SHARING ECONOMY INTERNATIONAL INC. - Quarter Report: 2010 June (Form 10-Q)

		Page
		No.
	PART I. - FINANCIAL INFORMATION
Item 1.	Financial Statements	3
	Consolidated Balance Sheets as of June 30, 2010 (Unaudited) and December 31, 2009 (Audited)	3
	Consolidated Statements of Income and Comprehensive Income for the Three and Six Months Ended June 30, 2010 and 2009 (unaudited)	4
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009 (unaudited)	5
	Notes to Unaudited Consolidated Financial Statements.	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations.	27
Item 3	Quantitative and Qualitative Disclosures About Market Risk.	43
Item 4	Controls and Procedures.	43

	PART II - OTHER INFORMATION
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	45
Item 6.	Exhibits.	45

FORWARD LOOKING STATEMENTS

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

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

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

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

PART 1 - FINANCIAL INFORMATION

Item 1. Financial Statements.

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	June 30, 2010		December 31, 2009
	(Unaudited)		(Audited)
ASSETS

CURRENT ASSETS:
Cash and cash equivalents	$	1,380,956	$	2,278,638
Notes receivable		192,404		329,492
Accounts receivable, net of allowance for doubtful accounts		6,651,052		6,046,422
Inventories, net of reserve for obsolete inventory		3,468,206		2,232,264
Advances to suppliers		378,857		450,507
Prepaid VAT on purchases		711,533		378,543
Prepaid expenses and other		66,977		213,835

Total Current Assets		12,849,985		11,929,701

PROPERTY AND EQUIPMENT - net		43,824,230		36,863,501

OTHER ASSETS:
Land use rights, net		3,701,682		3,729,427

Total Assets	$	60,375,897	$	52,522,629

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Loans payable	$	1,028,112	$	2,040,111
Accounts payable		5,071,713		3,404,521
Accrued expenses		353,914		556,662
VAT and service taxes payable		81,029		25,284
Advances from customers		321,755		143,261
Income taxes payable		1,053,011		1,018,514

Total Current Liabilities		7,909,534		7,188,353

STOCKHOLDERS' EQUITY:
Preferred stock $0.001 par value (60,000,000 shares authorized, all of which were designated as as series A convertible preferred, 14,934,264 and 15,419,088 shares issued and outstanding; at June 30, 2010 and December 31, 2009, respectively)		14,934		15,419
Common stock ($0.001 par value; 150,000,000 shares authorized; 17,639,787 and 16,402,204 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively)		17,640		16,402
Additional paid-in capital		24,277,813		22,332,756
Retained earnings		23,565,231		18,595,037
Statutory reserve		1,252,980		1,252,980
Accumulated other comprehensive gain - foreign currency translation adjustment		3,337,765		3,121,682

Total Stockholders' Equity		52,466,363		45,334,276

Total Liabilities and Stockholders' Equity	$	60,375,897	$	52,522,629

See notes to unaudited consolidated financial statements

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

	For the Three Months Ended						For the Six Months Ended
	June 30,						June 30,
	2010			2009			2010			2009
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)

NET REVENUES	$	18,977,274		$	13,584,030		$	35,817,956		$	21,444,897

COST OF REVENUES		14,000,017			10,479,370			26,424,004			16,743,588

GROSS PROFIT		4,977,257			3,104,660			9,393,952			4,701,309

OPERATING EXPENSES:
Depreciation		78,060			83,393			161,015			160,923
Selling, general and administrative		894,805			509,408			2,296,181			1,010,356

Total Operating Expenses		972,865			592,801			2,457,196			1,171,279

INCOME FROM OPERATIONS		4,004,392			2,511,859			6,936,756			3,530,030

OTHER INCOME (EXPENSE):
Interest income		1,478			98			2,722			328
Interest expense		(18,494	)		(176,058	)		(93,413	)		(199,729	)
Foreign currency loss		(5,042	)		-			(6,901	)		(11	)
Grant income		49,146			146,130			49,146			146,130
Debt issuance costs		-			-			-			(12,000	)

Total Other Income (Expense)		27,088			(29,830	)		(48,446	)		(65,282	)

INCOME BEFORE INCOME TAXES		4,031,480			2,482,029			6,888,310			3,464,748

INCOME TAXES		1,007,823			701,494			1,918,116			1,038,155

NET INCOME	$	3,023,657		$	1,780,535		$	4,970,194		$	2,426,593

COMPREHENSIVE INCOME:
NET INCOME	$	3,023,657		$	1,780,535		$	4,970,194		$	2,426,593

OTHER COMPREHENSIVE INCOME:
Unrealized foreign currency translation gain		208,813			3,253			216,083			44,793

COMPREHENSIVE INCOME	$	3,232,470		$	1,783,788		$	5,186,277		$	2,471,386

NET INCOME PER COMMON SHARE:
Basic	$	0.17		$	0.12		$	0.29		$	0.16
Diluted	$	0.12		$	0.08		$	0.20		$	0.12

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic		17,574,225			15,080,436			17,414,400			15,034,768
Diluted		25,210,214			21,256,154			25,193,517			20,207,770

See notes to unaudited consolidated financial statements

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	For the Six Months Ended
	June 30,
	2010			2009
	(Unaudited)			(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	4,970,194		$	2,426,593
Adjustments to reconcile net income from operations to net cash
provided by operating activities:
Depreciation		1,200,642			697,127
Amortization of debt discount to interest expense		44,993			16,997
Amortization of land use rights		43,245			43,191
Increase in allowance for doubtful accounts		223,333			143,620
Interest expense related to debt conversion		-			128,489
Stock-based compensation expense		345,386			119,612
Changes in assets and liabilities:
Notes receivable		137,942			(131,584	)
Accounts receivable		(800,348	)		(1,891,180	)
Inventories		(1,221,872	)		(621,840	)
Prepaid value-added taxes on purchases		(330,132	)		(234,142	)
Prepaid and other current assets		147,299			(50,602	)
Advances to suppliers		73,262			(5,964	)
Due from related party		-			438,389
Accounts payable		1,646,567			403,527
Accrued expenses		(203,916	)		82,146
VAT and service taxes payable		55,425			(97,497	)
Income taxes payable		30,102			131,045
Advances from customers		177,212			426,134

NET CASH PROVIDED BY OPERATING ACTIVITIES		6,539,334			2,024,061

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(7,980,484	)		(2,849,156	)

NET CASH USED IN INVESTING ACTIVITIES		(7,980,484	)		(2,849,156	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from loans payable		-			1,133,612
Repayment of loans payable		(1,061,556	)		-
Proceeds from exercise of warrants		1,600,000			83,111

NET CASH PROVIDED BY FINANCING ACTIVITIES		538,444			1,216,723

EFFECT OF EXCHANGE RATE ON CASH AND CASH EQUIVALENTS		5,024			585

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(897,682	)		392,213

CASH AND CASH EQUILAVENTS - beginning of year		2,278,638			328,614

CASH AND CASH EQUIVALENTS - end of period	$	1,380,956		$	720,827

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest	$	50,563		$	46,443
Income taxes	$	1,888,014		$	921,760

NON-CASH INVESTING AND FINANCING ACTIVITIES:
Debt discount for grant of warrants	$	-		$	92,985
Series A preferred converted to common shares	$	1,910		$	401
Common stock issued for debt	$	-		$	152,963
Common stock issued for future service	$	424		$	-

See notes to unaudited consolidated financial statements.

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

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

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

Electric was formed on May 21, 2004, and Fulland Wind Energy was formed on August 27, 2008. Beginning in April 2007, Electric began to produce large-scaled forged rolled rings that are up to three meters in diameter for the wind-power and other industries. In 2009, the Company began to produce and sell forged products through Fulland Wind Energy. Fulland Wind Energy manufactures forged rolled rings in the Company’s new facilities. The Company refers to this segment of its business as the forged rolled rings and related products division. The Company’s electric power equipment business was also included in this division prior to its discontinuation.

