UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





FOR
THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2009




OR





 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





Commission
file number 000-53052





SMARTHEAT
INC.


(Exact
name of registrant as specified in its charter)





NEVADA
            98-0514768(State
      or other jurisdiction of
            (IRS
      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: 32,784,825 shares as of November 11,
2009.











PART I –
      FINANCIAL INFORMATIONItem 1.
              Financial
      Statements (Unaudited)
              1Item 2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              18Item 3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              24Item 4T.
              Controls
      and Procedures
              24Item 1.
              Legal
      Proceedings
              25Item 1A.
              Risk
      Factors
              25Item 2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              25Item 3.
              Defaults
      Upon Senior Securities
              25Item 4.
              Submission
      of Matters to a Vote of Security Holders
              25Item 5.
              Other
      Information
              25Item 6.
              Exhibits
              26SIGNATURES
              62









PART
I – FINANCIAL INFORMATION




SMARTHEAT,
INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS




SEPTEMBER 30, 2009
                    
                    
                    DECEMBER 31, 2008(UNAUDITED)ASSETSCURRENT
      ASSETSCash
      & cash equivalents
                    
                    $
                    60,294,695
                    
                    
                    $
                    1,435,212Restricted
      cash
                    
                    
                    1,043,524
                    
                    
                    
                    462,048Accounts
      receivable, net
                    
                    
                    20,276,792
                    
                    
                    
                    11,390,169Retentions
      receivable
                    
                    
                    553,105
                    
                    
                    
                    290,852Advances
      to suppliers
                    
                    
                    3,474,936
                    
                    
                    
                    412,524Other
      receivables, prepayments and deposits
                    
                    
                    3,282,014
                    
                    
                    
                    698,834Inventories
                    
                    
                    14,394,162
                    
                    
                    
                    6,107,583Note
      receivable - bank acceptance
                    
                    
                    70,655
                    
                    
                    
                    14,631Total
      current assets
                    
                    
                    103,389,881
                    
                    
                    
                    20,811,853NON-CURRENT
      ASSETSRestricted
      cash
                    
                    
                    19,185
                    
                    
                    
                    219,472Accounts
      receivable, net
                    
                    
                    582,375
                    
                    
                    
                    310,810Retentions
      receivable
                    
                    
                    2,309,852
                    
                    
                    
                    166,912Construction
      in progress
                    
                    
                    60,230
                    
                    
                    
                    -Intangible
      assets, net
                    
                    
                    4,122,844
                    
                    
                    
                    1,155,131Property
      and equipment, net
                    
                    
                    7,578,356
                    
                    
                    
                    2,436,553Total
      noncurrent assets
                    
                    
                    14,672,842
                    
                    
                    
                    4,288,878TOTAL
      ASSETS
                    
                    $
                    118,062,723
                    
                    
                    $
                    25,100,731LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIESAccounts
      payable
                    
                    $
                    6,030,827
                    
                    
                    $
                    1,210,906Unearned
      revenue
                    
                    
                    2,084,036
                    
                    
                    
                    850,408Notes
      payable - bank acceptance
                    
                    
                    1,000,543
                    
                    
                    
                    -Taxes
      payable
                    
                    
                    2,147,376
                    
                    
                    
                    1,327,775Accrued
      liabilities and other payables
                    
                    
                    7,071,473
                    
                    
                    
                    1,330,812Due
      to minority shareholder
                    
                    
                    -
                    
                    
                    
                    5,303Loans
      payable
                    
                    
                    5,564,504
                    
                    
                    
                    2,443,450Total
      current liabilities
                    
                    
                    23,898,759
                    
                    
                    
                    7,168,654DEFERRED
      TAX LIABILITY
                    
                    
                    15,519
                    
                    
                    
                    38,854COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITYCommon
      stock, $0.001 par value; 75,000,000 shares authorized, 32,756,575 and
      24,179,900 shares issued and outstanding at September 30, 2009 and
      December 31, 2008, respectively
                    
                    
                    32,757
                    
                    
                    
                    24,180Paid
      in capital
                    
                    
                    71,679,770
                    
                    
                    
                    8,223,453Statutory
      reserve
                    
                    
                    2,689,432
                    
                    
                    
                    1,150,542Accumulated
      other comprehensive income
                    
                    
                    1,255,603
                    
                    
                    
                    984,629Retained
      earnings
                    
                    
                    18,490,884
                    
                    
                    
                    7,510,419Total
      stockholders' equity
                    
                    
                    94,148,446
                    
                    
                    
                    17,893,223TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                    
                    $
                    118,062,723
                    
                    
                    $
                    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
 (UNAUDITED)
  FOR THE NINE MONTHS ENDED SEPTEMBER 30,
                      
                      
                      FOR THE THREE MONTHS ENDED SEPTEMBER 30,2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Net
      sales
                      
                      $
                      56,541,795
                      
                      
                      $
                      29,345,571
                      
                      
                      $
                      37,835,897
                      
                      
                      $
                      20,708,288Cost
      of goods sold
                      
                      
                      36,562,363
                      
                      
                      
                      19,502,070
                      
                      
                      
                      24,687,460
                      
                      
                      
                      13,273,914Gross
      profit
                      
                      
                      19,979,433
                      
                      
                      
                      9,843,501
                      
                      
                      
                      13,148,438
                      
                      
                      
                      7,434,374Operating
      expensesSelling
      expenses
                      
                      
                      2,325,471
                      
                      
                      
                      1,664,882
                      
                      
                      
                      1,165,939
                      
                      
                      
                      1,056,854General
      and administrative expenses
                      
                      
                      2,626,775
                      
                      
                      
                      1,470,577
                      
                      
                      
                      1,286,643
                      
                      
                      
                      1,024,107Total
      operating expenses
                      
                      
                      4,952,245
                      
                      
                      
                      3,135,459
                      
                      
                      
                      2,452,581
                      
                      
                      
                      2,080,961Income
      from operations
                      
                      
                      15,027,187
                      
                      
                      
                      6,708,042
                      
                      
                      
                      10,695,856
                      
                      
                      
                      5,353,413Non-operating
      income (expenses)Interest
      income
                      
                      
                      145,839
                      
                      
                      
                      318,070
                      
                      
                      
                      65,418
                      
                      
                      
                      57,387Interest
      expense
                      
                      
                      (209,462
                      )
                      
                      
                      (257,116
                      )
                      
                      
                      (91,850
                      )
                      
                      
                      (94,076
                      )Subsidy
      income
                      
                      
                      21,443
                      
                      
                      
                      16,141
                      
                      
                      
                      (13,897
                      )
                      
                      
                      7,000Financial
      expense
                      
                      
                      (222,625
                      )
                      
                      
                      -
                      
                      
                      
                      (222,625
                      )
                      
                      
                      -Other
      expense
                      
                      
                      
                      
                      
                      
                      (13,676
                      )
                      
                      
                      11,199
                      
                      
                      
                      (13,676
                      )Other
      income
                      
                      
                      61,644
                      
                      
                      
                      9,744
                      
                      
                      
                      60,675
                      
                      
                      
                      1,454Total
      non-operating income (expenses)
                      
                      
                      (203,162
                      )
                      
                      
                      73,163
                      
                      
                      
                      (191,081
                      )
                      
                      
                      (41,911
                      )Income
      before income tax
                      
                      
                      14,824,026
                      
                      
                      
                      6,781,205
                      
                      
                      
                      10,504,776
                      
                      
                      
                      5,311,502Income
      tax expense
                      
                      
                      2,304,672
                      
                      
                      
                      1,246,935
                      
                      
                      
                      1,624,240
                      
                      
                      
                      980,907Net
      income from operations
                      
                      
                      12,519,354
                      
                      
                      
                      5,534,270
                      
                      
                      
                      8,880,536
                      
                      
                      
                      4,330,595Less:
      net income attributable to noncontrolling interest
                      
                      
                      -
                      
                      
                      
                      5,934
                      
                      
                      
                      -
                      
                      
                      
                      5,934Net
      income
                      
                      
                      12,519,354
                      
                      
                      
