Unassociated Document

10KSB 1 v119804_10ksb.htm Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-KSB

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

For the year ended December 31, 2006

-OR-

o	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 000-26175

CHINA WATER GROUP, INC.

(Name of Small Business Issuer as Specified in its Charter)

NEVADA		88-0409151
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

SUITE 7A01, BAICHENG BUILDING

584 YINGBIN ROAD

DASHI, PANYU DISTRICT

GUANGZHOU, GUANGDONG, CHINA

(Address of Principal Executive Offices)

(86-20) 3479 9768

(Issuer’s Telephone Number, Including Area Code)

Securities registered pursuant to section 12 (b) of the Act:

None

Securities registered pursuant to section 12(g) of the Act:

Common Stock, par value $0.001 per share

(Title of Class)

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. o

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No o

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. o

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

The registrant’s revenues for its most recent fiscal year were $4,797,324.

The aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant as of June 30, 2008 was approximately $2,210,881.

The number of shares of the common outstanding as of June 28, 2008 was 139,217,550.

Documents incorporated by reference: None.

EXPLANATORY NOTE

We, China Water Group, Inc., are filing this Annual Report on Form 10-KSB for the year ended December 31, 2006 during calendar 2008 as an initial step in our efforts to become current in our filing obligations under the Securities Exchange Act of 1934, as amended. We will endeavor to file additional periodic reports to become current in our filings as expeditiously as the limited size of our staff allows. Except where a date after April 2007 is specifically mentioned, this report is written as though it had been prepared during the first four months of calendar 2007.

Unless otherwise indicated, all references to our company include our wholly and majority owned subsidiaries.

All of our sales and nearly all our expenses are denominated in renminbi (“RMB”), the national currency of the People’s Republic of China (the “PRC”). Solely for the convenience of the reader, certain financial information as of and for the years ended December 31, 2005 and 2006 have been converted into United States dollars. Assets and liabilities are translated at the exchange rate in effect at period end. Income statement accounts are translated at the average rate of exchange prevailing during the period. No representation is made that the RMB amounts could have been, or could be, converted into United States dollars at that rate or at any other certain rate as of the respective dates or at any other date.

The statements contained in this report that are not historical are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements, without limitation, regarding our expectations, beliefs, intentions or strategies regarding the future. We intend that such forward-looking statements be subject to the safe-harbor provided by the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things: (1) expected revenue and earnings growth; (2) estimates regarding the size of target markets; and (3) regulation of our industries and markets by the Chinese government. These statements are qualified by important factors that could cause our actual results to differ materially from those reflected by the forward-looking statements. Such factors include, but are not limited to, those risk factors described elsewhere in this annual report.

Part I

Item 1. Description of Business.

We are a waste water engineering company based in the PRC. Through our majority-owned subsidiaries, we are engaged in the design, construction, implementation and management of industrial and municipal waste water treatment facilities throughout the PRC.

We provide turn-key waste water treatment engineering design and contracting. From 2000 to 2006 we completed the following turn-key projects: Yongji Development Zone Wastewater Treatment Plant (Phase 1), Guangdong Nanhai City Jinsha Town Wastewater Treatment Plant, Guangdong Sanshui Baini Wastewater Treatment Plant and Guangzhou Yantang Wastewater Treatment Plant, Tianjin City Meichang Town Wastewater Treatment Plant,Yongji Development Zone Wastewater Treatment Plant (Phase 2), China Environment Industrial Park Wastewater Treatment Plant and Huangzhuang Industrial Park Wastewater Treatment Plant. The following turn-key project is still in process:Tian Jin WuQing No.1 Waste Water Treatment Factory.