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

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

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

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

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

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

The Huayang Companies are considered variable interest entities (“VIE”), and the Company is the primary beneficiary. The Company’s relationships with the Huayang Companies and their shareholders are governed by a series of contractual arrangements between Green Power, the Company’s wholly foreign-owned enterprise in the PRC, and each of the Huayang Companies, which are the operating companies of the Company in the PRC. Under PRC laws, each of Green Power, Huayang Dye Machine and Huayang Electrical Power Equipment is an independent legal entity and none of them is exposed to liabilities incurred by the other parties. The contractual arrangements constitute valid and binding obligations of the parties of such agreements. Each of the contractual arrangements and the rights and obligations of the parties thereto are enforceable and valid in accordance with the laws of the PRC. On October 12, 2007, the Company entered into the following contractual arrangements with each of Huayang Dye Machine and Huayang Electrical Power Equipment:

Consulting Services Agreement. Pursuant to the exclusive consulting services agreements between Green Power and the Huayang Companies, Green Power has the exclusive right to provide to the Huayang Companies general business operation services, including advice and strategic planning, as well as consulting services related to the technological research and development of dye and finishing machines, electrical equipments and related products (the “Services”). Under this agreement, Green Power owns the intellectual property rights developed or discovered through research and development, in the course of providing the Services, or derived from the provision of the Services. The Huayang Companies shall pay a quarterly consulting service fees in Renminbi (“RMB”) to Fulland that is equal to all of the Huayang Companies’ profits for such quarter.

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

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

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

Use of estimates

The preparation of the financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Actual results could materially differ from these estimates. Significant estimates in 2010 and 2009 include the allowance for doubtful accounts, the allowance for obsolete inventory, the useful life of property and equipment and intangible assets, assumptions used in assessing impairment of long-term assets and valuation of deferred tax assets, accruals for taxes due, the calculation of the value of any beneficial conversion feature related to convertible debt and preferred stock, and the value of warrants granted upon the conversion of debt to preferred stock.

Cash and cash equivalents

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

Fair value of financial instruments

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

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

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

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

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

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

Concentrations of credit risk

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

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

	June 30, 2010				December 31, 2009
Country:
United States	$	307,005	22.2	%	$	506,777	22.2	%
China		1,073,951	77.8	%		1,771,861	77.8	%
Total cash and cash equivalents	$	1,380,956	100.0	%	$	2,278,638	100.0	%

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

Notes receivable

Notes receivable represents trade accounts receivable due from various customers where the customers’ bank has guaranteed the payment of the receivable. This amount is non-interest bearing and is normally paid within three to six months. Historically, the Company has experienced no losses on notes receivable. The Company‘s notes receivable totaled $192,404 and $329,492 at June 30, 2010 and December 31, 2009, respectively.

Accounts receivable

Accounts receivable are presented net of an allowance for doubtful accounts. The Company maintains allowances for doubtful accounts for estimated losses. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, the Company considers many factors, including the age of the balance, a customer’s historical payment history, its current credit-worthiness and current economic trends. Accounts are written off after exhaustive efforts at collection. At June 30, 2010 and December 31, 2009, the Company has established, based on a review of its outstanding balances, an allowance for doubtful accounts in the amount of $985,471 and $758,096, respectively.

Inventories

Inventories, consisting of raw materials, work in process and finished goods related to the Company’s products are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, the Company will record reserves for the difference between the cost and the market value. These reserves are recorded based on estimates. The Company recorded an inventory reserve of $161,307 and $160,632 at June 30, 2010 and December 31, 2009, respectively.

Advances to suppliers

Advances to suppliers represent the cash paid in advance for purchasing of inventory items from suppliers. The advance payments are meant to ensure preferential pricing and delivery. The amounts advanced under such arrangements totaled $378,857 and $450,507 as of June 30, 2010 and December 31, 2009, respectively.

Property and equipment

Property and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. The Company examines the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.

Included in property and equipment is construction-in-progress which consisted of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use. Property purchased from a related party is recorded at the cost to the related party and any payment to or on behalf of the related party in excess of the cost is reflected as a distribution to related party.

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

Impairment of long-lived assets

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

Advances from customers

Advances from customers at June 30, 2010 and December 31, 2009 amounted to $321,755 and $143,261, respectively, and consist of prepayments from customers for merchandise that had not yet been shipped. The Company will recognize the deposits as revenue as customers take delivery of the goods, in accordance with its revenue recognition policy.

Revenue recognition

Pursuant to the guidance of ASC Topic 605 and ASC Topic 360, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectability is reasonably assured. The Company accounts for the product sale as a multiple element arrangement. Revenue from multiple element arrangements is allocated among the separate accounting units based on the residual method. Under the residual method, the revenue is allocated to undelivered elements based on fair value of such undelivered elements and the residual amounts of revenue allocated to delivered elements. The Company recognizes revenues from the sale of dyeing equipment, forged rolled rings and other components, and electric equipment upon shipment and transfer of title. The other elements may include installation and, generally, a one-year warranty. Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally within a couple days of the delivery of the equipment. Grant income is recognized when funds have been received and all significant terms of the grant have been fulfilled by the Company. Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the six months ended June 30, 2010 and 2009, amounts allocated to warranty revenues were not material. Based on historical experience, warranty service calls and any related labor costs have been minimal.

All other product sales with customer specific acceptance provisions, including the forged rolled rings, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.

Income taxes

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

Income taxes (continued)

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

Stock-based compensation

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

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

Shipping costs

Shipping costs are included in selling expenses and totaled $693,424 and $99,704 for the six months ended June 30, 2010 and 2009, respectively.

Employee benefits

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

Advertising

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

Research and development

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

Foreign currency translation

The reporting currency of the Company is the U.S. dollar. The functional currency of the parent company is the U.S. dollar and the functional currency of the Company’s operating subsidiaries is the Chinese Renminbi (“RMB”). For the subsidiaries and affiliates whose functional currencies are the RMB, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. As a result, amounts relating to assets and liabilities reported on the statements of cash flows may not necessarily agree with the changes in the corresponding balances on the balance sheets. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income. The cumulative translation adjustment and effect of exchange rate changes on cash for the six months ended June 30, 2010 and 2009 was $5,024 and $585, respectively. Transactions denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing on the transaction dates. Assets and liabilities denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing at the balance sheet date with any transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

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

Asset and liability accounts at June 30, 2010 and December 31, 2009 were translated at 6.8086 RMB to $1.00 and at 6.8372 RMB to $1.00, respectively, which were the exchange rates on the balance sheet dates. Equity accounts were stated at their historical rate. The average translation rates applied to the statements of income for the six months ended June 30, 2010 and 2009 were 6.83475 RMB and 6,84323 RMB to $1.00, respectively. Cash flows from the Company’s operations are calculated based upon the local currencies using the average translation rate. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheets.

Reverse stock split

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

Income per share of common stock

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

Basic net income per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted income per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. Potentially dilutive common shares consist of common shares issuable upon the conversion of series A preferred stock (using the if-converted method) and common stock warrants (using the treasury stock method). The following table presents a reconciliation of basic and diluted net income per share:

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

Income per share of common stock (continued)

	Three Months Ended June 30,				Six Months Ended June 30,
	2010		2009		2010		2009
Net income available to common shareholders for basic and diluted net income per common share	$	3,023,657	$	1,780,535	$	4,970,194	$	2,426,593

Weighted average common shares outstanding - basic		17,574,225		15,080,436		17,414,400		15,034,768
Effect of dilutive securities:
Series A convertible preferred stock		4,978,088		4,542,243		4,978,088		4,542,242
Warrants		2,657,901		1,633,475		2,801,029		630,760
Weighted average common shares outstanding - diluted		25,210,214		21,256,154		25,193,517		20,207,770
Net income per common share - basic	$	0.17	$	0.12	$	0.29	$	0.16
Net income per common share - diluted	$	0.12	$	0.08	$	0.20	$	0.12

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

	June 30, 2010		June 30, 2009
Warrants		3,916,440		5,454,407
Series A convertible preferred stock		4,978,088		4,542,243
Total		8,894,528		9,996,650

Deemed preferred stock dividend

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

Accumulated other comprehensive income

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

Related parties

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

Subsequent events

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

Recent accounting pronouncements

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

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

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

Recent accounting pronouncements (continued)

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

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

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

In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements”. ASU 2010-06 requires additional disclosures about fair value measurements including transfers in and out of Levels 1 and 2 and a higher level of disaggregation for the different types of financial instruments. For the reconciliation of Level 3 fair value measurements, information about purchases, sales, issuances and settlements are presented separately. This standard is effective for interim and annual reporting periods beginning after December 15, 2009 with the exception of revised Level 3 disclosure requirements which are effective for interim and annual reporting periods beginning after December 15, 2010. Comparative disclosures are not required in the year of adoption. The Company adopted the provisions of the standard on January 1, 2010, which did not have a material impact on the Company’s financial statements.