                      5,528,336
                      
                      
                      
                      8,880,536
                      
                      
                      
                      4,324,661Other
      comprehensive itemForeign
      currency translation
                      
                      
                      270,399
                      
                      
                      
                      578,670
                      
                      
                      
                      257,256
                      
                      
                      
                      167,774Comprehensive
      Income
                      
                      $
                      12,789,753
                      
                      
                      
                      6,107,006
                      
                      
                      $
                      9,137,792
                      
                      
                      $
                      4,492,435Basic
      weighted average shares outstanding
                      
                      
                      24,430,806
                      
                      
                      
                      21,503,588
                      
                      
                      
                      24,924,435
                      
                      
                      
                      24,055,878Diluted
      weighted average shares outstanding
                      
                      
                      24,513,092
                      
                      
                      
                      21,503,647
                      
                      
                      
                      25,010,735
                      
                      
                      
                      24,056,054Basic
      earnings per share
                      
                      $
                      0.51
                      
                      
                      $
                      0.26
                      
                      
                      $
                      0.36
                      
                      
                      $
                      0.18Diluted
      earnings per share
                      
                      $
                      0.51
                      
                      
                      $
                      0.26
                      
                      
                      $
                      0.36
                      
                      
                      $
                      0.18


The
accompanying notes are an integral part of these consolidated financial
statements





2




SMARTHEAT,
INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(UNAUDITED)




FOR THE NINE MONTHS ENDED SEPTEMBER 30,2009
                
                
                2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income including noncontrolling interest
                
                $
                12,519,354
                
                
                $
                5,534,270Adjustments
      to reconcile net income including noncontrollinginterest
      to net cash used in operating activities:Depreciation
      and amortization
                
                
                409,371
                
                
                
                173,821Unearned
      interest on accounts receivable
                
                
                195,901
                
                
                
                (71,804
                )Stock
      option compensation expense
                
                
                1,755
                
                
                
                1,270Decrease
      in deferred tax liability
                
                
                (23,357
                )
                
                
                -(Increase)
      decrease in current assets:Accounts
      receivable
                
                
                (9,305,812
                )
                
                
                (4,995,840
                )Retentions
      receivable
                
                
                (2,403,726
                )
                
                
                107,279Advances
      to suppliers
                
                
                (3,051,902
                )
                
                
                320,260Other
      receivables, prepayments and deposits
                
                
                485,060
                
                
                
                (2,346,526
                )Inventories
                
                
                (8,277,813
                )
                
                
                118,223Note
      receivable
                
                
                (55,986
                )
                
                
                (201,118
                )Increase
      (decrease) in current liabilities:Accounts
      payable
                
                
                5,782,299
                
                
                
                928,337Unearned
      revenue
                
                
                1,232,371
                
                
                
                (1,581,803
                )Taxes
      payable
                
                
                818,141
                
                
                
                864,934Accrued
      liabilities and other payables
                
                
                (4,450,011
                )
                
                
                (266,072
                )Net
      cash used in operating activities
                
                
                (6,124,354
                )
                
                
                (1,414,769
                )CASH
      FLOWS FROM INVESTING ACTIVITIES:Restricted
      cash
                
                
                (380,457
                )
                
                
                (101,542
                )Purchase
      asset of Siping
                
                
                (0
                )
                
                
                -Construction
      in progress
                
                
                (60,203
                )
                
                
                (83,027
                )Acquisition
      of property & equipment
                
                
                (3,610,566
                )
                
                
                (287,398
                )Net
      cash used in investing activities
                
                
                (4,051,225
                )
                
                
                (471,967
                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Due
      to minority shareholders
                
                
                -
                
                
                
                (660
                )Due
      from / (to) shareholder
                
                
                -
                
                
                
                (587,644
                )Short
      term loans
                
                
                12,117,636
                
                
                
                -Repayment
      of short term loans
                
                
                (9,216,986
                )
                
                
                (1,361,113
                )Issuance
      of common stock
                
                
                66,138,390
                
                
                
                5,100,000Net
      cash provided by financing activities
                
                
                69,039,040
                
                
                
                3,150,583EFFECT
      OF EXCHANGE RATE CHANGE ON CASH & CASH EQUIVALENTS
                
                
                (3,978
                )
                
                
                (9,482
                )NET
      INCREASE IN CASH & CASH EQUIVALENTS
                
                
                58,859,482
                
                
                
                1,254,365CASH
      & CASH EQUIVALENTS, BEGINNING OF PERIOD
                
                
                1,435,213
                
                
                
                448,573CASH
      & CASH EQUIVALENTS, END OF PERIOD
                
                $
                60,294,695
                
                
                $
                1,702,938Supplemental
      Cash flow data:Income
      tax paid
                
                $
                1,272,797
                
                
                $
                426,809Interest
      paid
                
                $
                219,061
                
                
                $
                201,269




The
accompanying notes are an integral part of these consolidated financial
statements




3




SMARTHEAT
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 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 of RMB 25,000,000.
Concurrent with the share exchange, one of SmartHeat’s shareholders cancelled
2,500,000 shares of 6,549,900 of 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, 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, 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 SanDeKe was $741,516.
Under the terms of the Agreement, two shareholders of SanDeKe agreed not to
compete with the business of SanDeKe for four years after the
purchase.





On June
12, 2009, the Company incorporated a new subsidiary SmartHeat Siping Beifang
Energy Technology Co., Ltd (“SmartHeat Siping”) to manufacture heat
exchangers.





On June
16, 2009, Taiyu closed an asset purchase transaction with Siping Beifang Heat
Exchanger Manufacture Co.,Ltd (“Siping”), a
company organized under the laws of the PRC, to purchase certain assets
consisting of the plant and equipment and certain land use rights
for 54,000,000 RMB, or United States Dollars (USD)
7,906,296.  Taiyu then transferred all the assets acquired to
SmartHeat Siping, the newly incorporated subsidiary.  The purchase
consideration is non-interest bearing and was payable according to the following
schedule:




Payment
      in RMB
                        
                        Payment
      in USD
                        
                        Payment
      DateRMB
      3,000,000
                        
                        $
                        439,239
                        
                        May
      27, 2009RMB
      10,250,000
                        
                        $
                        1,500,732
                        
                        June
      30, 2009RMB 13,000,000
                        
                        $
                        1,903,367
                        
                        September
      30, 2009RMB
      12,300,000
                        
                        $
                        1,800,878
                        
                        March
      1, 2010RMB
      8,200,000
                        
                        $
                        1,200,586
                        
                        September
      30,
2010





At
September 30, 2009, the Company paid approximately $3 million. The payment terms
do not include any default provision.





The
unaudited financial statements were 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 (“US GAAP”) were 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 nine
months ended September 30, 2009 are not necessarily indicative of the results to
be expected for the full year ending December 31, 2009.





4





2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Principles
of Consolidation





The
accompanying consolidated financial statements include the accounts of
SmartHeat, Taiyu, SanDeKe and SmartHeat Siping, a newly incorporated subsidiary
in June of 2009. For purposes of this Quarterly Report, the "Company"
refers collectively to SmartHeat, Taiyu, SanDeKe and Siping. All significant
inter-company accounts and transactions have been eliminated in
consolidation.





Use
of Estimates





In
preparing the financial statements in conformity with 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 September 30, 2009, the Company maintained restricted cash of
$1,062,708 in several bank accounts, $562,436 representing cash deposits from
customers for securing payment from customers that occurs no later than the
warranty period expires, and $500,272 representing the deposits the Company paid
to a commercial bank for the bank issuing the bank acceptance to its
vendors; of the total restricted cash, $1,043,524 will be released to the
Company within one year. As of December 31, 2008, the Company maintained
restricted cash of $681,520, of which, $462,048 will be released to the Company
within one year. Restricted cash is held in the interest bearing bank
accounts.





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 $630,204 and $629,687 at September 30,
2009 and December 31, 2008, respectively.





At
September 30, 2009 and December 31, 2008, the Company had retentions receivable
from customers for product quality assurance of $2,862,956 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 $224,540 and $28,526 at September 30,
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:





5





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





Land
Use Rights





Right to
use land is stated at cost less accumulated amortization. Amortization is
provided using the straight-line method over 50 years.