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We hold 90% and 35%, respectively, of the equity interest in the following two water treatment facilities operated through build, operate and transfer (“BOT”) arrangements with the PRC government: (i) Tian Jin Shi Sheng Water Treatment Company Limited (“TianJin”), which commissioned water treatment in November 2003 and has a daily treatment capacity of approximately 10,000 tons; and (ii) Xin Le Sheng Mei Water Purifying Company Limited (“XinLe”), which also commissioned water treatment in November 2003 and has a daily treatment capacity of 40,000 tons. We have been retained as the manager to manage both TianJing and XinLe. The fees from XinLe and TianJing did not represent a significant portion of our revenue during 2006.

We also developed a BOT water treatment facility project in Hai Yang City under our subsidiary Hai Yang City Sheng Shi Environment Protection Company Limited (“HaiYang”) with capacity of 20,000 tons per day. We began construction of this project in April 2004 and completed the project and commenced water treatment in June 2005. We also developed another BOT water treatment facility project in Beijing under our subsidiary Bei Jing Hao Tai Shi Yuan Water Purifying Company Limited (“Beijing HaoTai”) with planned capacity of 20,000 tons per day. We began construction of this project in July 2004 completed approximately 90% till December, 2006. We retained a 90% interest in this facility until we disposed of it in December 2006 for a total consideration of US$1,442,567 realizing a gain of US$44,872. See Note 7 of Notes to Consolidated Financial Statements. In July 2005, we started construction of a BOT water treatment facility project for the Handan Fengfeng Mining Area in the Hebei Province under our subsidiary Han Dan Cheng Sheng Water Affairs Company Limited (“HanDan”) with capacity of 33,000 tons per day. The project expected to be completed in second quarter of 2007. The fees from these projects are expected to strengthen our net sales in the future.

Corporate History

Our predecessor in interest, Discovery Investments, Inc. (“Discovery”) was incorporated on September 10, 1996, under the laws of the State of Nevada to engage in any lawful corporate activity. Discovery had been in the development stage and was not active until October 26, 1999.

On December 10, 1999, Discovery entered into a Plan and Agreement of Reorganization (the “Plan”) with LLO-Gas, Inc. and John Castellucci. On October 26, 1999, LLO-Gas had acquired certain ARCO facilities and a so-called card lock facility and commenced operations. LLO-Gas was incorporated in July 1998 under the laws of the State of Delaware. On December 20, 1999, there was a closing under the Plan and LLO-Gas, Inc. became a wholly-owned subsidiary of Discovery and there was a change of control of Discovery. Between December 20, 1999 and August 10, 2000, differences of opinion as to matters of fact and as to matters of law had arisen by and between certain of the shareholders of Discovery, who were shareholders prior to the closing, and between Discovery, John Castellucci and LLO-Gas, Inc.

On June 7, 2000, LLO-Gas, Inc. filed a Voluntary Petition under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court, Central District of California, San Fernando Valley Division, case number SV 00-15398-AG. On December 1, 2000, the United States Bankruptcy Court converted the pending matter into a Chapter 7 liquidation. Said Chapter 7 effected LLO-Gas, Inc. and not Discovery.

On August 10, 2000, Discovery entered into a Mutual Rescission Agreement and Mutual Release with John Castellucci which provided, inter alia, that Discovery consented and agreed to rescind said Plan with John Castellucci consenting and agreeing to the rescission. The parties mutually agreed to forego all rights and benefits provided to each other thereunder.

On August 9, 2001, Discovery filed a voluntary petition under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court, District of Nevada, Case Number BK-S-01-18156-RCJ. On September 24, 2001, the Bankruptcy Court confirmed the Disclosure Statement and Plan of Reorganization submitted by Discovery and Discovery was thereafter released from Bankruptcy.

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On April 29, 2002, Discovery entered into a Plan and Agreement of Reorganization with Bycom Media Inc., an Ontario, Canada corporation (“Bycom”). Pursuant to this agreement, Discovery acquired all the outstanding shares of Bycom for 4,800,000 shares of Common Stock. On October 5, 2002, Bycom became a wholly-owned subsidiary of Discovery and there was a change of control.