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

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

Recent accounting pronouncements (continued)

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

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

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

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

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

NOTE 2 – ACCOUNTS RECEIVABLE

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

	June 30, 2010			December 31, 2009
Accounts receivable	$	7,636,523		$	6,804,518
Less: allowance for doubtful accounts		(985,471	)		(758,096	)
	$	6,651,052		$	6,046,422

NOTE 3 - INVENTORIES

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

	June 30, 2010			December 31, 2009
Raw materials	$	2,953,742		$	1,366,220
Work in process		307,840			288,811
Finished goods		367,931			737,865
		3,629,513			2,392,896
Less: reserve for obsolete inventory		(161,307	)		(160,632	)
	$	3,468,206		$	2,232,264

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 4 - PROPERTY AND EQUIPMENT

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

		June 30,			December 31,
	Useful Life	2010			2009
Office equipment and furniture	5 Years	$	104,708		$	103,320
Manufacturing equipment	5 – 10 Years		25,669,611			17,405,814
Vehicles	5 Years		116,113			79,570
Construction in progress	-		8,094,729			9,546,200
Building and building improvements	20 Years		16,491,557			15,153,046
			50,476,718			42,287,950
Less: accumulated depreciation			(6,652,488	)		(5,424,449	)

		$	43,824,230		$	36,863,501

For the six months ended June 30, 2010 and 2009, depreciation expense amounted to $1,200,642 and $697,127, of which $1,039,627 and $536,204 is included in cost of sales, respectively. Upon completion of the construction in progress, the assets will be classified to its respective property and equipment category.

NOTE 5 – LAND USE RIGHTS

There is no private ownership of land in China. Land is owned by the government and the government grants land use rights for specified terms. The Company’s land use rights have terms of 45 and 50 years and expire on January 1, 2053 and October 30, 2053. The Company amortizes the land use rights over the term of the respective land use right. For the six months ended June 30, 2010 and 2009, amortization of land use rights amounted to $43,245 and $43,191, respectively.

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

	Useful Life	June 30, 2010			December 31, 2009
Land Use Rights	45 - 50 years	$	3,965,690		$	3,949,101
Less: Accumulated Amortization			(264,008	)		(219,674	)
		$	3,701,682		$	3,729,427

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

Periods ending June 30:
2011	$	86,822
2012		86,822
2013		86,822
2014		86,822
2015		86,822
Thereafter		3,267,572
	$	3,701,682

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 6 – STOCKHOLDERS’ EQUITY

(a) Common stock

On January 31, 2010, the Company issued 1,500 shares of common stock to its Chief Financial Officer for services rendered and will be rendered pursuant to an employment agreement. The shares were valued at fair value on the date of grant and the Company recorded stock-based compensation of $7,226 and prepaid expense of $424.

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

The Company has a consulting agreement with a company that provides the services of its vice president of financial reporting. Pursuant to this agreement, the Company issued 2,000 shares of common stock on March 31, 2010 and June 30, 2010 for an aggregate of 4,000 shares of common stock. The shares were valued at fair value on the date of grant and the Company recorded stock-based compensation of $9,660 for the March 31, 2010 issuance and $8.940 for the June 30, 2010 issuance.

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

On May 7, 2010, the Company issued 7,000 shares of common stock to its Chief Executive Officer and 5,000 shares of common stock to two other key employees who are not executive officers pursuant to its 2010 long-term incentive plan. The shares were valued at fair value on the date of grant and the Company recorded stock-based compensation of $43,080.

During the six months ended June 30, 2010, the Company issued 955,000 shares of common stock upon the conversion of 2,865,000 shares of series A preferred stock.

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

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

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 6 – STOCKHOLDERS’ EQUITY (continued)

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

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

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

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

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

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

	·	All of the outstanding shares of series A preferred stock shall be automatically converted into common stock upon the close of business on the business day immediately preceding the date fixed for consummation of any transaction resulting in a change of control of the Company, as defined in the statement of designation.

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 6 – STOCKHOLDERS’ EQUITY (Continued)

(d) November 2007 Securities Purchase Agreement

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

The Company agreed to have appointed such number of independent directors that would result in a majority of its directors being independent directors, that the audit committee would be composed solely of not less than three independent directors and the compensation committee would have at least three directors, a majority of which shall be independent directors. If the Company does not meet these requirements for a period of 60 days for an excused reason, as defined in the securities purchase agreement, or 75 days for a reason which is not an excused reason, the Company would be required to pay liquidated damages. The Company is in compliance with this covenant.

The Company agreed to have a qualified chief financial officer. If the Company cannot hire a qualified chief financial officer promptly upon the resignation or termination of employment of a former chief financial officer, the Company may engage an accountant or accounting firm to perform the duties of the chief financial officer. In no event shall the Company either (i) fail to file an annual, quarterly or other report in a timely manner because of the absence of a qualified chief financial officer, or (ii) not have a person who can make the statements and sign the certifications required to be filed in an annual or quarterly report under the Securities Exchange Act of 1934.

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

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

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

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

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

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 6 – STOCKHOLDERS’ EQUITY (Continued)

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

On March 23, 2009, the Company sold to two investors, for $250,000, its 18-month, 15% notes in the aggregate principal amount of $250,000 and five-year warrants purchasing 145,833 shares at an exercise price of $1.20 per share. These warrants were treated as a discount on the secured notes and were valued at $92,985 to be amortized over the 18-month note term. The fair value of these warrants was estimated on the date of grant using the Black-Scholes option-pricing model using the following weighted-average assumptions: expected dividend yield of 0%; expected volatility of 137.51%; risk-free interest rate of 1.69% and an expected holding period of five years. The Company repaid the notes in full in February 2010 and fully amortized the balance of the debt discount in February 2010. For the six months ended June 30, 2010 and 2009, amortization of debt discount to interest expense was $44,993 and $16,997, respectively.

Warrant activities for the six months ended June 30, 2010 are summarized as follows:

	Six Months Ended June 30, 2010
	Number of Warrants			Weighted Average Exercise Price
Balance at beginning of year		4,941,498		$	1.49
Granted		-			-
Exercised		(1,025,058	)		1.63
Forfeited		-			-
Balance at end of period		3,916,440		$	1.45

Warrants exercisable at end of period		3,916,440		$	1.45

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

Warrants Outstanding								Warrants Exercisable
Range of Exercise Price		Number Outstanding at June 30, 2010		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Number Exercisable at June 30, 2010		Weighted Average Exercise Price
$	1.698		1,985,681		2.38	$	1.698		1,985,681	$	1.698
$	1.200		1,930,759		2.44		1.200		1,930,759		1.200
			3,916,440		2.41	$	1.45		3,916,440	$	1.45

(f) 2010 Long-Term Incentive Plan

In January 2010, the Company’s board of directors adopted, and in March 2010, the stockholders approved the Company’s 2010 long-term incentive plan, which covers 2,000,000 shares of common stock. The plan provides for the grant of incentive and non-qualified options and stock grants to employees, including officers, directors and consultants. The plan is to be administered by a committee of not less than three directors, each of whom is to be an independent director. In the absence of a committee, the plan is administered by the board of directors. Members of the committee are not eligible for stock options or stock grants pursuant to the plan unless such stock options or stock grant are granted by a majority of the Company’s independent directors other than the proposed grantee. As of June 30, 2010, the Company had issued a total of 65,500 shares of common stock, for which it expensed compensation in the amount of $345,386.

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 7 – INCOME TAXES

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

Accordingly, the net deferred tax asset related to the U.S. net operating loss carryforward has been fully offset by a valuation allowance. The Company is governed by the Income Tax Law of the People’s Republic of China and the United States. In 2010 and 2009, under the Income Tax Laws of PRC, Chinese companies are generally subject to an income tax at an effective rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments. The Company’s VIEs (Dyeing and Electric) and the Company’s subsidiary, Fulland Wind Energy, are subject to these statutory rates. The Company’s wholly-owned subsidiary, Fulland Limited was incorporated in the Cayman Islands. Under the current laws of the Cayman Islands, this entity is not subject to income taxes.

