOANS PAYABLE





The
Company is obligated for the following short term loans payable as of March 31,
2009 and December 31, 2008:


13


SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





March 31, 2009
                  
                  
                  December 31, 2008Loan
      from a commercial bank in the PRC for 6,000,000 RMB. This loan was entered
      into on Apr 28, 2007 and was due on Apr 12, 2008. This loan was renewed on
      Apr 12, 2008 with new maturity date on June 13, 2009. This loan currently
      bears interest at 7.159%.  The Company pledged its building in
      the value of approximately RMB 12,430,950 or approximately $1,818,000 for
      this loan.
                  
                  $
                  877,719
                  
                  
                  $
                  877,886The
      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. Some
      of the loans matured on various dates in 2008 and some of the loans are
      payable on demand. These loans bear variable interest at 8.591% for 2008
      and 6.903% for 2007.  The Company repaid RMB 2,600,000 in 2008
      and had RMB 7,700,000 outstanding as of March 31, 2009, due on December
      31, 2009 with interest of 8.591%.
                  
                  
                  1,126,406
                  
                  
                  
                  1,126,621The
      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. This loan is due on
      December 31, 2009 with interest of 8.591%.
                  
                  
                  438,860
                  
                  
                  
                  438,943$
                  2,442,985
                  
                  
                  $
                  2,443,450




11.
DEFERRED 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.





12.
INCOME TAXES





The
Company is subject to income taxes by entity on income arising in or derived
from the tax jurisdiction in which each entity is domiciled.





SmartHeat
was incorporated in the United States and has incurred net operating loss for
income tax purposes.  SmartHeat has net operating loss carry forwards
for income taxes amounting to approximately $220,000 at March 31, 2009 which may
be available to reduce future years’ taxable income as NOL can be carried
forward up to 20 years from the year the loss is incurred. Management believes
that the realization of the benefits from these losses appears uncertain due to
the Company’s limited operating history and continuing losses. Accordingly, a
100% deferred tax asset valuation allowance has been provided.





Taiyu and
SanDeKe are 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.





Taiyu, as
a manufacturing business, is subject to 18% income tax rate for 2008 and 20%
income tax rate for 2009. According to the new income tax law that became
effective January 1, 2008, new high-tech enterprises that government gives
special support are subject to income tax rate of 15%.  Taiyu was
recognized as a new high-tech enterprise and registered the status with tax
bureau, therefore, enjoys the income tax rate of 15% from 2009 through
2010.





SanDeKe
is subject to an 18% income tax rate after 7% reduction in federal income tax
rate given by federal government. SanDeKe, is also exempt from income tax for
two years starting from the 1st profitable year, and is entitled to a 50%
discount on the 18% income tax rate for 2010 through 2012.





The
Company's net income would be lower by approximately $58,700 or $0.0024 earnings
per share had Taiyu not enjoyed lower income tax rate and SanDeKe not been
exempted from income tax for 2009.




The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the three months ended March 31, 2009 and 2008:


14


SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





For the Three Months EndedMarch 31,2009
                  
                  
                  March 31, 2008US
      statutory rates
                  
                  
                  34.0
                  %
                  
                  
                  34.0
                  %Tax
      rate difference
                  
                  
                  (15.7
                  )%
                  
                  
                  (16.0
                  )%Effect
      of tax holiday
                  
                  
                  (4.5
                  )%
                  
                  
                  -Valuation
      allowance
                  
                  
                  4.2
                  %
                  
                  
                  -Tax
      per financial statements
                  
                  
                  18.0
                  %
                  
                  
                  18.0
                  %





13.
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.





14.
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. The warrants require the
Company to settle in its own shares.  There is no provision for cash
settlement, except in lieu of fractional shares.  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.  The value of the warrant was $70,246. There were no warrants
exercised from the grant date to March 31, 2009.





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.




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:


15


SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008




The
options vest over 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.
There were no options exercised during the first quarter of 2009.