Bycom was engaged in multimedia applications for internet-based business. Utilizing business search tools and databases, Bycom intended to be able to locate and access global business information for a fee, or was to act as an “out-source provider” of information. Bycom currently is an inactive, wholly owned subsidiary of the Company.

On September 4, 2002, Discovery completed a transaction set out in a Plan and Agreement of Reorganization dated June 13, 2002, pursuant to which Discovery acquired all of the outstanding shares of Cavio Corporation, a Washington corporation, (“Cavio”) in exchange for 14 million share of Discovery common stock. Due to poor market conditions and Discovery’s inability to seek adequate financing from third parties to properly finance the operations of Cavio, on December 2, 2002 Discovery’s board of directors approved, subject to receiving the approval of a majority of the shareholders, to unwind the acquisition of Cavio in cancellation of the shares of common stock issued.

On December 2, 2002, Discovery unanimously approved the disposition of its interest in Cavio and thereafter received the consent of a majority of the outstanding shares of the company’s common stock. Discovery determined the effective date for the divestiture to be June 30, 2003.

For the two years prior to a reverse acquisition in September 2004, we had not generated significant revenues and were considered a development stage company as defined in Statement of Financial Accounting Standards No. 7. We were seeking business opportunities or potential business acquisitions. Pursuant to a securities purchase agreement and plan of reorganization dated September 9, 2004, as amended, between our company, Evergreen Asset Group Limited, an International Business Company organized under the laws of the British Virgin Islands (“Evergreen” or “EGAG”), and the stockholders of Evergreen, we acquired 100% of the issued and outstanding shares of Evergreen’s capital stock. We issued 83,500,000 shares of our common stock in exchange for all the 300 issued and outstanding shares of Evergreen capital stock which had an estimated value of $4.24 million at the time of such issuance, valued based on the fair market value of the net assets of Evergreen. Since the stockholders of Evergreen acquired approximately 83.5% of our outstanding shares and the Evergreen management team and board of directors became the management team and board of directors of our company, according to FASB Statement No. 141 - “Business Combinations”, this acquisition has been treated as a recapitalization for accounting purposes, in a manner similar to reverse acquisition accounting. In accounting for this transaction:

•

Evergreen is deemed to be the purchaser and surviving company for accounting purposes. Accordingly, its net assets are included in the balance sheet at their historical book values and the results of operations of Evergreen have been presented for the comparative prior period;

•

Control of the net assets and business of our company was acquired effective October 15, 2004. This transaction has been accounted for as a purchase of the assets and liabilities of our company by Evergreen. The historical cost of the net liabilities assumed was $0.00.

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As a result of the transaction described above we changed our name from Discovery Investments, Inc. to China Evergreen Environmental Corporation.

Due to the reverse acquisition mentioned above, EGAG, pursuant to a group reorganization which was completed in July 2004, acquired 90% equity interests in each of XinXingmei, XianYang, HaiYang and BeijingHaoTai for cash consideration of RMB12,601,000 (approximately $1,521,860), RMB18,000,000 (approximately $2,173,913), RMB2,700,000 (approximately $326,087) and RMB1,800,000 (approximately $217,391) respectively, all of which are domestic incorporated companies established in the PRC with limited liability.

In March 2003, GDXS entered into a BOT agreement with Xian Yang City Environment Protection Bureau. The BOT agreement was later transferred to Xian Yang Bai Sheng Water Purifying Company Limited (“XianYang”), after XianYang was incorporated. The construction of the wastewater plant of XianYang started in the beginning of 2004. Due to the group reorganization in July 2004, 90% of GDXS’s interest in XianYang was transferred to EGAG. In October 2004, EGAG entered into a tri-party framework agreement with True Global Limited (“TGL”), an independent party and Guang Dong Xin Sheng Environmental Protection Company Limited (“GDXS”) for the disposal of its 90% interest in XianYang to TGL at a total consideration of $13,246,377. A gain on disposal of $5,220,299 was recorded in 2004 for the disposal of our entire 90% attributable interest in XianYang to TGL.The gain represents the difference between the disposal proceeds and our attributable share of net assets of XianYang at the date of disposal.