Impairment
of Long-Lived Assets





Long-lived
assets, which include property, plant and equipment and intangible assets, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.





Recoverability
of long-lived assets to be held and used is measured by a comparison of the
carrying amount of an asset to the estimated undiscounted future cash flows
expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated undiscounted future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the assets. Fair value is generally determined using the asset’s
expected future discounted cash flows or market value, if readily determinable.
Based on its review, the Company believes that, as of September 30, 2009 and
December 31, 2008, there were no significant impairments of its long-lived
assets.





Warranties





The
Company offers warranties to all customers on its products for one or two
heating seasons depending on the 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 September 30, 2009 and December 31, 2008 is as
follows:





For the Nine
                      Months
                      Ended
                      September 30, 2009
                    
                    
                    For the Year Ended
                      December 31, 2008Beginning
      balance
                    
                    $
                    -
                    
                    
                    $
                    -Provisions
      made
                    
                    
                    564,466
                    
                    
                    
                    95,000Actual
      costs incurred
                    
                    
                    (42,207
                    )
                    
                    
                    (95,000
                    )Ending
      balance in current liabilities
                    
                    $
                    522,259
                    
                    
                    $
                    -





Income
Taxes





The
Company utilizes Statement of Financial Accounting Standards ("SFAS") No. 109,
“Accounting for Income Taxes,” (codified in FASB ASC Topic 740), which requires
recognition of deferred tax assets and liabilities for expected future tax
consequences of events that were 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,
(codified in FASB ASC Topic 740) 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





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 (codified in FASB ASC Topic 480). Sales revenue
is recognized when products are delivered and for PHE and PHE (codified in FASB
ASC Topic 480) 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 for 30% of the
purchase price on placement of an order, 30% on delivery, 30% upon installation
and acceptance of the equipment after customer testing, and 10% of the purchase
price on a date no later than the termination 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 sold in the PRC are subject to Chinese value-added
tax of 17% of gross sales price. This VAT may be offset by VAT paid by the
Company on raw materials and other materials included in the cost of producing
their finished product. The Company recorded VAT payable and VAT receivable net
of payments in the financial statements. The VAT tax return is filed offsetting
the payables against the receivables.





Sales and
purchases are recorded net of VAT collected and paid as the Company acts as an
agent for the government. VAT taxes are not affected by the income tax
holiday.





Sales
returns and allowances were $0 for both the nine months ended September 30, 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 all customers and is not considered
an additional service; rather it is an integral part of the product’s sale. The
Company believes 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 EITF 00-21 (codified in Financial Accounting Standards Board
(“FASB”) Accounting Standards Codification (“ASC”) Topic 605-25) separation and
allocation model for a multiple deliverable arrangement. SFAS 5 (codified in
FASB ASC Topic 450) specifically address the accounting for standard warranties
and neither SAB 104 nor EITF 00-21 supersedes SFAS 5. The Company believes that
accounting for its standard warranty pursuant to SFAS 5 (codified in FASB ASC
Topic 450) does not impact revenue recognition because the cost of honoring the
warranty can be reliably estimated.





The
Company provides after sales services at a charge after expiration of the
warranty period, with after sales services mainly consisting of cleaning plate
heat exchangers and repairing and exchanging parts. The Company recognizes such
revenue when service is provided. For the nine months ended September 30, 2009
and 2008, revenue from after sales services after expiration of the warranty
period was approximately $299,000 and $28,000. For the three months ended
September 30, 2009 and 2008, revenue from after sales services after expiration
of the warranty period was approximately $295,000 and $7,200,
respectively.





Cost
of Goods Sold





Cost of
goods sold consists primarily of material costs, direct labor, and manufacturing
overhead which are directly attributable to the production of products. 
Write-down of inventories to lower of cost or market is also recorded in cost of
goods sold.





Concentration
of Credit Risk





Financial
instruments that potentially subject the Company to credit risk consist
primarily of accounts receivable and other receivables. The Company does not
require collateral or other security to support these receivables. The Company
conducts periodic reviews of its clients' financial condition and customer
payment practices to minimize collection risk on accounts
receivable.





7





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,” codified in FASB ASC
Topic 230, 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.  The cash flows
from operating, investing and financing activities exclude the effect of
conversion from accounts payable to notes payable – bank acceptance of $100,543
and assets purchased from Siping Manufacture of $7,906,296 during the nine
months ended September 30, 2009.





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 Nine
                        Months Ended September 30,
                        (Unaudited)
                      
                      
                      For the Three Months
                        Ended September 30,
                        (Unaudited)2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008Net
      income
                      
                      $
                      12,519,354
                      
                      
                      $
                      5,528,336
                      
                      
                      $
                      8,880,536
                      
                      
                      $
                      4,324,661Weighted
      average shares outstanding - basic
                      
                      
                      24,430,806
                      
                      
                      
                      21,503,588
                      
                      
                      
                      24,924,435
                      
                      
                      
                      24,055,878Effect
      of dilutive securities:Unexercised
      warrants  and options
                      
                      
                      82,286
                      
                      
                      
                      59
                      
                      
                      
                      86,300
                      
                      
                      
                      176Weighted
      average shares outstanding - diluted
                      
                      
                      24,513,092
                      
                      
                      
                      21,503,647
                      
                      
                      
                      25,010,735
                      
                      
                      
                      24,056,054Earnings
      per share - basic
                      
                      $
                      0.51
                      
                      
                      $
                      0.26
                      
                      
                      $
                      0.36
                      
                      
                      $
                      0.18Earnings
      per share - diluted
                      
                      $
                      0.51
                      
                      
                      $
                      0.26
                      
                      
                      $
                      0.36
                      
                      
                      $
                      0.18





Fair
Value of Financial Instruments





SFAS No.
107, “Disclosures about Fair Value of Financial Instruments,” (codified in FASB
ASC Financial Instruments, Topic 825) 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 SFAS No. 52, "Foreign Currency
Translation," (codified in Financial Accounting Standards Board (“FASB”)
Accounting Standards Codification (“ASC”) Topic 830), 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” (codified in FASB ASC Topic 220).





8




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” (codified in FASB ASC Topics 718 & 505). The Company recognizes in
the income statement 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"
(codified in FASB ASC Topic 280) requires use of the “management approach” model
for segment reporting. The management approach model is based on the way a
company's management organizes segments within the company for making operating
decisions and assessing performance. Reportable segments are based on products
and services, geography, legal structure, management structure, or any other
manner in which management disaggregates a company.





SFAS
131 has no effect on the Company's financial statements as substantially all of
the Company's operations are conducted in one industry segment. All of the
Company's assets are located in the PRC.





Registration
Rights Agreement





The
Company accounts for payment arrangements under registration rights agreement in
accordance with FASB Staff Position EITF 00-19-2, (codified in FASB ASC Topic
815), which requires 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 (codified in
FASB ASC Topic 450).





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 was 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 damage was
recorded as the Company’s G&A expense with charging corresponding account to
accrued liabilities.  The Registration Statement became effective on
June 23, 2009.





New
Accounting Pronouncements





On July
1, 2009, the Company adopted Accounting Standards Update (“ASU”) No.
2009-01, “Topic 105 - Generally Accepted Accounting Principles - amendments
based on Statement of Financial Accounting Standards No. 168 , “The FASB
Accounting Standards CodificationTM and the Hierarchy of Generally Accepted
Accounting Principles” (“ASU No. 2009-01”).  ASU No. 2009-01
re-defines authoritative GAAP for nongovernmental entities to be only comprised
of the FASB Accounting Standards CodificationTM (“Codification”) and, for SEC
registrants, guidance issued by the SEC.  The Codification is a
reorganization and compilation of all then-existing authoritative GAAP for
nongovernmental entities, except for guidance issued by the SEC.  The
Codification is amended to effect non-SEC changes to authoritative
GAAP.  Adoption of ASU No. 2009-01 only changed the referencing
convention of GAAP in Notes to the Consolidated Financial
Statements.