Following
is a summary of the warrant activity:




Number of
                    Shares
                  
                  
                  Average
                    Exercise
                    Price per Share
                  
                  
                  Weighed
                    Average
                    Remaining
                    Contractual
                    Term in YearsOutstanding
      at December 31, 2007
                  
                  
                  -Exercisable
      at December 31, 2007
                  
                  
                  -Granted
                  
                  
                  393,000
                  
                  
                  
                  6.00
                  
                  
                  3.00ExercisedForfeitedOutstanding
      at December 31, 2008
                  
                  
                  393,000
                  
                  
                  
                  6.00
                  
                  
                  
                  2.51Exercisable
      at December 31, 2008
                  
                  
                  393,000
                  
                  
                  
                  6.00
                  
                  
                  
                  2.51GrantedExercisedForfeitedOutstanding
      at March 31, 2009
                  
                  
                  393,000
                  
                  
                  
                  6.00
                  
                  
                  
                  2.27Exercisable
      at March 31, 2009
                  
                  
                  393,000
                  
                  
                  
                  6.00
                  
                  
                  
                  2.27





Following
is a summary of the option activity:





Number of
                    Shares
                  
                  
                  Average
                    Exercise
                    Price per Share
                  
                  
                  Weighed
                    Average
                    Remaining
                    Contractual
                    Term in YearsOutstanding
      at December 31, 2007
                  
                  
                  -Exercisable
      at December 31, 2007
                  
                  
                  -Granted
                  
                  
                  20,000
                  
                  
                  
                  4.60
                  
                  
                  5.00ExercisedForfeitedOutstanding
      at December 31, 2008
                  
                  
                  20,000
                  
                  
                  
                  4.60
                  
                  
                  
                  4.54Exercisable
      at December 31, 2008
                  
                  
                  20,000
                  
                  
                  
                  4.60
                  
                  
                  
                  4.54GrantedExercisedForfeitedOutstanding
      at March 31, 2009
                  
                  
                  20,000
                  
                  
                  
                  4.60
                  
                  
                  
                  4.29Exercisable
      at March 31, 2009
                  
                  
                  20,000
                  
                  
                  
                  4.60
                  
                  
                  
                  4.29





15.
COMMITMENTS





Employment
Agreements




On
January 1, 2008, the Company entered into a three years employment agreement
with Mr. Jun Wang, which agreement may be renewed at the end of the initial term
upon mutual agreement between Mr. Jun Wang and the Company.  Either
party shall give written notice to the other party of its intention not to
renew the agreement at least 30 days prior to the end of the initial
term.  Pursuant to the terms of the employment agreement, Mr. Jun Wang
shall receive a salary in an amount that is not less than the lowest minimum
wage per month paid in Shenyang and shall be based on the uniform wage and
incentive system in Shenyang, currently $18,000 per annum. In addition, Mr. Jun
Wang shall be entitled to overtime pay in accordance with the applicable
law.


16





SMARTHEAT INC. AND
SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





On
January 1, 2008, The Company entered into a three years employment agreement
with Ms. Zhijuan Guo, at terms identical to the terms of the employment
agreement with Mr. Jun Wang with current salary of $10,684 per
annum.





Lease
agreements





The
Company leased several offices for its sales representative in different cities
under various one-year, non-cancellable, and renewable operating lease
agreements.





At March
31, 2009, future minimum rental payments required under these operating leases
are as follows:





Year
      Ending March 31,
                
                Amount2010
                
                $
                87,0002011
                
                
                87,000Total
                
                $
                174,000




16.
CONTINGENCIES





The
Company sold goods to its customers and received Commercial Notes from the
customers in lieu of the payments for accounts receivable.  The
Company discounts the Notes with the bank or endorses 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 March
31, 2009 and December 31, 2008, the Company is contingently liable to vendors
for endorsed notes receivable amounting to $53,493 and $14,631,
respectively.





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.




17.
ACQUISITION OF SANDEKE 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.  At
March 31, 2009, the Company has paid $593,213; the balance of $148,303 will be
paid once the title is officially transferred to the Company.





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.


17


SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 (UNAUDITED) AND DECEMBER 31, 2008





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 is amortized over 5 years, the
customer list is amortized over 5 years and covenants not to compete, is
amortized over 4 years.





The
following unaudited pro forma consolidated results of operations of the Company
for the three months ended March 31, 2008 presents the operations of the Company
and SanDeKe as if the acquisition of SanDeKe occurred on January 1,
2008.  The pro forma results are not necessarily indicative of the
actual results that would have occurred had the acquisitions been completed as
of the beginning of the periods presented, nor are they necessarily indicative
of future consolidated results.