NOTE 8 – LOANS PAYABLE

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

	June 30,		December 31,
	2010		2009
Loan payable to Industrial and Commercial Bank of China, due on September 24, 2010 with an annual interest rate at June 30, 2010 and December 31, 2009 of 5.84% and 5.84%, respectively, secured by assets of the Company.	$	146,873	$	146,259
Loan payable to Industrial and Commercial Bank of China, due on September 15, 2010 with an annual interest rate at June 30, 2010 and December 31, 2009 of 5.58% and 5.58%, respectively, secured by assets of the Company.		146,873		146,259
Loan payable to Industrial and Commercial Bank of China, due on September 22, 2010 with an annual interest rate at June 30, 2010 and December 31, 2009 of 5.58% and 5.58%, respectively, secured by assets of the Company.		146,873		146,259
Loan payable to Bank of Communications, due on June 8, 2010 with annual interest at December 31, 2009 of 5.84%, the rate being adjusted quarterly based on People’s Bank of China’s base rate times 120% and repaid on due date		-		438,775

Loan payable to Bank of Communications, due on June 14, 2010 with annual interest at December 31, 2009 of 5.84%, the rate being adjusted quarterly based on People’s Bank of China’s base rate times 120% and repaid on due date			-				292,517
Loan payable to Agricultural and Commercial Bank, due on March 31, 2011 with annual interest at June 30, 2010 and December 31, 2009 of 5.75% and 6.90%, respectively, secured by certain assets of the Company.			587,493				585,035

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 8 – LOANS PAYABLE (Continued)

Principal amount of loan payable to an investor, due on February 7, 2011 with annual interest at December 31, 2009 of 12% and repaid in January 2010.		-		80,000

Principal amount of loan payable to investors, due on September 23, 2010, with interest of 15% per annum (see (a) below) and repaid in January 2010.		-		250,000
Total loans payable		1,028,112		2,085,104
Less: debt discount (a)		-		(44,993	)
Current portion of loans payable – net	$	1,028,112	$	2,040,111

(a)

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

NOTE 9 - SEGMENT INFORMATION

For the three and six months ended June 30, 2010 and 2009, the Company operated in two reportable business segments - (1) the manufacture of dyeing and finishing equipment and (2) the manufacture of forged rolled rings and related components for the wind power and other industries and, in the three and six months ended June 30, 2009, electric power auxiliary apparatuses (including coking equipment) although no revenue was generated from and no expenses were incurred in connection with the electric power auxiliary equipment business, which was discontinued in the fourth quarter of 2009. The Company's reportable segments are strategic business units that offer different products. They are managed separately based on the fundamental differences in their operations. All of the Company’s operations are conducted in the PRC. Information with respect to these reportable business segments for the three and six months ended June 30, 2010 and 2009 is as follows:

	For the Three Months Ended						For the Six Months Ended
	June 30,						June 30,
	2010			2009			2010			2009
Revenues:
Dyeing and finishing equipment	$	5,224,490		$	3,797,008		$	10,217,723		$	7,326,449
Forged rolled rings and related components		13,752,784			9,787,022			25,600,233			14,118,448

		18,977,274			13,584,030			35,817,956			21,444,897
Depreciation:
Dyeing and finishing equipment		124,892			103,585			235,102			203,692
Forged rolled rings and related components		491,104			418,429			965,540			493,435

		615,996			522,014			1,200,642			697,127
Interest expense:
Forged rolled rings and related components		18,494			22,875			45,470			44,139
Other (a)		-			153,183			47,943			155,590

		18,494			176,058			93,413			199,729
Net income (loss):
Dyeing and finishing equipment		702,525			427,088			1,202,503			891,591
Forged rolled rings and related components		2,516,330			1,647,318			4,487,755			2,071,354
Other (a)		(195,198	)		(293,871	)		(720,064	)		(536,352	)

		3,023,657			1,780,535			4,970,194			2,426,593

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 9 - SEGMENT INFORMATION (Continued)

Identifiable long-lived tangible assets at June 30, 2010
and December 31, 2009 by segment:
Dyeing and finishing equipment	$	6,071,991	$	5,728,590
Forged rolled rings and related components		37,752,239		31,134,911

	$	43,824,230	$	36,863,501
Identifiable long-lived tangible assets at June 30, 2010
and December 31, 2009 by geographical location:
China	$	43,824,230	$	36,863,501
United States		-		-

	$	43,824,230	$	36,863,501

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

NOTE 10 – STATUTORY RESERVES

The Company is required to make appropriations to reserve funds, comprising the statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (the “PRC GAAP”). Appropriation to the statutory surplus reserve should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of the entities’ registered capital or members’ equity. Appropriations to the statutory public welfare fund are at a minimum of 5% of the after tax net income determined in accordance with PRC GAAP. Commencing on January 1, 2006, the new PRC regulations waived the requirement for appropriating retained earnings to a welfare fund. Prior to December 31, 2009, the Company appropriated the required maximum 50% of its registered capital to statutory reserves for Dyeing and Electric.

For the six months ended June 30, 2010, statutory reserve activity is as follows:

	Dyeing		Electric		Wuxi Fulland		Total
Balance – December 31, 2009	$	72,407	$	1,168,796	$	11,777	$	1,252,980
Additional to statutory reserves		-		-		-		-
Balance – June 30, 2010	$	72,407	$	1,168,796	$	11,777	$	1,252,980

NOTE 11 – CONCENTRATIONS

Customers

During the six months ended June 30, 2010, one customer of the forged rolled rings and related components segment accounted for 24% of the Company’s total sales. No other customer accounted for more than 10% of the Company’s total sales for the six months ended June 30, 2009.

CHINA WIND SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2010

NOTE 11 – CONCENTRATIONS (Continued)

Suppliers

Three major suppliers provided approximately 61% of the Company’s purchases of raw materials for the six months ended June 30, 2010 primarily consisting of steel for the forged rolled rings and related components segment. No supplier provided more than 10% of the Company’s purchases of raw materials for the six months ended June 30, 2009.

NOTE 12 – RESTRICTED NET ASSETS

Regulations in the PRC permit payments of dividends by the Company’s PRC VIEs only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Subject to certain cumulative limit, a statutory reserve fund requires annual appropriations of at least 10% of after-tax profit, if any, of the relevant PRC VIE’s and subsidiary. The statutory reserve funds are not distributable as cash dividends. As a result of these PRC laws and regulations, the Company’s PRC VIE’s and subsidiary are restricted in their abilities to transfer a portion of their net assets to the Company. Foreign exchange and other regulation in PRC may further restrict the Company’s PRC VIEs and subsidiary from transferring funds to the Company in the form of loans and/or advances.

As of June 30, 2010 and December 31, 2009, substantially all of the Company’s net assets are attributable to the PRC VIE’s and subsidiary. Accordingly, the Company’s restricted net assets were approximately $59,843,000 and $51,652,000, respectively.

NOTE 13 – SUBSEQUENT EVENTS

On July 8, 2010, the Company issued 100,000 shares of its common stock upon the conversion of 300,000 shares of Series A Convertible Preferred Stock.

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

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

On July 29, 2010, the Company issued 1,500 shares of common stock to its Chief Financial Officer for services rendered and will be rendered pursuant to an employment agreement. The shares were valued at fair value on the date of grant and the Company recorded a prepaid expense of $7,020, which will be amortized over the service period.

On July 29, 2010, the Company issued 7,000 restricted shares of common stock to its Chief Executive Officer and 5,000 shares of common stock to two other key employees who are not executive officers pursuant to its 2010 long-term incentive plan. The shares were valued at fair value on the date of grant and the Company recorded stock-based compensation of $56,160.

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

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

Overview

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

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

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

In October 2009, we ordered the initial machinery to expand our completed state-of-the-art forged product facility with a new production line, enabling us to manufacture electro-slag re-melted forged products for the high performance components market of the wind power industry. We believe that electro-slag re-melted forged products will be important components in the next generation of larger wind turbines, which will require stronger steel alloy precision forged components than the smaller turbines. Electro-slag re-melted technology is used to increase the durability and quality of steel and to blend specific alloys that are required to meet the anticipated strength requirements of the next generation of wind turbines. We delivered the initial units from this production line in July2010.

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

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

Prior to 2009, the manufacturing of textile dyeing and finishing machines was our principal source of revenue. We have changed our focus to the manufacture of forged rolled rings, shafts, gear rims and yaw bearings in order to meet the growing demands of China’s wind energy industry. We believe that there is a shortage of wind components in China’s wind energy supply chain. The shortage is caused by the lack of forged products including rolled rings, shafts, and gear rims which are used in the gearbox, and rolled rings used in yaw bearings.