In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R)” (“SFAS 167”), codified as FASB ASC Topic 810-10, which modifies how a
company determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. SFAS 167
clarifies that the determination of whether a company is required to consolidate
an entity is based on, among other things, an entity’s purpose and design and a
company’s ability to direct the activities of the entity that most significantly
impact the entity’s economic performance. SFAS 167 requires an ongoing
reassessment of whether a company is the primary beneficiary of a variable
interest entity. SFAS 167 also requires additional disclosures about a company’s
involvement in variable interest entities and any significant changes in risk
exposure due to that involvement. SFAS 167 is effective for fiscal years
beginning after November 15, 2009. The Company does not believe the adoption of
SFAS 167 will have an impact on its financial condition, results of operations
or cash flows.





9




In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets — an amendment of FASB Statement No. 140” (“SFAS 166”), codified as FASB
Topic ASC 860, which requires entities to provide more information regarding
sales of securitized financial assets and similar transactions, particularly if
the entity has continuing exposure to the risks related to transferred financial
assets. SFAS 166 eliminates the concept of a “qualifying special-purpose
entity,” changes the requirements for derecognizing financial assets and
requires additional disclosures. SFAS 166 is effective for fiscal years
beginning after November 15, 2009. The Company does not believe the adoption of
SFAS 166 will have an impact on its financial condition, results of operations
or cash flows.




In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”) codified in
FASB ASC Topic 855-10-05, which provides guidance to establish general standards
of accounting for and disclosures of events that occur after the balance sheet
date but before financial statements are issued or are available to be issued.
SFAS 165 also requires entities to disclose the date through which subsequent
events were evaluated as well as the rationale for why that date was selected.
SFAS 165 is effective for interim and annual periods ending after June 15, 2009,
and accordingly, the Company adopted this pronouncement during the second
quarter of 2009. SFAS 165 requires that public entities evaluate subsequent
events through the date that the financial statements are issued. The Company
has evaluated subsequent events through November 12, 2009.





In April
2009, the FASB issued FSP No. SFAS 107-1 and APB 28-1, “Interim Disclosures
about Fair Value of Financial Instruments,” which is codified in FASB ASC Topic
825-10-50. This FSP essentially expands the disclosure about fair value of
financial instruments that were previously required only annually to also be
required for interim period reporting. In addition, the FSP requires certain
additional disclosures regarding the methods and significant assumptions used to
estimate the fair value of financial instruments. These additional disclosures
are required beginning with the quarter ending June 30, 2009. This FSP had no
material impact on the Company’s financial position, results of operations or
cash flows.





In
April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition
and Presentation of Other-Than-Temporary Impairments,” which is codified in FASB
ASC Topic 320-10. This FSP modifies the requirements for recognizing
other-than-temporarily impaired debt securities and changes the existing
impairment model for such securities. The FSP also requires additional
disclosures for both annual and interim periods with respect to both debt and
equity securities. Under the FSP, impairment of debt securities will be
considered other-than-temporary if an entity (1) intends to sell the security,
(2) more likely than not will be required to sell the security before recovering
its cost, or (3) does not expect to recover the security’s entire amortized cost
basis (even if the entity does not intend to sell). The FSP further indicates
that, depending on which of the above factor(s) causes the impairment to be
considered other-than-temporary, (1) the entire shortfall of the security’s fair
value versus its amortized cost basis or (2) only the credit loss portion would
be recognized in earnings while the remaining shortfall (if any) would be
recorded in other comprehensive income. FSP 115-2 requires entities to initially
apply the provisions of the standard to previously other-than-temporarily
impaired debt securities existing as of the date of initial adoption by making a
cumulative-effect adjustment to the opening balance of retained earnings in the
period of adoption. The cumulative-effect adjustment potentially reclassifies
the noncredit portion of a previously other-than-temporarily impaired debt
security held as of the date of initial adoption from retained earnings to
accumulate other comprehensive income. The Company adopted FSP No. SFAS 115-2
and SFAS 124-2 beginning April 1, 2009. This FSP had no material impact on the
Company’s financial position, results of operations or cash flows.


In April
2009, the Financial Accounting Standards Board (“FASB”) issued FSP
No. SFAS 157-4, “Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly” (“FSP No. SFAS 157-4”). FSP
No. SFAS 157-4, which is codified in FASB ASC Topics 820-10-35-51 and
820-10-50-2, provides additional guidance for estimating fair value and
emphasizes that even if there has been a significant decrease in the volume and
level of activity for the asset or liability and regardless of the valuation
technique(s) used, the objective of a fair value measurement remains the same.
The Company adopted FSP No. SFAS 157-4 beginning April 1, 2009.
This FSP had no material impact on the Company’s financial position, results of
operations or cash flows.





3.
INVENTORIES





Inventories
at September 30, 2009 and December 31, 2008 were as follows:





2009
                  
                  
                  2008Raw
      materials
                  
                  $
                  7,810,861
                  
                  
                  $
                  4,411,298Work
      in process
                  
                  
                  2,762,646
                  
                  
                  
                  652,472Finished
      Goods
                  
                  
                  3,820,655
                  
                  
                  
                  1,043,813Total
                  
                  $
                  14,394,162
                  
                  
                  $
                  6,107,583





10




4.
PROPERTY AND EQUIPMENT, NET





Property
and equipment consisted of the following at September 30, 2009 and December
31, 2008:





2009
                      
                      
                      2008Building
                      
                      $
                      4,326,504
                      
                      
                      $
                      1,818,827Production
      equipment
                      
                      
                      2,970,416
                      
                      
                      
                      441,065Office
      equipment
                      
                      
                      362,166
                      
                      
                      
                      231,975Vehicles
                      
                      
                      544,158
                      
                      
                      
                      300,9568,203,244
                      
                      
                      
                      2,792,823Less:
      Accumulated depreciation
                      
                      
                      (624,888
                      )
                      
                      
                      (356,270
                      )$
                      7,578,356
                      
                      
                      $
                      2,436,553





Depreciation
expense for the nine months ended September 30, 2009 and 2008 was approximately
$268,000 and $119,000, respectively.  Depreciation expense for the
three months ended September 30, 2009 and 2008 was approximately $157,000 and
$42,000, respectively.





5.
OTHER RECEIVABLES, PREPAYMENTS AND DEPOSITS





Other
receivables, prepayments and deposits consisted of the following at September
30, 2009 and December 31, 2008, respectively:





2009
                    
                    
                    2008Cash
      advance to third parties
                    
                    $
                    2,346,809
                    
                    
                    $
                    89,628Deposit
      for public bids of sales contracts
                    
                    
                    758,769
                    
                    
                    
                    353,399Prepayment
      for freight and related insurance expenses
                    
                    
                    33,728
                    
                    
                    
                    95,888Deposits
                    
                    
                    21,965
                    
                    
                    
                    42,783Advance
      to employees
                    
                    
                    120,743
                    
                    
                    
                    117,136Total
                    
                    $
                    3,282,014
                    
                    
                    $
                    698,834





Cash
advance to third parties was 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 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 right 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.  The Company acquired
another land use right of $3,106,676 from Siping on June 16, 2009.





Intangible
assets consisted of the following at September 30, 2009 and December 31, 2008,
respectively:





2009
                      
                      
                      2008Land
      use rights
                      
                      $
                      3,627,791
                      
                      
                      $
                      519,369Know-how
      technology
                      
                      
                      267,027
                      
                      
                      
                      266,808Customer
      list
                      
                      
                      191,
      809
                      
                      
                      
                      191,652Covenant
      not to compete
                      
                      
                      104,
      344
                      
                      
                      
                      104,258Software
                      
                      
                      190,322
                      
                      
                      
                      190,1664,381,293
                      
                      
                      
                      1,272,253Less:
      accumulated amortization
                      
                      
                      (258,449
                      )
                      
                      
                      (117,122
                      )$
                      4,122,844
                      
                      
                      $
                      1,155,131





Amortization
expense of intangible assets for the nine months ended September 30, 2009 and
2008 was approximately $141,000 and $38,000, respectively. Amortization expense
for the three months ended September 30, 2009 and 2008 was approximately $58,000
and $12,000, respectively. Annual amortization expense for the next five years
from September 30, 2009 is expected to be: $242,000, $242,000, $242,000,
$242,000 and $202,000.