For the
      three months ended
                      March 31, 2008
                    
                    Pro forma
                      ConsolidatedNet
      revenue
                    
                    $
                    3,303,963Cost
      of revenue
                    
                    
                    2,263,354Gross
      profit
                    
                    
                    1,040,609Selling
      expense
                    
                    
                    222,025General
      & administrative expense
                    
                    
                    329,730Total
      operating expenses
                    
                    
                    551,755Income
      from operations
                    
                    
                    488,854Non-operating
      income, net
                    
                    
                    91,752Income
      before income tax
                    
                    
                    580,606Income
      tax
                    
                    
                    104,957Net
      income
                    
                    $
                    475,649Basic
      and diluted weighted average shares outstanding
                    
                    
                    18,500,000Basic
      and diluted net earnings per share
                    
                    $
                    0.03


18





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 were
incorporated in the State of Nevada on August 4, 2006 under the name Pacific
Goldrim Resources, Inc. as an exploration stage corporation that intended to
engage in the exploration of silver, lead and zinc. On April 14, 2008 we changed
our name to SmartHeat Inc. and acquired all of the equity interests in
Taiyu.




Prior to
our acquisition of Taiyu, we were in the development stage and had minimal
business operations. We had no interest in any property, but had the right to
conduct exploration activities on thirteen (13) mineral title cells covering
270.27 hectares (667.85 acres) in the Slocan Mining Division of southeastern
British Columbia, Canada. In connection with the acquisition of Taiyu, we
transferred our prior assets and liabilities to a wholly owned subsidiary and
sold all of the outstanding capital stock of that subsidiary to our former
director and officer in exchange for 2,500,000 shares of our common
stock.




Taiyu was
formed in July 2002 under the laws of China and is headquartered in Shenyang
City, Liaoning Province, China. As a result of our acquisition of Taiyu, we are
a leading provider of plate heat exchange products to China's industrial,
residential, and commercial markets, specializing in the manufacturing, sale,
research, and servicing of PHEs, PHE Units and heat meters for a broad range of
industries such as petroleum refinement, petrochemicals, power generation,
metallurgy, food & beverage, and chemical processing. We sell PHEs under the
Sondex brand and PHE Units that are designed by us and using PHEs that are
assembled with Sondex plates under our Taiyu brand name.




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. Our quarterly revenues may fluctuate significantly due to the seasonal
nature of central heating services in the PRC, whereas, the equipment used in
residential building s must be delivered and installed prior to the beginning of
the heating season in late fall.  Additionally, 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. In particular, our 2009 sales
may be affected by weaker demand from steel processing, petrochemical and HVAC
sectors.  To date, we have not been adversely affected by these
trends. Moreover, the PRC government has recently passed an economic stimulus
package and we believe that our sales will benefit from an increase in
government spending on infrastructure as provided in this
package.  However, 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.





While
our significant accounting policies are more fully described in Note 2 to our
consolidated financial statements, we believe that the following accounting
policies are the most critical to aid you in fully understanding and evaluating
this management discussion and analysis.




Basis
of Presentation




Our
financial statements are prepared in accordance with generally accepted
accounting principles in the United States of America.


19





Principle
of Consolidation





The
accompanying consolidated financial statements include the accounts of
SmartHeat, Taiyu and SanDeKe. For purposes of this Quarterly Report, the
"Company" refers collectively to SmartHeat, SanDeKe, and Taiyu. 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, allowance for doubtful accounts, and the
reserve for obsolete and slow-moving inventories. Actual results could differ
from those estimates.




Accounts
Receivable




Our
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 are net of unearned
interest. Unearned interest represents imputed interest on accounts receivable
with due dates over one year from the invoice date discounted at our 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
      yearsVehicles
              5
      yearsOffice
      Equipment
              5
      yearsProduction
      Equipment
              5 -
      10 years




Revenue
Recognition




Our
revenue recognition policies are in compliance with Securities and Exchange
Commission (SEC) Staff Accounting Bulletin (“SAB”) 104. Sales revenue is
recognized when products are delivered, and for PHE and PHE units, when customer
acceptance occurs, the price is fixed or determinable, no other significant
obligations of the Company exist and collectibility is reasonably assured.
Payments received before all of the relevant criteria for revenue recognition
are recorded as unearned revenue.





Our sales
contracts with the customers generally provide that 30% of the purchase price is
due upon the placement of an order, 30% is due on delivery, 30% is due upon
installation and acceptance of the equipment after customer testing, the final
10% of the purchase price is due on a date that is no later than the termination
date of the standard warranty period.