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

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
		Dollars	%			Dollars	%			Dollars	%			Dollars	%
Dyeing and finishing equipment	$	5,225	27.5	%	$	3,797	28.0	%	$	10,218	28.6	%	$	7,326	34.2	%
Forged rolled rings - wind power industry		9,181	48.4	%		3,643	26.8	%		16,134	45.0	%		6,367	29.7	%
Forged rolled rings - other industries		4,571	24.1	%		6,144	45.2	%		9,466	26.4	%		7,752	36.1	%

Total	$	18,977	100	%	$	13,584	100	%	$	35,818	100	%	$	21,445	100	%

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

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

A major element of our cost of revenues is raw materials, principally steel and other metals. These metals are subject to price fluctuations, and recently these fluctuations have been significant. In times of increasing prices, we need to try to fix the price at which we purchase raw materials in order to avoid increases in costs which we cannot recoup through increases in sales prices. Similarly, in times of decreasing prices, we may have purchased metals at prices which are high in terms of the price at which we can sell our products, which also can impair our margins. Three major suppliers provided approximately 61% of our purchases of raw materials for the six months ended June 30, 2010 primarily consisting of steel for the forged rolled rings and related components segment. No supplier provided more than 10% of the Company’s purchases of raw materials for the six months ended June 30, 2009.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our estimates, including those related to bad debts, inventories, recovery of long-lived assets, income taxes, and the valuation of equity transactions. We base our estimates on historical experience and on various other assumptions that we believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Any future changes to these estimates and assumptions could cause a material change to our reported amounts of revenues, expenses, assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the financial statements

Variable Interest Entities

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

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

The accounts of the Huayang Companies are consolidated in the accompanying financial statements. As VIEs, the Huayang Companies sales are included in our total sales, their income from operations is consolidated with ours, and our net income includes all of the Huayang Companies’ net income, and their assets and liabilities are included in our consolidated balance sheet. The VIEs do not have any non-controlling interest and accordingly, we did not subtract any net income in calculating the net income attributable to us. Because of the contractual arrangements, we have pecuniary interest in the Huayang Companies that require consolidation of the Huayang Companies financial statements with our financial statements.

Accounts receivable

We have a policy of reserving for uncollectible accounts based on our best estimate of the amount of probable credit losses in our existing accounts receivable. We periodically review our accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

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

Inventories

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

Property and equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets are as follows:

		Useful Life
Building and building improvements		20 Years
Manufacturing equipment		5 – 10 Years
Office equipment and furniture		5 Years
Vehicle		5 Years

The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition.

Included in property and equipment is construction-in-progress which consists of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use.

We examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. We recognize an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value.

Land use rights

There is no private ownership of land in the PRC. All land in the PRC is owned by the government and cannot be sold to any individual or company. The government grants a land use right that permits the holder of the land use right to use the land for a specified period. Our land use rights were granted with a term of 45 or 50 years. Any transfer of the land use right requires government approval. We have recorded as an intangible asset the costs paid to acquire a land use right. The land use rights are amortized on the straight-line method over the land use right terms.

Revenue recognition

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

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

Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the six months ended June 30, 2010 and 2009, amounts allocated to warranty revenues were not material. Based on historical experience, warranty service calls and any related labor costs have been minimal.

All other product sales, including the forged rolled rings, with customer specific acceptance provisions, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.

Research and development

Research and development costs are expensed as incurred. We incurred minimal research and development expenses in the six months ended June 30, 2010 and 2009. Product development expenses are included in general and administrative expenses. These costs primarily consist of cost of material used and salaries paid for the development of our products and fees paid to third parties.

Income taxes

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

Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probably that taxable profit will be available against which deductible temporary differences can be utilized.

Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity.

Deferred tax assets and liabilities are offset when they related to income taxes levied by the same taxation authority and the Company intends to settle its current tax assets and liabilities on a net basis.

Deemed preferred stock dividend

Stock-based compensation

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

Recent accounting pronouncements

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

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

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

Currency Exchange Rates

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

Our exposure to foreign exchange risk primarily relates to currency gains or losses resulting from timing differences between signing of sales contracts and settling of these contracts. Furthermore, we translate monetary assets and liabilities denominated in other currencies into RMB, the functional currency of our operating subsidiaries. Our results of operations and cash flow are translated at average exchange rates during the year, and assets and liabilities are translated at the unified exchange rate as quoted by the Peoples’ Bank of China at the end of the year. Translation adjustments resulting from this process are included in accumulated other comprehensive income in our statement of shareholders’ equity. We have not used any forward contracts, currency options or borrowings to hedge our exposure to foreign currency exchange risk. We cannot predict the impact of future exchange rate fluctuations on our results of operations and may incur net foreign currency losses in the future. As our sales denominated in foreign currencies, such as RMB, continue to grow, we will consider using arrangements to hedge our exposure to foreign currency exchange risk.

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

RESULTS OF OPERATIONS

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

	Six Months Ended June 30,
	2010						2009
	Dollars			Percent			Dollars			Percent
Net revenues	$	35,818			100.0	%	$	21,445			100.0	%
Cost of revenues		26,424			73.8	%		16,744			78.1	%
Gross profit		9,394			26.2	%		4,701			21.9	%
Operating expenses		2,457			6.9	%		1,171			5.5	%
Income from operations		6,937			19.4	%		3,530			16.5	%
Other income (expenses)		(49	)		(0.1	) %		(65	)		(0.3	)%
Income before provision for income taxes		6,888			19.2	%		3,465			16.2	%
Provision for income taxes		1,918			5.4	%		1,038			4.8	%
Net income		4,970			13.9	%		2,427			11.3	%
Other comprehensive income:
Foreign currency translation adjustment		216			0.6	%		45			0.2	%
Comprehensive income	$	5,186			14.5	%	$	2,472			11.5	%

	Three Months Ended June 30,
	2010					2009
	Dollars		Percent			Dollars			Percent
Net revenues	$	18,977		100.0	%	$	13,584			100.0	%
Cost of revenues		14,000		73.8	%		10,479			77.1	%
Gross profit		4,977		26.2	%		3,105			22.9	%
Operating expenses		973		5.1	%		593			4.4	%
Income from operations		4,004		21.1	%		2,512			18.5	%
Other income (expenses)		27		0.1	%		(30	)		(0.2	)%
Income before provision for income taxes		4,031		21.2	%		2,482			18.3	%
Provision for income taxes		1,008		5.3	%		701			5.2	%
Net income		3,023		15.9	%		1,781			13.1	%
Other comprehensive income:
Foreign currency translation adjustment		209		1.1	%		3			0.0	%
Comprehensive income	$	3,232		17.0	%	$	1,784			13.1	%

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

				Forged									Forged
				rolled									rolled
	Dyeing and			rings and						Dyeing and			rings and
	finishing			related						finishing			related
	equipment			products			Total			equipment			products			Total
	Three Months Ended June 30, 2010									Six Months Ended June 30, 2010
Revenues	$	5,225		$	13,752		$	18,977		$	10,218		$	25,600		$	35,818
Cost of revenues	$	4,144		$	9,856		$	14,000		$	8,128		$	18,296		$	26,424
Gross profit	$	1,081		$	3,896		$	4,977		$	2,090		$	7,304		$	9,394
Gross margin %		20.7	%		28.3	%		26.2	%		20.5	%		28.5	%		26.2	%

				Forged									Forged
				rolled									rolled
	Dyeing and			rings and						Dyeing and			rings and
	finishing			related						finishing			related
	equipment			products			Total			equipment			products			Total
	Three Months Ended June 30, 2009									Six Months Ended June 30, 2009
Revenue	$	3,797		$	9,787		$	13,584		$	7,326		$	14,119		$	21,445
Cost of revenues	$	2,959		$	7,520		$	10,479		$	5,737		$	11,007		$	16,744
Gross profit	$	838		$	2,267		$	3,105		$	1,589		$	3,112		$	4,701
Gross margin %		22.1	%		23.2	%		22.9	%		21.7	%		22.0	%		21.9	%

Six Months Ended June 30, 2010 and 2009

Revenues. For the six months ended June 30, 2010, we had revenues of $35,818,000 as compared to revenues of $21,445,000 for the six months ended June 30, 2009, an increase of $14,373,000, or 67.0%. The increase in revenue was attributable to the increases in revenue from both our forged rolled rings and our dyeing and finishing equipment segments, and is summarized as follows (dollars in thousands):

	For the Six Months Ended June 30, 2010		For the Six Months Ended June 30, 2009		Increase (Decrease)		Percentage Change
Dyeing and finishing equipment	$	10,218	$	7,326	$	2,892		39.5	%
Forged rolled rings - wind power industry		16,134		6,367		9,767		153.4	%
Forged rolled rings – other industries		9,466		7,752		1,714		22.1	%
Total net revenues	$	35,818	$	21,445	$	14,373		67.0	%

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

Revenues from forging of rolled rings and related products totaled $25,600,000 for the six months ended June 30, 2010, with revenues from the wind power industry amounting to $16,134,000 and revenues from other forging operations amounting to $9,466,000. Due to the deliberate shift in focus of our sales effort to the wind segment, we increased sales of forged rolled rings to the wind power industry by 153.4% for the six months ended June 30, 2010 compared to the six months ended June 30, 2009. We also experienced a 22.1% increase in forging revenues from other industries, such as the railway, heavy machinery manufacturing, petrochemical, metallurgical, sea port machinery, and defense and radar industries. During 2010, we have been able to secure new customers though our marketing efforts.