In April 2005, we conducted a private placement of 20 investment units, at $25,000 per unit, for gross proceeds of $500,000. Each unit consisted of (a) one 12% convertible debenture in the original principal amount of $25,000, convertible into shares of our common stock at the rate of the lesser of (i) $0.20 per share or (ii) a 10% discount to the price per share of common stock (or conversion price per share of common stock) of the next private placement conducted by us prior to any conversion of the debenture, and (b) 125,000 detachable warrants to purchase one share each of our common stock at an exercise price of $0.20 per share, expiring ten years from their date of issuance. The debentures were due and payable August 1, 2005. The debenture holders, however, extended the payment period to September 30, 2005. We granted the investors limited registration rights for the common shares underlying their debentures and warrants. Westminster Securities Corporation acted as placement agent for this offering on our behalf. All the debenture holders have converted the debentures into 3,703,701 shares of our common stock on October 1, 2005.

On November 7, 2006, China Evergreen Environmental Corporation changed its name to China Water Group, Inc. to reflect its focus on China’s water treatment and supply needs and on build-operate-transfer(BOT), Transfer-operate-transfer(TOT), and turnkey wastewater treatment facilities in China, at the same time, bottled water is considered.

Our executive offices are located at Suite 7A01, Baicheng Building, 584 Yingbin Road, Dashi, Panyu District, Guangzhou, Guangdong, China; telephone number (86-20) 3479 9768.

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Our Business

General

Our business was originally established in 1999 by our Chairman, Mr. Chong Liang Pu, with a focus on developing innovative biochemical technologies and processes for waste water treatment. We have the exclusive rights to MHA biological treatment processes technologies (“MHA”) and GM Bio-carriers. Both are the subject of patents owned by our Chairman, Mr. Pu, and we have acquired the exclusive rights pursuant to a license agreement with Mr. Pu. Both technologies were developed to improve the efficiency and effectiveness of waste water treatment processes and reduce the initial investment and on-going operating cost of waste water treatment facilities.

We have applied biotechnological processes to waste water treatment and have developed relationships with the PRC environmental authorities at both national and provincial levels throughout the PRC. Since 2000, we have successfully completed the design and construction of over 14 waste water facilities across China with total daily capacity of over 120,000 tons (inclusive of three BOT waste water treatment facilities with daily capacity of 70,000 tons). Our customers include municipal governments, food processing and beverage companies and industrial companies.

Because of these achievements, we have been recognized as a “Key Enterprise in Environmental Industry in the PRC” by the General Bureau of Environmental Protection of China and are viewed as a “High-Tech Enterprise” by the Bureau of Science and Technology of Guangzhou, PRC.

Industry Background

Waste Water Treatment Markets in the PRC. The waste water treatment business is in a developmental stage in China. Following decades of rapid industrialization and urbanization resulting from PRC’s breakneck economic expansion, demands for urban and industrial waste water treatment are immense. In 2002, total volume of municipal and industrial waste water produced reached 23 billion and 26 billion tons, respectively, of which only approximately 25% was treated in some form. The PRC government, which views environmental issues as a policy priority, has targeted a 90% treatment ratio by 2030. This targeted growth, combined with a policy of privatizing all existing government facilities, is resulting in extraordinarily high levels of expansion in an industry that did not effectively exist until the 1980s.

In order to promote investment in the waste water treatment industry, the central government has created incentives such as tax relief and higher throughput fees which can improve the profitability of certain municipal projects.

Under the tax regulations in the PRC, companies providing water purification are exempted from business tax on the collection of waste water treatment fees. The PRC government also gives tax relief in the form of reduction in or exemption from value-added tax and income tax to encourage treated water to be reused in residential, agricultural, commercial or industrial sectors.