Our
standard warranty is provided to all customers and is not considered an
additional service; rather it is considered an integral part of the products
sale. We believe that the existence of the standard product warranty in a sales
contract does not constitute a deliverable in the arrangement and thus there is
no need to apply the EITF 00-21 separation
and allocation model for a multiple deliverable arrangement. FAS 5 specifically
address the accounting for standard warranties and neither SAB 104 nor EITF 00-21 supersedes
FAS 5. We
believe that accounting for our standard warranty pursuant to FAS 5 does not impact
revenue recognition because the cost of honoring the warranty can be reliably
estimated.




20




Warranties
 
 We offer
warranty to all customers on our products for a period of one or two heating
seasons depending on the contract terms negotiated with the customers. We accrue
for warranty costs based on estimates of the costs that may be incurred under
its warranty obligations. The warranty expense and related accrual is included
in our selling expenses and other payable respectively, and is recorded at the
time revenue is recognized. Factors that affect our warranty liability include
the number of sold units, its estimates of anticipated rates of warranty claims,
costs per claim and estimated support labor costs and the associated
overhead.  The Company periodically assesses the adequacy of its
recorded warranty liabilities and adjusts the amounts as necessary.
 
 Foreign
Currency Translation and Comprehensive Income (Loss)
  The
accounts of the Company’s Chinese subsidiaries are maintained in the Chinese
Yuan Renminbi (RMB) and the accounts of the U.S. parent company are maintained
in the U.S. Dollar (USD). The accounts of the Chinese subsidiaries were
translated into USD in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 52, "Foreign Currency Translation," with the RMB as the
functional currency for the Chinese subsidiaries. According to the Statement,
all assets and liabilities were translated at the exchange rate on the balance
sheet date, stockholders’ equity are translated at the historical rates and
statement of operations items are translated at the weighted average exchange
rate for the year. The resulting translation adjustments are reported under
other comprehensive income in accordance with SFAS No. 130, "Reporting
Comprehensive Income”.
 Recent
Accounting Pronouncements
  Employer’s
Disclosures about Postretirement Benefit Plan Assets
 
 In
December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures
about Postretirement Benefit Plan Assets” (“FSP FAS 132(R)-1”). FSP
FAS 132(R)-1 applies to an employer that is subject to the disclosure
requirements of SFAS No. 132 (revised 2003), “Employers’ Disclosures
about Pensions and Other Postretirement Benefits” (“SFAS 132R”) and amends
SFAS 132R to provide guidance on an employer’s disclosures about plan
assets of a defined benefit pension or other postretirement plan. The
disclosures about plan assets required by FSP FAS 132(R)-1 shall be
provided for fiscal years ending after December 15, 2009. Earlier
application is permitted. The adoption of FSP FAS 132(R)-1 did not have a
material impact on its financial statements.
 
 Accounting
for Defensive Intangible Assets
 
 In
November 2008, the FASB issued EITF Issue No. 08-7, “Accounting for
Defensive Intangible Assets” (“EITF 08-7”). EITF 08-7 applies to all
acquired intangible assets in situations in which the acquirer does not intend
to actively use the asset but intends to hold the asset to prevent its
competitors from obtaining access to the asset (a defensive intangible
asset). Defensive intangible assets could include assets that the acquirer will
never actively use, as well as assets that will be used by the acquirer during a
transition period when the intention of the acquirer is to discontinue the use
of those assets. EITF 08-7 concluded that a defensive intangible asset
should be accounted for as a separate unit of accounting and should be amortized
over the period that the defensive intangible asset directly or indirectly
contributes to the future cash flows of the entity. EITF 08-7 is effective
prospectively for intangible assets acquired on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008.
Earlier application is not permitted.  The adoption of EITF 08-7 did
not have a material impact on its financial statements.
 
 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.”The
adoption of SFAS No. 163 did not have a material impact on its financial
statements.
  21
 
 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 adoption did not have an impact on
the Company’s financial statements.
 
 Determination
of the Useful Life of Intangible Assets
 
 In
April 2008, the FASB issued FASB Staff Position FAS 142-3, “Determination
of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends
the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”),
and requires additional disclosures. The objective of FSP FAS 142-3 is to
improve the consistency between the useful life of a recognized intangible asset
under SFAS 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141 (R), “Business Combinations” (“SFAS
141(R)”), and other accounting principles generally accepted in the United
States of America. FSP FAS 142-3 applies to all intangible assets, whether
acquired in a business combination or otherwise and shall be effective for
financial statements issued for fiscal years beginning after December 15,
2008, and interim periods within those fiscal years. The guidance for
determining the useful life of intangible assets shall be applied prospectively
to intangible assets acquired after the effective date. The disclosure
requirements apply prospectively to all intangible assets recognized as of, and
subsequent to, the effective date. Early adoption is prohibited. The adoption of
FSP FAS 142-3 did not have a material impact on its 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.  SFAS 161 is effective for fiscal years, and interim periods within
those fiscal years, beginning on or after November 15, 2008, the
adoption of SFAS 161 did not have a significant impact on its results of
operations or financial position.
 