Cost of revenues. Cost of revenues for the six months ended June 30, 2010 increased $9,680,000 or 57.8%, from $16,744,000 for the six months ended June 30, 2009 to $26,424,000 for the six months ended June 30, 2010. Cost of revenues for Dyeing was $8,128,000 for the six months ended June 30, 2010, as compared to $5,737,000 for the six months ended June 30, 2009. Cost of revenues related to the manufacture of forged rolled rings and related products was $18,296,000 for the six months ended June 30, 2010 as compared to $11,007,000 for the six months ended June 30, 2009.

Gross profit and gross margin. Our gross profit was $9,394,000 for the six months ended June 30, 2010 as compared to $4,701,000 for the six months ended June 30, 2009, representing gross margins of 26.2% and 21.9%, respectively. Gross profit for Dyeing was $2,090,000 for the six months ended June 30, 2010 as compared to $1,590,000 for the six months ended June 30, 2009, representing gross margins of approximately 20.5% and 21.7%, respectively. The decrease in our gross margin for Dyeing was attributable to a reduction of our sales price due to stronger competition in the textile industry in China. Gross profit from forged rolled rings and related products segment was $7,304,000 for the six months ended June 30, 2010 as compared to $3,112,000 for the six months ended June 30, 2009, representing gross margins of approximately 28.5% and 22.0%, respectively. The increase in our gross margin was mainly attributed to operational efficiencies from the increase in our production in the first half of fiscal 2010 as compared to the comparable period of 2009. We believe that our gross margins will improve to the extent that we are able to utilize our factory capacity more efficiently.

Depreciation. Depreciation was $1,201,000 for the six months ended June 30, 2010 and $697,000 for the six months ended June 30, 2009, of which $1,040,000 for the six months ended June 30, 2010 and $536,000 for the six months ended June 30, 2009 is included in cost of revenues and $161,000 for the six months ended June 30, 2010 and $161,000 for the six months ended June 30, 2009 is included in operating expenses. The overall increase in depreciation is attributable to an increase in our depreciable production equipment, primarily relating to our forged rolled rings and other related products segment. We expect depreciation to increase in future periods, as we install and place in service new equipment and facilities related to our new production line for electro-slag re-melted forged products.

Selling, general and administrative expenses. Selling, general and administrative expenses totaled $2,296,000 for the six months ended June 30, 2010, as compared to $1,010,000 for the six months ended June 30, 2009, an increase of $1,286,000 or approximately 127.3%. Selling, general and administrative expenses consisted of the following (dollars in thousands):

	Six Months Ended June 30, 2010		Six Months Ended June 30, 2009
Professional fees	$	156	$	209
Bad debt expense		223		144
Payroll and related benefits		707		215
Travel		163		68
Shipping		693		100
Other		354		274
	$	2,296	$	1,010

Professional fees decreased for the six months ended June 30, 2010 by $53,000, as compared to the six months ended June 30, 2009. The decrease is primarily attributed to a decrease in accounting expense of approximately $74,000 related to a change in the method of accruing for our auditing fees. In the 2009 period, we expensed the 2008 auditing fees reflecting the period in which the services were performed. In order to reflect the audit and review fees in the period in which the services relate to, in December 2009, we accrued the entire 2009 auditing fee. Accordingly, accounting fees for the six months ended June 30, 2010 only reflects the fee for our quarterly reviews. The decrease in professional fees also reflected a decrease in investor relations expenses of approximately $33,000 offset by an increase in legal fees of approximately $14,000, an increase in stock transfer fees of approximately $14,000 and an increase in consulting expenses of approximately $26,000.

Bad debt expense increased for the six months ended June 30, 2010 by $79,000. Based on our periodic review of accounts receivable balances, we adjusted the allowance for doubtful accounts after considering management’s evaluation of the collectability of individual receivable balances, including the analysis of subsequent collections, the customers’ collection history, and recent economic events.

Payroll and related benefits increased for the six months ended June 30, 2010 by $492,000, as compared to the six months ended June 30, 2009. The increase was mainly attributable to an increase in stock-based and other compensation for our management of approximately $337,000 and an increase in compensation and related benefits of approximately $165,000 in our forged rolled rings and related products segment resulting from increased operations offset by a decrease in compensation and related benefits of approximately $10,000 in our dyeing and finishing segment.

	·	Travel expense for the six months ended June 30, 2010 increased by $95,000, as compared to the six months ended June 30, 2009. The increase is primarily related to an increase in travel for investor road shows and conferences.

	·	Shipping expense for the six months ended June 30, 2010 increased by $593,000, as compared to the six months ended June 30, 2009. For the six months ended June 30, 2009, we charged partial shipping fees to our customers while, for the six months ended June 30, 2010, we paid the related shipping fees for our customers. Therefore, our selling expense was substantially increased. For customers that we have absorbed shipping costs, we negotiated a higher selling price with these customers to offset the shipping costs, which also had a modest positive effect upon our gross margins.

Other selling, general and administrative expenses increased by $80,000 for the six months ended June 30, 2010 as compared with the six months ended June 30, 2009. The increase was primarily attributed to an increase in advertising expense of approximately $12,000 and an increase in entertainment expenses of approximately $13,000 and other miscellaneous expenses of approximately $55,000.

Income from operations. For the six months ended June 30, 2010, income from operations amounted to $6,937,000, as compared to $3,530,000 for the six months ended June 30, 2009, an increase of $3,407,000 or 96.5%.

Other income (expenses). For the six months ended June 30, 2010, other expenses amounted to $48,000 as compared to $65,000 for the six months ended June 30, 2009. For the six months ended June 30, 2010, other income (expenses) included:

interest expense of $93,000, consisting of non-cash interest expense of $45,000 from the amortization of debt discount arising from our March 2009 financing and interest expense of $48,000 incurred on our outstanding loans;

	·	foreign currency losses of $7,000;

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

interest income of $3,000.

For the six months ended June 30, 2009, other income (expenses) included:

interest expense of $200,000, consisting of non-cash interest expense of $17,000 from the amortization of debt discount arising from our March 2009 financing, $135 ,000 from the issuance of common stock as payment of the principal and interest on a note, of which $7,000 represented interest on the note and $128,000 represented the amount by which the value of the stock issued in payment of principal exceeded the principal amount of the note, and interest expense of $47,000 incurred on our outstanding loans.

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

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

nominal foreign currency losses and interest income.

Income tax expense. Income tax expense totaled $1,918,000 for the six months ended June 30, 2010, as compared to $1,038,000 for the six months ended June 30, 2009, an increase of $880,000, or approximately 84.8%, which was primarily attributable to the increase in taxable income generated by our operating entities.

Net income. As a result of the foregoing, our net income for the six months ended June 30, 2010 was $4,970,000, or $0.29 per share (basic) and $0.20 per share (diluted). Net income for the six months ended June 30, 2009 was $2,427,000, or $0.16 per share (basic) and $0.12 per share (diluted).

Foreign currency translation gain. The functional currency of our subsidiaries and variable interest entities operating in the PRC is the Chinese Yuan or Renminbi (“RMB”). The financial statements of our subsidiaries are translated to U.S. dollars using period end rates of exchange for assets and liabilities, and average rates of exchange (for the period) for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations and were minimal. As a result of unrealized foreign currency translations, which are a non-cash adjustment, we reported a foreign currency translation gain of $216,000 for the six months ended June 30, 2010 as compared to $45,000 for the six months ended June 30, 2009. This non-cash gain had the effect of increasing our reported comprehensive income.

Comprehensive income. As a result of our unrealized foreign currency translation gains, we had comprehensive income for the six months ended June 30, 2010 of $5,186,000, compared with $2,471,000 for the six months ended June 30, 2009.