The PRC government introduced a new policy in relation to the water supply tariff management methods for the water-resource system which became effective in January 2004. The new policy prescribes a water tariff approach, comprising of water production costs, expenses, profit, and tax. Pertinent pricing is expected to be in accord with local market demand.

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Before the 1990s, water tariffs were extremely low, and there were no wastewater discharge fees. People were more concerned with water quality than with the price and quantity they used. As citizens now pay closer attention to water quality, they expect higher prices to accompany water quality improvements. Therefore, water tariff and wastewater treatment throughput fees, especially in the cities, are rising to rational levels.

Fresh Water Markets. Before 2003, the facilities for fresh water supply in the PRC were owned and operated by the agencies of local governments. As industrial, economic and population growth and chronic pollution have placed intense demands on the water supply in China, the fresh water supply has had a serious shortage. Similar to the waste water treatment industry, the PRC government has opened up the fresh water supply business to private sector and international operators.

Our Business Activities

There are different types and quantities of pollutants in water due to the environment, conditions and purpose for which the water is used. Municipal water has organic matters including nitrogen and phosphorus. The composition of such municipal wastewater is relatively stable. In contrast, pollutants in water discharged from industries include organic pollutants, inorganic matters, metal ions and salt ion. We adopt varying treatment processes for different industrial wastewater.

We provide turn-key engineering, equipment and chemical sales for industrial and municipal waste water treatment facilities in the PRC. We also invest in, manage and operate our own water treatment facilities through BOT arrangements in the PRC.

The following chart describes the waste water treatment process that we service:

Turn-Key Waste Water Engineering. We provide turn-key waste water treatment engineering services to both public and private sectors. Our public sector clients include municipal governments at the city, district and town levels. Our private sector clients include heavy industries, such as steel, car manufacturing, electronic; light industries, such as chemical, food and beverage, paper, printing and breweries; and others, including hospitals and the pharmaceutical industry. The industrial wastewater qualities differ due to the different industrial products and manufacturing processes.

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These contracts are awarded either by public tender or by direct contract. A typical turn-key waste water treatment project can be classified into three phases; (1) survey and design, (2) construction and equipment installation, and (3) operation and management services.

From 2000 to 2006, we completed the following turn-key projects: Yongji Development Zone Wastewater Treatment Plant (Phase 1), Guangdong Nanhai City Jinsha Town Wastewater Treatment Plant, Guangdong Sanshui Baini Wastewater Treatment Plant and Guangzhou Yantang Wastewater Treatment Plant, Tianjin City Meichang Town Wastewater Treatment Plant,Yongji Development Zone Wastewater Treatment Plant (Phase 2), China Environment Industrial Park Wastewater Treatment Plant and Huangzhuang Industrial Park Wastewater Treatment Plant. The following turn-key projects are still in process:Tian Jin WuQing No.1 Waste Water Treatment Factory. The following table sets forth the company’s turn-key projects which are still in process:

Name of New Turn-key Project		Project value			Capacity/Per Day			Date of commencement of construction
Tianjin City WuQing No.1 Wastewater Treatment Plant		US $	1.03 million			10,000 tons			Commenced in September 2006

As of December 31, 2006 we had completed approximately 38% of Tianjin City WuQing No.1 Wastewater Treatment Plant.

We financed our turn-key projects through progressive payments from our customers as stipulated in the agreements for these projects.

Investment in BOT Waste Water Treatment Facilities. We also invest in waste water treatment facilities through BOT arrangements. BOT projects provide us with a stable income source under a long-term (usually 20-30 year) contract granted by municipal governments to build and operate waste water plants. BOT project land is typically contributed by the municipal government with the operator providing investment and daily management. After the contract period, the project is transferred to the local government. After we secure a contract for a BOT project from a municipal government and the financing for such project is in place, we will proceed to construct the facility. After the completion of construction and testing and commissioning, we will operate the waste water treatment facility for a period of 20-25 years as stipulated in the BOT contract.