 Fair
value of measurements
 
 On
January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements.”
SFAS 157 defines fair value, establishes a three-level valuation hierarchy for
disclosures of fair value measurement and enhances disclosures requirements for
fair value measures..  The three levels are defined as follow:
 
 o
              Level
      1 inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active
  markets.
 
 o
              Level
      2 inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the asset or liability, either directly or indirectly, for
      substantially the full term of the financial
  instrument.
 
 o
              Level
      3 inputs to the valuation methodology are unobservable and significant to
      the fair value measurement.
  As of
March 31, 2009, the Company did not identify any assets and liabilities that are
required to be presented on the balance sheet at fair value.
  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. The Company expects SFAS 160 will
have an impact on accounting for business combinations, but the effect is
dependent upon acquisitions at that time. The Company adopted the
provisions of SFAS 160 on January 1, 2009.
  22
 
 Business
Combinations
  SFAS 141
(Revised 2007), Business Combinations (SFAS 141(R)), is effective for the
Company for business combinations for which the acquisition date is on or after
January 1, 2009. SFAS 141(R) changes how the acquisition method is applied in
accordance with SFAS 141. The primary revisions to this Statement require an
acquirer in a business combination to measure assets acquired, liabilities
assumed, and any noncontrolling interest in the acquiree at the acquisition
date, at their fair values as of that date, with limited exceptions specified in
the Statement. This Statement also requires the acquirer in a business
combination achieved in stages to recognize the identifiable assets and
liabilities, as well as the noncontrolling interest in the acquiree, at the full
amounts of their fair values (or other amounts determined in accordance with the
Statement). Assets acquired and liabilities assumed arising from contractual
contingencies as of the acquisition date are to be measured at their
acquisition-date fair values, and assets or liabilities arising from all other
contingencies as of the acquisition date are to be measured at their
acquisition-date fair value, only if it is more likely than not that they meet
the definition of an asset or a liability in FASB Concepts Statement No. 6,
Elements of Financial Statements. This Statement significantly amends other
Statements and authoritative guidance, including FASB Interpretation No. 4,
Applicability of FASB Statement No. 2 to Business Combinations Accounted for by
the Purchase Method, and now requires the capitalization of research and
development assets acquired in a business combination at their acquisition-date
fair values, separately from goodwill. FASB Statement No. 109, Accounting for
Income Taxes, was also amended by this Statement to require the acquirer to
recognize changes in the amount of its deferred tax benefits that are
recognizable because of a business combination either in income from continuing
operations in the period of the combination or directly in contributed capital,
depending on the circumstances. The Company expects SFAS 141R will have a
significant impact on accounting for business combinations, but the effect is
dependent upon acquisitions at that time. The Company adopted the
provisions of SFAS 160 on January 1, 2009.
  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. EITF 07-03
is effective for fiscal years beginning after December 15, 2008.  The
adoption of EITF 07-03 did not have a significant impact on the Company’s
financial statements.
 
 Results
of Operations
  Three
Months Ended March 31, 2009 Compared to the Three Months Ended March 31,
2008
  The
following table sets forth the results of our operations for the years indicated
as a percentage of net sales:
  Three
      months Ended March 312009
                  
                  
                  2008$
                  
                  
                  % of Sales
                  
                  
                  $
                  
                  
                  % of SalesSales
                  
                  
                  6,207,503
                  
                  
                  
                  
                  
                  
                  3,079,051Cost
      of sales
                  
                  
                  3,900,947
                  
                  
                  
                  63.0
                  %
                  
                  
                  2,112,956
                  
                  
                  
                  69.0
                  %Gross
      Profit
                  
                  
                  2,306,556
                  
                  
                  
                  37.0
                  %
                  
                  
                  966,095
                  
                  
                  
                  31.0
                  %Operating
      Expenses
                  
                  
                  1,030,435
                  
                  
                  
                  17.0
                  %
                  
                  
                  481,566
                  
                  
                  