11





7.
TAXES PAYABLE





Taxes
payable consisted of the following at September 30, 2009 and December 31,
2008:





2009
                      
                      
                      2008Income
      tax payable
                      
                      $
                      1,579,058
                      
                      
                      $
                      723,958Value
      added tax payable
                      
                      
                      557,693
                      
                      
                      
                      597,676Other
      taxes payable
                      
                      
                      10,625
                      
                      
                      
                      6,141$
                      2,147,376
                      
                      
                      $
                      1,327,775




8.
ACCRUED LIABILITIES AND OTHER PAYABLES





Accrued
liabilities and other payables consisted of the following at September 30, 2009
and December 31, 2008:




2009
                      
                      
                      2008Advance
      from third parties
                      
                      $
                      113,591
                      
                      
                      $
                      453,625Payable
      for purchase of SanDeKe
                      
                      
                      -
                      
                      
                      
                      741,516Payable
      to SiPing – current portion
                      
                      
                      6,239,670
                      
                      
                      
                      -Other
      payables
                      
                      
                      17,628
                      
                      
                      
                      99,418Warranty
      reserve
                      
                      
                      522,259
                      
                      
                      
                      -Accrued
      liabilities
                      
                      
                      178,325
                      
                      
                      
                      36,253Total
                      
                      $
                      7,071,473
                      
                      
                      $
                      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.





9.
LOAN PAYABLE – INSTITUTIONAL INVESTOR




On
July 3, 2009, the Company entered into a Senior Loan Agreement with an
institutional investor to obtain a loan of US $9,000,000.00.  Under
the terms of the Agreement, the Company agreed to a simple interest rate of 10%
payable quarterly beginning on September 30, 2009. The principal amount and any
unpaid interest accrued thereon are due six (6) months from the date of the
Agreement. This loan was repaid during the quarter from the proceeds of a public
offering.





10.
NOTES PAYABLE – BANK ACCEPTANCE





Notes
payable represented accounts payable to vendors that were converted to notes
payable accepted by the bank. The Company deposited a portion of the acceptance
amount into the bank. The bank charged 2.5% of the face value of the note which
is amortized over the term of the acceptance.





11.
LOANS PAYABLE - BANK





The
Company was obligated for the following short term loans payable as of September
30, 2009 and December 31, 2008:




2009
                    
                    
                    2008From
      a commercial bank in the PRC for 30,000,000 RMB. Of which, 17,000,000 RMB
      was entered into on April 22, 2009 and is due on April 22, 2010.
      13,000,000 RMB was entered into on June 12, 2009 and is due on June 12,
      2010. These loans currently bear interest at 5.576%.  The
      Company pledged its building in the value of approximately RMB 12,430,950
      or approximately $1,818,000 for this loan.
                    
                    $
                    4,393,030
                    
                    
                    $
                    -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. The Company repaid loan in April, 2009.
                    
                    
                    -
                    
                    
                    
                    877,886Short
      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 during 2008 and some
      of the loans are payable on demand. These loans bear variable interest at
      8.591% for 2009 and 2008.  The Company repaid RMB 2,600,000 in
      2008, RMB 2,700,000 in April, 2009, and had RMB 5,000,000 outstanding as
      of September 30, 2009, due on December 31, 2009 with interest of
      8.591%.
                    
                    
                    732,171
                    
                    
                    
                    1,126,621One
      year loan on July 1, 2008 with another third party company in the PRC for
      total of 3,000,000 RMB. This loan is renewed and due on December
      31, 2009 with interest of 8.591%.
                    
                    
                    439,303
                    
                    
                    
                    438,943$
                    5,564,504
                    
                    
                    $
                    2,443,450




12




12.
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.





13.
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 US and has net operating losses (NOL) for income tax
purposes.  SmartHeat has net operating loss carry forwards for income
taxes of approximately $320,000 at September 30, 2009 which may be available
to reduce future years’ taxable income as NOL; NOL can be carried forward
up to 20 years from the year the loss is incurred. Management believes the
realization of benefits from these losses 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 for the nine and three months ended September 30, 2009
would be lower by approximately $810,000 or $0.03 earnings per common share, and
$619,000 or $0.02 earnings per common share had Taiyu not enjoyed lower income
tax rate and SanDeKe not been exempted from income tax for the nine and three
months ended September 30, 2009.





Foreign
pretax earnings approximated $15,145,000 and $6,888,000 for the nine months
ended September 30, 2009 and 2008 respectively. Pretax earnings of a foreign
subsidiary are subject to U.S. taxation when effectively repatriated. The
Company provides income taxes on the undistributed earnings of non-U.S.
subsidiaries except to the extent that such earnings are indefinitely invested
outside the United States. At September 30, 2009, $18,924,000 of accumulated
undistributed earnings of non-U.S. subsidiaries was indefinitely invested. At
the existing U.S. federal income tax rate, additional taxes of $1,703,000 would
have to be provided if such earnings were remitted currently.





The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the nine and three months ended September 30, 2009 and
2008:





For the Nine Months
                  
                  
                  For the Three Months2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008US
      statutory rates
                  
                  
                  34.0
                  %
                  
                  
                  34.0
                  %
                  
                  
                  34.0
                  %
                  
                  
                  34.0
                  %Tax
      rate difference
                  
                  
                  (14
      .0
                  )%
                  
                  
                  (16.0
                  )
      %
                  
                  
                  (14.0
                  )%
                  
                  
                  (16.0
                  )%Effect
      of tax holiday
                  
                  
                  (5.0
                  )%
                  
                  
                  -
                  
                  
                  
                  (5.0
                  )%
                  
                  
                  -Valuation
      allowance
                  
                  
                  1.0
                  %
                  
                  
                  -
                  
                  
                  
                  0.0
                  %
                  
                  
                  -Tax
      per financial statements
                  
                  
                  16
                  %
                  
                  
                  18.0
                  %
                  
                  
                  15.0
                  %
                  
                  
                  18.0
                  %





13




14.
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.





15.
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 1,630,000 Units at $3.50 per Unit for aggregate gross proceeds of
approximately $5.7 million. Each "Unit" consisted of one share of SmartHeat
common stock and a three year warrant to purchase 15% of one share of common
stock at $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 were 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 Warrants was $70,246.  During the
third quarter of 2009, 243,675 warrants were exercised at $6 per
share for the aggregate amount of $1,462,050.




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 vest on July 17, 2009; 3,333 shares vest on
July 17, 2010; and 3,334 shares 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)”), (codified in FASB ASC Financial Instruments, Topic 718 & 505) 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:





14





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 nine months ended September 30,
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
                        
                        
                        
                        2.51GrantedExercised
                        
                        
                        (243,675)ForfeitedOutstanding
      at September 30, 2009
                        
                        
                        149,325
                        
                        
                        $
                        6.00
                        
                        
                        
                        1.76Exercisable
      at September 30, 2009
                        
                        
                        149,325
                        
                        
                        $
                        6.00
                        
                        
                        
                        1.76





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 September 30, 2009
                        
                        
                        20,000
                        
                        
                        $
                        4.60
                        
                        
                        
                        3.79Exercisable
      at  September 30, 2009
                        
                        
                        20,000
                        
                        
                        $
                        4.60
                        
                        
                        
                        3.79





Stocks
issues for public offering




On
September 22, 2009, the Company closed its public offering of 8,333,000 shares
of its common stock, at $9 per share, which includes 1,086,913 shares sold as a
result of the underwriters' exercise of their over-allotment option in full at
closing. After underwriting discounts and commissions and offering expenses, the
Company received net proceeds of US $69,507,210, and net
proceeds have been recorded as increase in Company’s common stock and paid in
capital.  The Company paid $5,489,790 to the underwriters as
commission for this public offering. In addition, the Company paid an additional
6% advisory fee in connection with this public offering.