The following table sets forth the BOT projects which we have completed or are in process of completing:

BOT Projects

Cost of

investment

Capacity/

Per Day

Operation

Period

Date of

commencement of

operation

Waste water treatment plant of TianJing

US $

1.09 million

10,000 tons

20 years

November 2003

Waste water treatment plant of XinLe

US $

4.11 million

40,000 tons

22 years

October 2003

Waste water treatment plant of HaiYang

US $

3.62 million

20,000 tons

22 years

June 2005

Waste water treatment plant of HanDan

US $

3.53 million

33,000 tons

22 years

Operation expected to commence in second quarter of 2007

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As of December 31, 2006, the waste water treatment plants of TianJin, XinLe and HaiYang were operational and have been providing waste water treatment services. The waste water treatment plant of HanDan is still in the stage of testing and commissioning .

We have been financing the BOT projects of TianJing, XinLe and HaiYang through capital injections and funds generated from our operations. We will finance the remaining capital expenditure of HanDan of approximately $2 million through funds generated from our operations.

Our Production Process

Though the chemicals used for treating municipal and industrial wastewater qualities are different due to the different sources of wastewater for municipal wastewater treatment and different industrial product and manufacturing process for industrial wastewater treatment, the treatment processes are largely similar.

During the wastewater treatment process, the wastewater is first collected by a pipeline network system and then transported to a sand sedimentation pool. The wastewater will then go through the MHA waste water treatment process, which is a natural, chemical-free, biological and mineral-based process that facilitates the rapid growth of bacteria in order to improve the efficiency of degrading the micro-organism materials in the wastewater and for more efficient operation and reduced energy consumption. After the MHA waste water treatment process, the wastewater is then transported to the sedimentation pool to remove the fine particles in the wastewater. The wastewater will then be sterilized in the sterilization pool and be transported to the water outlet.

Our Project Management Process

The following is the flow chart of our project management process for both turn-key wastewater engineering projects and BOT projects:

Market Intelligence. The starting point for all our projects is market intelligence so that our management is able to decide which projects they wish to secure for the benefit of the company. Our marketing personnel are in charge of market information on potential projects on a regular and ad-hoc basis. Our management is able to identify and decide on projects which we may potentially bid for.

Project Tracking. Based on the information gathered through market intelligence and the subsequent comprehensive analysis conducted on such information, our management will decide on which projects to pursue. We carry out internal evaluations which consist of three steps: initial evaluation, revaluation and valuation by professionals. We also engage external advisors to carry out external evaluation. We will then embark on determining what the tender rules and conditions are and the capital requirements and technologies used for the project. Project tracking allows us to plan ahead and make the necessary cost planning.

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Tender Process. Once we decide to proceed to tender for a particular project, we will form a tender committee comprising marketing personnel and technical personnel, who will be responsible for compiling the tender documents to be submitted for tender within the stipulated deadline. The tender committee will compile internal costing and budgetary estimates of labor and material costs based on quotations from the relevant suppliers and factor in a suitable profit margin in determining our tender pricing.

Design and Development. After signing of the contract, we will appoint a project team to be responsible for the execution of the project, including an ad-hoc research and development team to handle the design and development of that particular project. The research and development team will follow our overall guidelines to analyze, assess and determine the design and specifications of a system which will ensure that all of our customers’ requirements are met. The design and development process includes collection of information, site survey, key design concept, design specification, individual design, evaluation, revaluation and issue for construction. In addition to our own design and development capabilities, we have also entered into collaboration arrangements with other parties to test our equipment to ensure its suitability and effectiveness.

Procurement. After the necessary design and analysis, the specifications of the system are confirmed, and our procurement department will proceed to purchase all the materials and equipment required or appoint appropriate sub-contractors to carry out certain parts of the project.

Construction. The construction process includes sub-contracting and site supervision. During construction, we will send site representatives to control and supervise the construction.