                  16.0
                  %Income
      from Operation
                  
                  
                  1,276,121
                  
                  
                  
                  20.0
                  %
                  
                  
                  484,529
                  
                  
                  
                  15.0
                  %Other
      Income (Expenses), net
                  
                  
                  (37,251
                  )
                  
                  
                  (0.6
                  )%
                  
                  
                  91,691
                  
                  
                  
                  3.0
                  %Net
      Income
                  
                  
                  1,021,269
                  
                  
                  
                  16.0
                  %
                  
                  
                  471,263
                  
                  
                  
                  15.0
                  %
  23
  Sales. Net sales during the
three months ended March 31, 2009 were approximately $6.21 million, while our
net sales for the three months ended March 31, 2008 were approximately $3.08
million, an increase in revenues of $3.13 million, or 102%. The increase in
sales was attributable to an increase in our sales volume with selling price
determined based on our standard profit margin rate, of which, $4.47 million
of  the total sales was from our existing customers and $1.74 million
of the total sales was from the new customers. We have a strict review process
for approving each sales contract, especially with respect to the determination
of selling price.  Sales price under each contract is determined in
proportion to our estimated cost in order to ensure our gross
profit.  Our selling price varies on each sale which mainly depends on
each customer’s specific needs and our negotiation of the contract amount and
term. We have also increased the number of our branch offices and sales
representatives throughout China to develop new customers in more regions during
2008. These new regions’ developments that occurred during the first
quarter of 2009 accounted for approximately $0.95 million of the increase
in our revenues.  In addition, our sales on heating meters have been
increased to approximately $110,000 during the first quarter of 2009 from
approximately $20,000 during the first quarter of 2008.  As we continue to
expand our customer base and increase our sales volume, we become less dependent
on these customers for revenue.  We believe that our sales will
continue to grow because we are strengthening our sales efforts by hiring more
sales personnel, increasing the sales channels, and improving the quality of our
products.
  Cost of
Sales.  Cost of sales for the three months ended March 31, 2009
was approximately $3.90 million, while our cost of sales for the same period in
2008 was approximately $2.11 million, an increase of $1.79 million, or
85%.  Cost of sales mainly consisted of the cost of materials and
labor, as well as factory overhead costs, with material costs accounting for 70%
or more of our total cost of sales.  The increase in cost of sales can
be attributed to the increase of production and sales volume in the first
quarter of 2009.  Cost of sales as a percentage of sales was
approximately 63% for the first quarter of 2009 and 68% for the same period of
2008. The decrease in cost of sales as a percentage to the sales was mainly due
to decreased raw material cost, economy of scale on fixed costs as a result of
increased production, and our continuous improvement on control of the
manufacturing costs. We believe our cost of sales will remain stable as a result
of our current pricing strategy and the continued improvement in the efficiency
of our manufacturing facility.
  Gross
Profit.  Gross profit was $2.31 million for the three months
ended March 31, 2009, as compared to $0.97 million for the same period in 2008,
representing gross margins of approximately 37% and 31%,
respectively.  The increase in our gross profits and gross profit
margin was mainly due to the decrease of cost of goods sold as a percentage of
sales while the company’s sales activities increased.
  Operating
Expenses.  Operating expenses consisted of selling, general and
administrative expenses totaled approximately $1.03 million for the three months
ended March 31, 2009, as compared to $0.48 million for the three months ended
March 31, 2008, an increase of approximately $0.55 million or
114%.  The increase in operating expenses was mainly due to a
proportional increase in payroll, insurance, employee welfare and travel
expenses with our increased sales and production; as well as the increase in
audit, legal, consulting and filing expenses in connection with the Company of
being public in US since April of 2008.  In addition, a one-time
charge of approximately $110,000 occurred in the first quarter of 2009 as a
result of failure to declare the effectiveness of the Registration Statement
within 180 days of the final closing of the offering.
 
 Net Income.  Our
net income for the three months ended March 31, 2009 was $1.02 million as
compared to approximately $0.47 million for the same period in 2008, an increase
of $0.55 million or 117%.  Net income as a percentage of sales
increased from 15% in the first quarter of 2008 to 16% in the same period of
2009. This increase was attributable to economy of scale combined with rapid
growth in revenue and efficiency of operations, and lower income tax rate of 15%
for Taiyu effective January 1, 2009, down from 18% for 2008.  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
  Three
Months Ended March 31, 2009 Compared to the Three Months Ended March 31,
2008
 
 As of
March 31, 2009, we had cash and cash equivalents of approximately $0.74 million.
Working capital was approximately $14.05 million at March 31, 2009. The
ratio of current assets to current liabilities was 2.81:1 at March 31,
2009.
 