16.
COMMITMENTS





Employment
Agreements





On
January 1, 2008, the Company entered into a three year 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.





15




On
January 1, 2008, The Company entered into a three year 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 September 30, 2009, future minimum rental payments
required under these operating leases are as follows by years:





Year
      Ending September 30,
                    
                    Amount2010
                    
                    $
                    87,000




17.
CONTINGENCIES





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.





18.
ACQUISITION OF SANDEKE CO., LTD.





On
September 25, 2008, the Company entered into an Agreement for the acquisition of
all the outstanding capital stock of SanDeKe. The purchase price for the SanDeKe
shares was $741,516. 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 June 30, 2009,
the Company paid the purchase consideration for SanDeKe.





For
convenience of reporting the acquisition for accounting purposes, September 1,
2008 was designated as the acquisition date.





The
following table summarizes the fair values of the assets acquired and
liabilities assumed at the date of acquisition.   The fair value of
the net assets acquired exceeded the total consideration for the acquisition by
approximately $117,000 (RMB 800,000). The excess (negative goodwill) was
allocated on a pro rata basis to long-lived assets.





Cash
                  
                  $
                  59,245Accounts
      receivable
                  
                  
                  489,527Advance
      to suppliers
                  
                  
                  329,951Other
      receivables
                  
                  
                  128,646Inventory
                  
                  
                  92,370Property
      and equipment
                  
                  
                  73,324Intangible
      assets
                  
                  
                  563,567Accounts
      payable
                  
                  
                  (332,276
                  )Advance
      from customers
                  
                  
                  (557,216
                  )Deferred
      tax liability
                  
                  
                  (39,076
                  )Other
      current liabilities
                  
                  
                  (66,546
                  )Purchase
      price
                  
                  $
                  741,516





The
intangible asset consisted of know-how technology is amortized over 5 years, the
customer list over 5 years and covenants not to compete, over 4
years.





16





The
following unaudited pro forma consolidated results of operations of the Company
for the nine months ended September 30, 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.




Pro forma
                    ConsolidatedNet
      revenue
                  
                  $
                  31,499,617Cost
      of revenue
                  
                  
                  (21,264,191
                  )Gross
      profit
                  
                  
                  10,235,425Selling
      expense
                  
                  
                  (1,664,882
                  )General
      & administrative expense
                  
                  
                  (1,877,286
                  )Total
      operating expenses
                  
                  
                  (3,542,168
                  )Income
      from operations
                  
                  
                  6,693,257Non-operating
      income, net
                  
                  
                  74,936Income
      before income tax
                  
                  
                  6,768,193Income
      tax
                  
                  
                  (1,246,935
                  )Minority
      interest
                  
                  
                  5,934Net
      income
                  
                  $
                  5,515,324




17





CAUTIONARY
STATEMENT FOR FORWARD-LOOKING STATEMENTS





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





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





Overview





We 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.





As
a continuous expansion of our business, we acquired SanDeKe Co., Ltd., a
Shanghai based manufacturer of heat plate exchangers on September 25, 2008, and
closed an asset purchase transaction with Siping Beifang Heat Exchanger
Manufacture Co.,Ltd on June 16, 2009 in
order to acquire plant and equipment and land use rights to set up a new
manufacturing facility under our newly incorporated subsidiary SmartHeat Siping
Beifang Energy Technology Co., Ltd (“SmartHeat Siping”).





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.





18




Basis
of Presentation




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





Principle
of Consolidation





The
accompanying consolidated financial statements include the accounts of
SmartHeat, SmartHeat Siping, SanDeKe, and Taiyu. For purposes of this
Quarterly Statement, the "Company" refers collectively to SmartHeat, Siping,
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 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.





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 (codified in Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”)
Topic 480). 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 30% of the purchase price on
placement of an order, 30% on delivery, 30% is installation and acceptance of
the equipment after customer testing and 10% of the purchase price on a
termination of the standard warranty period.





Our
standard warranty is provided to all customers and is not considered an
additional service; rather it is integral part of the product sale. We believe
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 (codified in FASB ASC Topic 605-25) separation and
allocation model for a multiple deliverable arrangement. SFAS5(codified in
FASB ASC Topic 450) specifically address the accounting for standard
warranties and neither SAB 104 nor EITF 00-21 supersedes SFAS 5.
We believe that accounting for our standard warranty pursuant to SFAS
5 does not impact revenue recognition because the cost of honoring the
warranty can be reliably estimated.





19





We
provide after sales services at a charge after expiration of the warranty
period, with after sales services mainly consisting of cleaning plate heat
exchangers and repairing and exchanging parts. We recognize such revenue when
service is provided.  The revenue earned from these services was not
material.





Foreign
Currency Translation and Comprehensive Income (Loss)





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





We use
Statement of Financial Accounting Standards ("SFAS") No. 130, “Reporting
Comprehensive Income” (codified in FASB ASC Topic 220). Comprehensive income is
comprised of net income and all changes to the statements of shareholders’
equity, except those due to investments by shareholders, changes in paid-in
capital and distributions to shareholders.





Recent
Accounting Pronouncements





On July
1, 2009, the Company adopted Accounting Standards Update (“ASU”) No.
2009-01, “Topic 105 - Generally Accepted Accounting Principles - amendments
based on Statement of Financial Accounting Standards No. 168 , “The FASB
Accounting Standards CodificationTM and the Hierarchy of Generally Accepted
Accounting Principles” (“ASU No. 2009-01”).  ASU No. 2009-01
re-defines authoritative GAAP for nongovernmental entities to be only comprised
of the FASB Accounting Standards CodificationTM (“Codification”) and, for SEC
registrants, guidance issued by the SEC.  The Codification is a
reorganization and compilation of all then-existing authoritative GAAP for
nongovernmental entities, except for guidance issued by the SEC.  The
Codification is amended to effect non-SEC changes to authoritative
GAAP.  Adoption of ASU No. 2009-01 only changed the referencing
convention of GAAP in Notes to the Consolidated Financial
Statements.





In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R)” (“SFAS 167”), codified as FASB ASC Topic 810-10, which modifies how a
company determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. SFAS 167
clarifies that the determination of whether a company is required to consolidate
an entity is based on, among other things, an entity’s purpose and design and a
company’s ability to direct the activities of the entity that most significantly
impact the entity’s economic performance. SFAS 167 requires an ongoing
reassessment of whether a company is the primary beneficiary of a variable
interest entity. SFAS 167 also requires additional disclosures about a company’s
involvement in variable interest entities and any significant changes in risk
exposure due to that involvement. SFAS 167 is effective for fiscal years
beginning after November 15, 2009. The Company does not believe the adoption of
SFAS 167 will have an impact on its financial condition, results of operations
or cash flows.





In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets — an amendment of FASB Statement No. 140” (“SFAS 166”), codified as FASB
Topic ASC 860, which requires entities to provide more information regarding
sales of securitized financial assets and similar transactions, particularly if
the entity has continuing exposure to the risks related to transferred financial
assets. SFAS 166 eliminates the concept of a “qualifying special-purpose
entity,” changes the requirements for derecognizing financial assets and
requires additional disclosures. SFAS 166 is effective for fiscal years
beginning after November 15, 2009. The Company does not believe the adoption of
SFAS 166 will have an impact on its financial condition, results of operations
or cash flows.





In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”) codified in
FASB ASC Topic 855-10-05, which provides guidance to establish general standards
of accounting for and disclosures of events that occur after the balance sheet
date but before financial statements are issued or are available to be issued.
SFAS 165 also requires entities to disclose the date through which subsequent
events were evaluated as well as the rationale for why that date was selected.
SFAS 165 is effective for interim and annual periods ending after June 15, 2009,
and accordingly, the Company adopted this pronouncement during the second
quarter of 2009. SFAS 165 requires that public entities evaluate subsequent
events through the date that the financial statements are issued. The Company
has evaluated subsequent events through November 12, 2009.