Three Months Ended June 30, 2010 and 2009

Revenues. For the three months ended June 30, 2010, we had revenues of $18,977,000, as compared to revenues of $13,584,000 for the three months ended June 30, 2009, an increase of approximately 39.7%. The increase in total revenue was attributable to the increases in revenue from forged rolled rings related to wind power industry and revenue from dyeing and finishing equipment, offset by the decrease in revenue from forged rolled rings related to other industries and is summarized as follows (dollars in thousands):

	For the Three Months Ended June 30, 2010		For the Three Months Ended June 30, 2009		Increase (Decrease)			Percentage Change
Dyeing and finishing equipment	$	5,225	$	3,797	$	1,428			37.6	%
Forged rolled rings - wind power industry		9,181		3,643		5,538			152.1	%
Forged rolled rings – other industries		4,571		6,144		(1,573	)		(25.6	)%
Total net revenues	$	18,977	$	13,584	$	5,393			39.7	%

Revenues from forging of rolled rings totaled $13,752,000 for the three months ended June 30, 2010, with revenues from the wind power industry amounting to $9,181,000 and revenues from other forging operations amounting to $4,571,000. Due to the deliberate shift in focus of our sales effort to the wind segment, we increased sales of forged rolled rings to the wind power industry by 152.1% for the three months ended June 30, 2010 compared to the three months ended June 30, 2009. We also experienced a 25.6% decrease in forging revenues from other industries, such as the railway, heavy machinery manufacturing, petrochemical, metallurgical, sea port machinery, and defense and radar industries. The decrease in forging revenues from other industries was mainly attributable to the timing of shipments to our customers during the quarterly periods. Overall, for the six months ended June 30, 2010, we had an increase in revenues in forging from other industries of 22.1%.

Cost of revenues. Cost of revenues for the three months ended June 30, 2010 increased $3,521,000 or 33.6%, from $10,479,000 for the three months ended June 30, 2009 to $14,000,000 for the three months ended June 30, 2010. Cost of goods sold for Dyeing was $4,144,000 for the three months ended June 30, 2010, as compared to $2,959,000 for the three months ended June 30, 2009. Cost of revenues related to the manufacture of forged rolled rings and related products was $9,856,000 for the three months ended June 30, 2010 as compared to $7,520,000 for the three months ended June 30, 2009.

Gross profit and gross margin. Our gross profit was $4,977,000 for the three months ended June 30, 2010 as compared to $3,105,000 for the three months ended June 30, 2009, representing gross margins of 26.2% and 22.9%, respectively. Gross profit for Dyeing was $1,081,000 for the three months ended June 30, 2010 as compared to $838,000 for the three months ended June 30, 2009, representing gross margins of approximately 20.7% and 22.1%, respectively. The decrease in our gross margin for Dyeing was attributable to a reduction of our sales price due to stronger competition in the textile industry in China. Gross profit from forged rolled rings and related products segment was $3,896,000 for the three months ended June 30, 2010 as compared to $2,267,000 for the three months ended June 30, 2009, representing gross margins of approximately 28.3% and 23.2%, respectively. The increase in our gross margin was mainly attributed to operational efficiencies from the increase in our production in the second quarter of fiscal 2010 as compared to the corresponding period of fiscal 2009. We believe that our gross margins will improve to the extent that we are able to utilize our factory capacity more efficiently.

Depreciation. Depreciation was $616,000 and $522,000 for the three months ended June 30, 2010 and 2009, respectively, of which $538,000 for the three months ended June 30, 2010 and $439,000 for the three months ended June 30, 2009 is included in cost of revenues and $78,000 for the three months ended June 30, 2010 and $83,000 for the three months ended June 30, 2009 is included in operating expenses. The overall increase in depreciation is attributable to an increase in our depreciable production equipment, primarily relating to our forged rolled rings and other related products.

Selling, general and administrative expenses. Selling, general and administrative expenses totaled $895,000 for the three months ended June 30, 2010, as compared to $509,000 for the three months ended June 30, 2009, an increase of $386,000 or approximately 75.7%. Selling, general and administrative expenses consisted of the following (dollars in thousands):

	Three Months Ended June 30, 2010			Three Months Ended June 30, 2009
Professional fees	$	80		$	61
Bad debt expense (recovery)		(28	)		142
Payroll and related benefits		280			113
Travel		73			30
Shipping		295			43
Other		195			120
	$	895		$	509

Professional fees increased for the three months ended June 30, 2010 by $19,000, as compared to the three months ended June 30, 2009.

Bad debt expense decreased for the three months ended June 30, 2010 by $170,000. Based on our periodic review of accounts receivable balances, we adjusted the allowance for doubtful accounts after considering management’s evaluation of the collectability of individual receivable balances, including the analysis of subsequent collections, the customers’ collection history, and recent economic events.

Payroll and related benefits increased for the three months ended June 30, 2010 by $167,000, as compared to the three months ended June 30, 2009. The increase was mainly attributable to an increase in stock-based compensation for our management of approximately $39,000 and an increase in compensation and related benefits of approximately $128,000 in our forged rolled rings and related products segment resulting from increased operations.

	·	Travel expense for the three months ended June 30, 2010 increased by $43,000, as compared to the three months ended June 30, 2009. The increase is related to the increase in travel for investor road shows and conferences.

	·	Shipping expense for the three months ended June 30, 2010 increased by $252,000, as compared to the three months ended June 30, 2009. For the three months ended June 30, 2009, we charged partial shipping fees to our customers while, for the three months ended June 30, 2010, we paid the related shipping fees for our customers. Therefore, our selling expense was substantially increased. For customers that we have absorbed shipping costs, we negotiated a higher selling price with these customers to offset the shipping costs, which had a modest positive effect on our gross margin.

Other selling, general and administrative expenses increased by $75,000, for the three months ended June 30, 2010 as compared with the three months ended June 30, 2009.

Income from operations. For the three months ended June 30, 2010, income from operations amounted to $4,004,000, as compared to $2,512,000 for the three months ended June 30, 2009, an increase of $1,492,000 or 59.4%.

Other income (expenses). For the three months ended June 30, 2010, other income amounted to $27,000 as compared to other expenses of $30,000 for the three months ended June 30, 2009. For the three months ended June 30, 2010, other income (expenses) included:

interest expense of $18,000, which was incurred on our outstanding loans;

	·	foreign currency losses of $5,000;

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

nominal interest income of $1,000.

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

interest expense of $176,000, consisting of non-cash interest expense of $16,000 from the amortization of debt discount arising from our March 2009 financing, $131,700 from the issuance of common stock, as payment of the principal and interest on a note, of which $3,700 represented interest on the note and $128,000 represented the amount by which the value of the stock issued in payment of principal exceeded the principal amount of the note, and interest expense of $28,300 incurred on our outstanding loans.

grant income of $146,000 from the Economic and Trade Bureau of Huishan District, Wuxi City on June 18, 2009. We used the grant for working capital purposes to increase production of forged products; and

nominal interest income.

Income tax expense. Income tax expense totaled $1,008,000 for the three months ended June 30, 2010, as compared to $701,000 for the three months ended June 30, 2009, an increase of $307,000, or approximately 43.7% which was primarily attributable to the increase in taxable income generated by our operating entities.

Net income. As a result of the foregoing, our net income for the three months ended June 30, 2010 was $3,024,000, or $0.17 per share (basic) and $0.12 per share (diluted). Net income for the three months ended June 30, 2009 was $1,781,000, or $0.12 per share (basic) and $0.08 per share (diluted).

Foreign currency translation gain. The functional currency of our subsidiaries and variable interest entities operating in the PRC is the Chinese Yuan or Renminbi (“RMB”). The financial statements of our subsidiaries are translated to U.S. dollars using period end rates of exchange for assets and liabilities, and average rates of exchange (for the period) for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations and were minimal. As a result of unrealized foreign currency translations, which are a non-cash adjustment, we reported an unrealized foreign currency translation gain of $209,000 and $3,000 for the three months ended June 30, 2010 and 2009, respectively. This non-cash gain had the effect of increasing our reported comprehensive income.

Comprehensive income. As a result of our foreign currency translation gains, we had comprehensive income for the three months ended June 30, 2010 of $3,232,000, compared with $1,784,000 for the three months ended June 30, 2009.