 The
following is a summary of cash provided by or used in each of the indicated
types of activities during the period ended March 31, 2009 and
2008:
  For the Three
      Months Ended March 31,2009
                  
                  
                  2008Cash
      provided by (used in):Operating
      Activities
                  
                  $
                  (734,199
                  )
                  
                  $
                  (169,117
                  )Investing
      Activities
                  
                  
                  36,887
                  
                  
                  
                  78,272Financing
      Activities
                  
                  
                  -
                  
                  
                  
                  (198,453
                  )
  24
  Net cash
flow used in operating activities was $734,199 in the first quarter of 2009, as
compared to net cash flow used in operating activities of $169,117 in the same
period of 2008. The increase in net cash flow used in operating activities
during the first quarter of 2009 was mainly due to $2.04 million cash paid for
inventories as we expect increased production and sales volumes in the 2nd quarter
of 2009; and more income tax paid as our net income increased.  Our
net income has increased rapidly compared to the same period of 2008 along with
the timely collection of the accounts receivable, which brought about $1.07
million cash to the company, The significant amount in accounts receivable was
due to the rapid increase in our sales with most of our accounts receivables
aging within one year from the sales recognition date.
 
 Net cash
flow provided by investing activities was $36,887 in the first quarter of 2009,
as compared to net cash provided by investing activities of $78,272 in the same
period of 2008.  The decrease of net cash flow provided by investing
activities in the first quarter of 2009 was mainly due to release of the
restricted cash as the warranty period expired, and less restricted cash
received from customers while retentions receivable which is generally due upon
termination of the warranty period has been increased.
  Net cash
flow used in financing activities was $0 in the first quarter of 2009 as
compared to net cash used in financing activities of $198,453 in the same period
of 2008.  In the first quarter of 2009, we did not have any financing
activities; while in the same period of 2008, we‘ve repaid $25,890 to our
shareholders and $172,563 to third party lenders.
 
 Our sales
contracts with our customers generally provide that 30% of the purchase price is
due upon the placement of an order, 30% is due on delivery and 30% is due upon
installation and acceptance of the equipment after customer testing. As a common
practice in the heating manufacturing business in China, payment is due on
the final 10% of the purchase price no later than the termination date of the
standard warranty period which ranges from 3 to 24 months from the acceptance
date of the products. Our receipts for payment on our products depend on the
complexity of the equipment ordered which impacts manufacturing, delivery,
installation and testing times and warranty periods.  For example,
PHEs are less complex than PHE units and therefore have a shorter manufacturing,
acceptance, warranty and payment schedule. The Company may experience payment
delays from time to time which may last up to 3 months; however, the Company
does not believe the delays are material.
  Indirect
sales through distributors are usually paid in full on delivery. Our accounts
receivable turnover and inventory turnover are relatively low, and days sales outstanding
ratio relatively high. Consequently, collection on our sales is rather slow and
capital is tied up in inventories which may result in pressure on cash flows.
For the first
quarter of 2009, we had accounts receivable turnover of 0.55, with days sales
outstanding of 163 and inventory turnover of 0.55. For the first quarter of
2008, we had
accounts receivable turnover of 0.45, with days sales outstanding of 198 and
inventory turnover of 0.27.




We are in
the manufacturing and processing business.  We purchase substantial
amounts of raw materials before the high season starts to meet production
needs.  There is no concern about inventory obsolescence since our
product can be sold for a profit without time limitation as long as there is
continued demand.  Additionally, we have increased our sales force for
developing new customers, which we believe will reduce on-hand inventory levels
and increase inventory turnover going forward.  Therefore, we believe
the potential risks and uncertainties associated with lower inventory turnover
are limited.
 
 We
recognize the final 10% of the purchase price as a Retention Receivable which is
due no later than the termination of our warranty period.  The
deferral of the final payment is a common practice in the heating manufacturing
business in China.  Sometimes our customers are required to deposit
5%-10% of the sales price on high value products like assembled heat exchanger
unit and main part of plate heat exchanger into designated bank accounts as
restricted cash for securing the payment after such period
expires.  Based on our historical experience, there have been no
defaults on such deferrals.  Therefore, we believe the potential risks
and uncertainty associated with defaults on such receivables are not
material.
 