20




In April
2009, the FASB issued FSP No. SFAS 107-1 and APB 28-1, “Interim Disclosures
about Fair Value of Financial Instruments,” which is codified in FASB ASC Topic
825-10-50. This FSP essentially expands the disclosure about fair value of
financial instruments that were previously required only annually to also be
required for interim period reporting. In addition, the FSP requires certain
additional disclosures regarding the methods and significant assumptions used to
estimate the fair value of financial instruments. These additional disclosures
are required beginning with the quarter ending June 30, 2009. This FSP had no
material impact on the Company’s financial position, results of operations or
cash flows.





In
April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition
and Presentation of Other-Than-Temporary Impairments,” which is codified in FASB
ASC Topic 320-10. This FSP modifies the requirements for recognizing
other-than-temporarily impaired debt securities and changes the existing
impairment model for such securities. The FSP also requires additional
disclosures for both annual and interim periods with respect to both debt and
equity securities. Under the FSP, impairment of debt securities will be
considered other-than-temporary if an entity (1) intends to sell the security,
(2) more likely than not will be required to sell the security before recovering
its cost, or (3) does not expect to recover the security’s entire amortized cost
basis (even if the entity does not intend to sell). The FSP further indicates
that, depending on which of the above factor(s) causes the impairment to be
considered other-than-temporary, (1) the entire shortfall of the security’s fair
value versus its amortized cost basis or (2) only the credit loss portion would
be recognized in earnings while the remaining shortfall (if any) would be
recorded in other comprehensive income. FSP 115-2 requires entities to initially
apply the provisions of the standard to previously other-than-temporarily
impaired debt securities existing as of the date of initial adoption by making a
cumulative-effect adjustment to the opening balance of retained earnings in the
period of adoption. The cumulative-effect adjustment potentially reclassifies
the noncredit portion of a previously other-than-temporarily impaired debt
security held as of the date of initial adoption from retained earnings to
accumulate other comprehensive income. The Company adopted FSP No. SFAS 115-2
and SFAS 124-2 beginning April 1, 2009. This FSP had no material impact on the
Company’s financial position, results of operations or cash flows.


In April
2009, the Financial Accounting Standards Board (“FASB”) issued FSP
No. SFAS 157-4, “Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly” (“FSP No. SFAS 157-4”). FSP
No. SFAS 157-4, which is codified in FASB ASC Topics 820-10-35-51 and
820-10-50-2, provides additional guidance for estimating fair value and
emphasizes that even if there has been a significant decrease in the volume and
level of activity for the asset or liability and regardless of the valuation
technique(s) used, the objective of a fair value measurement remains the same.
The Company adopted FSP No. SFAS 157-4 beginning April 1, 2009.
This FSP had no material impact on the Company’s financial position, results of
operations or cash flows.





Results
of Operations





Nine
Months Ended September 30, 2009 Compared to the Nine Months Ended September 30,
2008





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




For the Nine Months Ended September 30,2009
                
                
                2008$
                
                
                % of Sales
                
                
                $
                
                
                % of SalesSales
                
                
                56,541,795
                
                
                
                
                
                
                29,345,571Cost
      of sales
                
                
                36,562,363
                
                
                
                64.7
                %
                
                
                19,502,070
                
                
                
                66.5
                %Gross
      Profit
                
                
                19,979,433
                
                
                
                35.3
                %
                
                
                9,843,501
                
                
                
                33.5
                %Operating
      Expenses
                
                
                4,952,245
                
                
                
                8.8
                %
                
                
                3,135,459
                
                
                
                10.7
                %Income
      from Operations
                
                
                15,027,187
                
                
                
                26.6
                %
                
                
                6,708,042
                
                
                
                22.8
                %Other
      Income (Expenses), net
                
                
                (203,162
                )
                
                
                (0.4
                )%
                
                
                73,163
                
                
                
                0.3
                %Income
      tax expense
                
                
                2,304,672
                
                
                
                4.1
                %
                
                
                1,246,935
                
                
                
                4.2
                %Net
      Income
                
                
                12,519,354
                
                
                
                22.1
                %
                
                
                5,528,336
                
                
                
                18.8
                %





Sales. Net sales during
the nine months ended September 30, 2009 were $56.54 million, while our net
sales for the nine months ended September 30, 2008 were $29.35 million, an
increase in revenues of $27.2 million, or 93%. The increase in sales was
attributable to an increase in our sales volume with selling price determined
based on our standard profit margin rate. 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. During the nine months ended September 30, 2009, we’ve
recognized $5.11 million revenue or 9% of the total revenue from the contracts
that we’ve previously signed; we have been continuously expanding the
heat-supply market in more regions as a result of the PRC government’s economy
stimulus plan stressing on increasing domestic infrastructure construction and
our sales from the traditional heat-supply industry was approximately $24.22
million or 43% of the total sales.  We have also developed new
customers in other industries like chemical engineering, electric power, metal
smelting, etc. which accounted for $19.37 million or 34% of our total sales.
 Our sales on heat meters have been increased to $7.8 million or 14% during
the nine months. In addition, since July of 2009, the new subsidiary Siping
began operations and accounted for sales of $2.7 million or 4.8% of the total
sales to the Company. We believe 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.





21





Cost of
Sales.  Cost of sales for the nine months ended September 30,
2009 was $36.56 million, while our cost of sales for the same period in 2008 was
$19.5 million, an increase of $17.06 million, or 87%.  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 is attributed to the increase of
production and sales volume in the nine months of 2009. Cost of sales as a
percentage of sales was 64.7% for the nine months of 2009 and 66.5% for the same
period of 2008. The decrease in cost of sales as a percentage to the sales was
mainly due to the stable raw material cost comparing to the cost in the nine
months of 2008, 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 $19.98 million for the nine months
ended September 30, 2009, as compared to $9.84 million for the same period in
2008, representing gross margins of 35.3% and 33.5%,
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 $4.95 million for the nine months ended
September 30, 2009, as compared to $3.14 million for the nine months ended
September 30, 2008, an increase of $1.82 million or 58%.  The increase
in operating expenses was mainly due to a proportional increase in payroll,
insurance, and 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 nine months ended September 30, 2009 was $12.52 million
compared to $5.53 million for the same period in 2008, an increase of $6.99
million or 126%.  Net income as a percentage of sales increased from
18.8% in the nine months of 2008 to 22.1% 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.





Quarter
Ended September 30, 2009 Compared to the Quarter Ended September 30,
2008





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




For the Quarter Ended September 30,2009
                
                
                2008$
                
                
                % of Sales
                
                
                $
                
                
                % of SalesSales
                
                
                37,835,897
                
                
                
                
                
                
                20,708,288Cost
      of sales
                
                
                24,687,460
                
                
                
                65.2
                %
                
                
                13,273,914
                
                
                
                64.1
                %Gross
      Profit
                
                
                13,148,438
                
                
                
                34.8
                %
                
                
                7,434,374
                
                
                
                35.9
                %Operating
      Expenses
                
                
                2,452,581
                
                
                
                6.5
                %
                
                
                2,080,961
                
                
                
                10.1
                %Income
      from Operations
                
                
                10,695,856
                
                
                
                28.3
                %
                
                
                5,353,413
                
                
                
                25.9
                %Other
      Income (Expenses), net
                
                
                (191,081
                )
                
                
                (0.5
                )%
                
                
                (41,911
                )
                
                
                (0.2
                )%Income
      tax expense
                
                
                (1,624,240
                )
                
                
                (4.3
                )%
                
                
                (980,907
                )
                
                
                (4.7
                )%Net
      Income
                
                
                8,880,536
                
                
                
                23.4
                %
                
                
                4,324,661
                
                
                
                20.8
                %





Sales. Net sales during
the three months ended September 30, 2009 were $37.84 million, while our net
sales for the three months ended September 30, 2008 were $20.71 million, an
increase in revenues of $17.13 million, or 83%. The increase in sales was
attributable to an increase in our sales volume with selling price determined
based on our standard profit margin rate. 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.  The increase in our sales volume was mainly attributed to (1)
our continuous expansion in the heat-supply market in more regions as a
result of the PRC government’s economy stimulus plan stressing on increasing
domestic infrastructure construction, (2) development of new customers from
other industries like chemical engineering, electric power, metal smelting, etc
(3) increase sales in heat meters, 4) sales from Siping, our newly established
subsidiary. As we continue to expand our customer base and increase our sales
volume, we become less dependent on these customers for revenue.  We
believe 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.