Liquidity and Capital Resources

Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis. At June 30, 2010 and December 31, 2009, we had cash balances of $1,380,956 and $2,278,638, respectively. These funds are located in financial institutions located as follows (dollars in thousands):

	June 30, 2010				December 31, 2009
Country:
United States	$	307	22.2	%	$	507	22.2	%
China		1,074	77.8	%		1,772	77.8	%
Total cash and cash equivalents	$	1,381	100.0	%	$	2,279	100.0	%

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

					December 31, 2009 to June 30, 2010
Category	2010		2009		Change		Percentage Change
Current assets:
Cash and cash equivalents	$	1,381	$	2,279	$	(898)		(39.4)	%
Notes receivable		192		329		(137)		(41.6)	%
Accounts receivable, net of allowance for doubtful accounts		6,651		6,046		605		10.0	%
Inventories, net of reserve for obsolete inventory		3,468		2,232		1,236		55.4	%
Advances to suppliers		379		451		(72)		(15.9)	%
Prepaid value-added taxes on purchase		712		379		333		80.0	%
Prepaid expenses and other current assets		67		214		(147)		(68.7)	%
Current liabilities:
Loans payable		1,028		2,040		(1,012)		(49.6)	%
Accounts payable		5,072		3,405		1,667		49.0	%
Accrued expenses		354		557		(203)		(36.4)	%
VAT and service taxes payable		81		25		56		220.5	%
Advances from customers		322		143		179		124.6	%
Income tax payable		1,053		1,019		34		3.4	%
Working capital:
Total current assets		12,850		11,930		920		7.7	%
Total current liabilities		7,910		7,189		721		10.0	%
Working capital		4,940		4,741		199		4.2	%

Our working capital increased $199,000 to $4,940,000 at June 30, 2010 from working capital of $4,741,000 at December 31, 2009. This increase in working capital is primarily attributable to an increase in accounts receivable, net of allowance for doubtful accounts, of $605,000, an increase in inventories, net of reserve for obsolete inventory, of $1,236,000 attributable to the purchase of steel forged rolled rings and other related products division and for our new production line to manufacture electro-slag re-melted forged products for the high performance components market of the wind power industry which we began manufacturing in July 2010, an increase in prepaid VAT taxes on purchases of $333,000, a decrease in loans payable of $1,012,000 due to the repayment of certain loans, a decrease in accrued expenses of $203,000 offset by a decrease in cash and cash equivalents of $898,000, a decrease in notes receivable of $137,000, a decrease in advances to suppliers of $72,000, a decrease in prepaid expenses and other current assets of $147,000, an increase in accounts payable of $1,667,000, an increase in VAT and service taxes payable of $56,000, an increase in advances from customers of $178,000 and an increase in income taxes payable of $34,000.

During the six months ended June 30, 2010, we used cash of approximately $8,000,000 for the construction of and equipment for our new electro-slag re-melted production line. In early July 2010, the Company incurred minimal costs to complete the installation of the new production line and all construction in progress was transferred to its respective property and equipment account.

We plan to add an additional electro-slag re-melted production line. We are currently preparing a budget in connection with this plan which would require us to construct or purchase a new factory and to purchase equipment. In the near term, in response to growing demand for our forged products for the wind industry, we plan to add an additional small-scale production line to complement our current forging facility and support strong order flow. The estimated cost of this small-scale production line is $1,200,000. We may not have sufficient working capital to fund this expansion as well as providing working capital necessary for our ongoing operations and obligations. We will need to raise additional capital to complete this project. We may seek to raise additional capital through the sale of equity securities. At this time, we have no commitments or plans to obtain additional capital.

Net cash flow provided by operating activities was $6,539,000 for the six months ended June 30, 2010 as compared to net cash flow provided by operating activities of $2,024,000 for the six months ended June 30, 2009, an increase of $4,515,000. Net cash flow provided by operating activities for the six months ended June 30, 2010 was mainly due to net income of $4,970,000 and the add-back of non-cash items such as depreciation of $1,201,000, the amortization of debt discount to interest expense of $45,000, the amortization of land use rights of $43,000, the increase in allowance for doubtful accounts of $223,000, and stock-based compensation of $345,000, and changes in operating assets and liabilities such as a decrease in notes receivable of $138,000, a decrease in prepaid and other current assets of $147,000, a decrease in advances to suppliers of $73,000, an increase in accounts payable of $1,647,000, an increase in VAT and service taxes payable of $55,000, an increase in income taxes payable of $30,000 and an increase in advances from customers of $177,000, offset by an increase in accounts receivable of $800,000, an increase in inventories of $1,222,000, an increase in prepaid value-added taxes on purchases of $330,00 and a decrease in accrued expenses of $204,000. Net cash flow provided by operating activities for the six months ended June 30, 2009 was mainly due to net income of $2,427,000, the add-back of non-cash items of depreciation of $697,000, the amortization of debt discount of $17,000, the amortization of land use rights of $43,000, the increase in our allowance for bad debt of $143,000, the add-back of interest expense of $128,000 resulting from the issuance of common stock in payment of principal and interest on a note, and the add-back of stock-based compensation of $120,000, the decrease in due from related party of $438,000, the increase in accounts payable of $404,000, the increase in accrued expenses of $82,000, the increase in income taxes payable of $131,000 and the increase in advances from customers of $426,000 offset by an increase in notes receivable of $132,000, an increase in accounts receivable of $1,891,000, an increase in inventories of $622,000, an increase in prepaid and other current assets and prepaid value-added taxes on purchases of $51,000, and an increase in advances to suppliers of $6,000 and a decrease in VAT and service taxes payable of $97,000.

Net cash flow used in investing activities was $7,980,000 for the six months ended June 30, 2010 as compared to net cash used in investing activities of $2,849,000 for the six months ended June 30, 2009. For the six months ended June 30, 2010, we purchased property and equipment of $7,980,000. For the six months ended June 30, 2009, we used cash to purchase of property and equipment of $2,849,000. During the six months ended June 30, 2010, we acquired property and equipment in connection with our expansion into a new production line, enabling us to manufacture electro-slag re-melted forged products for the high performance components market of the wind power industry. We believe that electro-slag re-melted forged products will be important components in the next generation of larger wind turbines, which will require stronger steel alloy precision forged components than the smaller turbines.

Net cash flow provided by financing activities was $538,000 for the six months ended June 30, 2010 as compared to net cash provided by financing activities of $1,217,000 for the six months ended June 30, 2009. For the six months ended June 30, 2010, we received $1,600,000 from the exercise of warrants offset by the repayment of loans payable of $1,062,000. For the six months ended June 30, 2009, we received proceeds from loans of $1,134,000 and proceeds from the exercise of warrants of $83,000.

Contractual Obligations and Off-Balance Sheet Arrangements

We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, in order to assist in the review of this information within the context of our consolidated financial position, results of operations, and cash flows.

The following tables summarize our contractual obligations as of June 30, 2010 (dollars in thousands), and the effect these obligations are expected to have on our liquidity and cash flows in future periods.

	Payments Due by Period
	Total		Less than 1 year		1-3 Years		3-5 Years		5 Years +
Contractual obligations :
Bank indebtedness (1)	$	1,028	$	1,028	$	-	$	-	$	-

Total	$	1,028	$	1,028	$	-	$	-	$	-

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

Off-balance Sheet Arrangements

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

Foreign Currency Exchange Rate Risk

We produce and sell almost all of our products in China. Thus, most of our revenues and operating results may be impacted by exchange rate fluctuations between RMB and US dollars. For the six months ended June 30, 2010, we had unrealized foreign currency translation gain of $216,083, because of the change in the exchange rate.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not required for smaller reporting companies.

ITEM 4. CONTROLS AND PROCEDURES

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

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

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

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act. Our management is also required to assess and report on the effectiveness of our internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”) on an annual basis. As previously reported on our Form 10-K for the year ended December 31, 2009, management identified significant deficiencies related to (i) the U.S. GAAP expertise of our internal accounting staff, (ii) our internal audit functions and (iii) a lack of segregation of duties within accounting functions.

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

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

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

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

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

Changes in Internal Controls over Financial Reporting

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

PART II - OTHER INFORMATION

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

On May 4, 2010, we issued 43,750 shares of common stock upon cashless exercise of warrants. The issuance of such shares was exempt from the registration requirement of the Securities Act by virtue of Section 3(a)(9) of such Act.

During the six months ended June 30, 2010, we issued 955,000 shares of common stock upon the conversion of 2,865,000 shares of series A preferred stock. The issuance of such shares was exempt from the registration requirement of the Securities Act by virtue of Section 3(a)(9) of such Act.

ITEM 6. EXHIBITS

31.1		Rule 13a-14(a)/15d-14(a) certification of Chief Executive Officer

31.2		Rule 13a-14(a)/15d-14(a) certificate of Principal Financial Officer

32.1		Section 1350 certification of Chief Executive Officer and Chief Financial Officer

SIGNATURES

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

	CHINA WIND SYSTEMS, INC.

Date: August 16, 2010	By:	/s/ Jianhua Wu
		Jianhua Wu, Chief Executive Officer


Date: August 16, 2010	By:	/s/ Ying (Teresa) Zhang
		Teresa Zhang, Chief Financial Officer
		and Principal Accounting Officer