 Recent
Developments
 
 Under the
terms of the Registration Rights Agreement, the Company is required to file a
Registration Statement registering the common stock and common stock underlying
the warrants with the Securities and Exchange Commission (the “SEC”) within 60
days of the closing of the private placement offering. The Registration
Statement must be declared effective by the SEC within 180 days of the final
closing of the offering or the Company will be subject to penalties as described
below. Subject to certain grace periods, the Registration Statement must remain
effective and available for use until the investors can sell all of the
securities covered by the Registration Statement without restriction pursuant to
Rule 144. If the Company fails to meet the filing or effectiveness requirements
of the Registration Statement, it is required to pay liquidated damages of 2% of
the aggregate purchase price paid by such investor for any Registrable
Securities then held by such investor on the date of such failure and on each
anniversary of the date of such failure until such failure is
cured.
 
 The
closing the private placement occurred on September 24, 2008. The Company was
obligated to cause the Registration Statement become effective on or before
March 23, 2009.  As a result of its failure to have a registration
statement effective on this date, the Company is liable to pay approximately
$110,000 liquidated damages to investors in the private placement.
 
 The
Company expects to pay liquidated damages from its working
capital.  The Company had approximately $737,000 cash at March 31,
2009 which is more than adequate to make payments on any liquidated damages. The
Company expects the Registration Statement to become effective prior to any
additional penalties being assessed which would occur if the Registration
Statement is not effective by March 23, 2010.
  25
 
 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.
  26
  Contractual
Obligations
 
 The
Company was obligated for the following short term loans payable as of March 31,
2009 and December 31, 2008:
 
 March 31, 2009
                    
                    
                    December 31, 2008Loan
      from a commercial bank in the PRC for 6,000,000 RMB. This loan was entered
      into on Apr 28, 2007 and was due on Apr 12, 2008. This loan was renewed on
      Apr 12, 2008 with new maturity date on June 13, 2009. This loan currently
      bears interest at 7.159%.  The Company pledged its building in
      the value of approximately RMB 12,430,950 or approximately $1,818,000 for
      this loan.
                    
                    $
                    877,719
                    
                    
                    $
                    877,886The
      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. Some
      of the loans matured on various dates in 2008 and some of the loans are
      payable on demand. These loans bear variable interest at 8.591% for 2008
      and 6.903% for 2007.  The Company repaid RMB 2,600,000 in 2008
      and had RMB 7,700,000 outstanding as of March 31, 2009, due on December
      31, 2009 with interest of 8.591%.
                    
                    
                    1,126,406
                    
                    
                    
                    1,126,621The
      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. This loan is due on
      December 31, 2009 with interest of 8.591%.
                    
                    
                    438,860
                    
                    
                    
                    438,943$
                    2,442,985
                    
                    
                    $
                    2,443,450
  Item
3. Quantitative and
Qualitative Disclosures About Market Risk
  Not
required
  Item
4T. Controls and Procedures
  Disclosure Controls and
Procedures
  An
evaluation was conducted under the supervision and with the participation of the
Company’s management, including the Chief Executive Officer (“CEO”), its
principal executive officer, and Chief Financial Officer (“CFO”), its principal
financial officer, of the effectiveness of the design and operation of the
Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and
Rule 15d-15(e) of the Exchange Act) as of March 31, 2009. Based on that
evaluation, the CEO and CFO concluded that the Company’s disclosure controls and
procedures were effective as of such date to ensure that information required to
be disclosed in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms.
 
 Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by the Company in
the reports that it files or submits under the Exchange Act is accumulated and
communicated to the Company's management, including its principal executive and
principal financial officers, or persons performing similar functions, as
appropriate to allow timely decisions regarding required
disclosure.
  Changes in Internal Controls
Over Financial Reporting
  There
were no changes in our internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during
the quarter ended March 31, 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
 
 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.
  27
 
 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
      Description31.1
                      
                      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).
  28
 
 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 WangMay
      22, 2009
                  
                  Jun
      Wang
                    President
      and Chief Executive Officer(Principle
      Executive Officer)By:
                  /s/ Zhijuan
      GuoMay
      22, 2009
                  
                  Zhijuan
      Guo
                    Chief
      Financial Officer
                    (Principal Financial and
      Accounting
Officer)
  29
  EXHIBIT
INDEX
 
 Exhibit No.
                    
                    Document
      Description31.1
                    
                    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).
  30