22




Cost of
Sales.  Cost of sales for the three months ended September 30,
2009 was $24.69 million while our cost of sales for the same period in 2008 was
$13.27 million, an increase of $11.41 million, or 86%. 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 is attributed to the increase of
production and sales volume in the third quarter of 2009.  Cost of
sales as a percentage of sales was 65.2% for the third quarter of 2009 and 64.1%
for the same period of 2008. 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 $13.15 million for the three months
ended September 30, 2009, as compared to $7.43 million for the same period in
2008, representing gross margins of 34.8% and 35.9%,
respectively.  The increase in our gross profits and slight decrease
on gross profit margin was mainly due to the company’s increased sales
activities with slightly lower profit margin rate of 29% for Siping, our new
subsidiary started operation since July 2009,


Operating
Expenses.  Operating expenses consisted of selling, general and
administrative expenses were $2.45 million for the three months ended September
30, 2009, as compared to $2.08 million for the three months ended September 30,
2008, an increase of $0.37 million or 18%.  The increase in operating
expenses was mainly due to a proportional increase in payroll, insurance, and
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.





Net Income.  Our
net income for the three months ended September 30, 2009 was $8.88 million
compared to $4.32 million for the same period in 2008, an increase of $4.56
million or 106%.  Net income as a percentage of sales increased from
21% in the third quarter of 2008 to 23% 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





Nine
months Ended September 30, 2009 Compared to the Nine months Ended September 30,
2008





As of
September 30, 2009, we had cash and cash equivalents of $60.29 million. Working
capital was $79.49 million at September 30, 2009. The ratio of current
assets to current liabilities was 4.33:1 at September 30, 2009.





The
following is a summary of cash provided by or used in each of the indicated
types of activities during the nine months ended September 30, 2009 and
2008:




2009
                
                
                2008Cash
      provided by (used in):Operating
      Activities
                
                $
                (6,124,354
                )
                
                $
                (1,414,769
                )Investing
      Activities
                
                
                (4,051,225
                )
                
                
                (471,967
                )Financing
      Activities
                
                
                69,039,040
                
                
                
                (3,150,583
                )





Net cash
flow used in operating activities was $6,124,354 in the nine months of 2009, as
compared to net cash flow used in operating activities of $1,414,769 in the same
period of 2008. The increase in net cash flow used in operating activities
during the nine months of 2009 was mainly due to increases in accounts
receivable and retentions receivable despite an significant increase of net
income, 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. We’ve also increased payment for
advance to suppliers and inventory as we are preparing for the peak
season.


Net cash
flow used in investing activities was $4,051,225 in the nine months of 2009, as
compared to net cash used in investing activities of $471,967 in the same period
of 2008.  The increase of net cash flow used in investing activities
in the nine months of 2009 was mainly due to purchase of fixed assets for
Siping.





Net cash
flow provided by financing activities was $69,039,040 in the nine months of 2009
as compared to net cash used in financing activities of $3,150,583 in the same
period of 2008.  The increase of cash inflow was mainly due to net
proceeds of $65 million from issuing new common stock through a public offering
completed in September of 2009, and proceeds from the bank loans of $12.12
million with repayment of $9.22 during the same period.





23




Our sales
contracts with our customers generally provide 30% of the purchase price is due
on placement of an order, 30% on delivery and 30% on 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 acceptance 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. We may experience payment delays from time to time with a
range from 1 month to 3 months from the due date; however, we do not believe the
delays have significant negative impact on our liquidity as the payment delays
are very common in heating manufacturing industry in China, and the collection
of payment can be reasonably assured based on our historical collection
experience.   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 nine months of
2009, we had accounts receivable turnover of 3.15 on annualized basis, with days
sales outstanding of 153 and inventory turnover of 3.57 on annualized
basis.  For the nine months of 2008, we had accounts receivable
turnover of 3.41 on annualized basis, with days sales outstanding of 150 and
inventory turnover of 2.38 on annualized basis. The low accounts
receivable turnover and high days outstanding is due to relatively longer terms
for payment collection in the heating manufacturing business in
China.





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 Registration Statement became effective on June 23,
2009.





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.





24




Contractual
Obligations





The
Company was obligated for the following short term loans payable as of September
30, 2009 and December 31, 2008:




2009
                    
                    
                    2008From
      a commercial bank in the PRC for 30,000,000 RMB. Of which, 17,000,000 RMB
      was entered into on April 22, 2009 and is due on April 22, 2010.
      13,000,000 RMB was entered into on June 12, 2009 and is due on June 12,
      2010. These loans currently bear interest at 5.576%.  The
      Company pledged its building in the value of approximately RMB 12,430,950
      or approximately $1,818,000 for this loan.
                    
                    $
                    4,393,030
                    
                    
                    $
                    -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. The Company repaid loan in April, 2009.
                    
                    
                    -
                    
                    
                    
                    877,886Short
      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 during in 2008 and
      some of the loans are payable on demand. These loans bear variable
      interest at 8.591% for 2009 and 2008.  The Company repaid RMB
      2,600,000 in 2008, RMB 2,700,000 in April, 2009, and had RMB 5,000,000
      outstanding as of September 30, 2009, due on December 31, 2009 with
      interest of 8.591%.
                    
                    
                    732,171
                    
                    
                    
                    1,126,621One
      year loan on July 1, 2008 with another third party company in the PRC for
      total of 3,000,000 RMB. This loan is renewed and due on December
      31, 2009 with interest of 8.591%.
                    
                    
                    439,303
                    
                    
                    
                    438,943$
                    5,564,504
                    
                    
                    $
                    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 September 30, 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 September 30, 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




25




Part II. OTHER INFORMATION





Item 1. Legal Proceedings





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





Item 1A. Risk Factors





Not
required.





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





Use
of Proceeds from Public Offering of Common Stock





On
September 22, 2009, we completed an underwritten public offering of 8,333,000
million shares of our common stock (including 1,086,913 million shares issued as
a result of the full exercise of an overallotment option by the underwriters) at
a price to the public of $9.00 per share, or an aggregate offering price of
$74,997,000 million. The offer and sales of the shares in the offering were
registered under the Securities Act of 1933 pursuant to a shelf registration
statement on Form S-3 (File No. 333-160190), which became effective with the
Securities and Exchange Commission on July 6, 2009 and which registered an
indeterminate amount of common stock. The offering commenced on September 17,
2009 and did not terminate before all of the securities offered were sold.
William Blair & Company acted as sole book-running manager of the offering.
BMO Capital Markets was Co-Lead Manager





We raised
approximately $65,007,210 million in the offering, after deducting underwriting
discounts and commissions of $5,249,790 million, a consulting fee of
approximately $4.5 million paid to a non-U.S. corporate advisor, and other
estimated offering costs of $240,000 thousand. No payments were made by
SmartHeat to its directors, officers or persons owning ten percent or more of
its common stock or to their associates, or to SmartHeat’s
affiliates.





We used
approximately $9.2 million of the net proceeds of the offering to repay an
outstanding loan from Strong Growth Capital for $9 million, which
was a use of working capital.




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.





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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).




SIGNATURES





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




SMARTHEAT
      INC.
              (Registrant)By:
            /s/
      Jun WangNovember
      16, 2009
            
            Jun
      Wang
              President
      and Chief Executive Officer(Principle Executive
      Officer)By:
            /s/
      Zhijuan GuoNovember
      16, 2009
            
            Zhijuan
      Guo
              Chief
      Financial Officer
              (Principal
      Financial and Accounting Officer)




27





EXHIBIT
INDEX





Exhibit No.
            
            Document
      Description31.1
            
            Certification
      of Chief Executive Officer pursuant to Rule 13a-15(e) and 15d-15(e),
      promulgated under theSecurities
      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 theSecurities
      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-OxleyAct
      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-OxleyAct
      of 2002 (Chief Financial Officer).




28