Assembly and Installation. We will carry out assembly and installation of equipment and/or system and coordinate the assembly and installation fully with the construction process to ensure all equipment and/or system are properly assembled and installed. We will send technical staff to assist and guide the assembly and installation.

Testing. After the equipment and/or system has been assembled and installed, we will test the system in accordance with industrial and national rules and regulations formulated by the relevant PRC authorities.

Commissioning and Fine-Tuning. For turn-key projects, should the system pass all tests, we will proceed to hand over the system to our customers. 5%-10% of the total contract value will be treated as retention monies during the warranty period of up to 12 months requirement. Our technical personnel will carry out fine-tuning and on-site services. After successful commissioning of the entire system, the retention monies will be paid by our customers to us after the warranty period of up to 12 months. For BOT projects, the plant will start operation after passing all tests. The technical team will carry out fine-tuning and on-site services. The operation team will follow the operational guidelines and monitor the quality of treated water.

Competition

We believe our main competitor is Beijing Capital Co., Ltd. (“Beijing Capital”), a subsidiary of Capital Group, which has identified investment, development, operation and management in the PRC water industry as its core business. Beijing Capital provides environment management services. We also compete with some other environmental and water treatment companies. We believe that we compete primarily on the basis of contract pricing. Though many of our competitors offer similar but less cost-effective services, they may have greater financial resources and hence be able to secure contracts with reduced operating margins but more competitive pricing. However, we believe that as a result of our cost efficiency through our patented technologies, we are able to offer even more competitive pricing. In addition, having access to the capital markets in the United States through our public listing will help to differentiate us from our competition. Another area of competition comes from local protectionism where local governments wish to protect local environmental businesses. In order for us to overcome this kind of competition, we rely on our financial and technical resources.

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Our Competitive Strengths

Key elements of our competitive strengths include:

Capital Resources. The threshold of capital requirements for entering the waste water treatment segment and the initial capital investment of waste water treatment facilities and projects, especially BOT projects, is relatively high. Based on our good track record and relationships with local governments in the PRC, we believe we are capable of obtaining sufficient capital resources to fund our operation of projects and expansion plan.

Experienced Management Team and Strong Research and Development Capability. We have a qualified and experienced management team and staff who possess strong technical capabilities and who specialize in project management, project design and research and development in relation to the water purification and wastewater treatment industry. Among our senior management, most possess degrees or senior technical qualifications. Members of our senior management team also have prior experience in managing large corporations and are familiar with all levels of management. Most of our management and staff have strong technical expertise and are professionally trained.

We place great emphasis on technical research and development, and typically set up research and development teams for specific projects to handle the design, development and improvement of such projects.

We also keep track of the latest developments in water treatment technology through our advisors and consultants who are experts in the water purification and waste water treatment industry. We have established a long-term cooperation with the Chinese Academy of Science at Guangdong and a number of universities to maintain its superiority in developing innovative wastewater treatment technology.

We believe that our management experience and our strong technical capabilities provide us with a competitive edge over our competitors.

Good Track Record and Professional Quality. We believe that our good track record and goodwill that we have built up in the provision of water treatment systems for the municipal government and industrial waste water treatment give us an edge over our competitors. Due to our strong track record, we have been awarded various certifications by different environmental institutions, including certifications of Quality Facility for Environmental Protection, Gold Price of 2^nd Chinese Patent Technology Fair, World Chinese Scientific and Technology Invention Prize, certificates of “Quality Branded Environmental Protection” and “Asia International Scientific and Technology Improvement Prize”. These certificates typically strengthen our ability to tender for BOT projects with the municipal government and also turn-key projects for industrial waste water treatment.

Effective Market Network. We emphasize the importance of marketing and have people specialized in promotion of our company and securing projects. We have marketing networks in Shangdong, Tianjin, Beijing, Handan Hebei, Xianyang Shangxi and Guangdong, where we have BOT projects. Such offices provide feedback on market intelligence and deal with existing and potential customers. Project selection is partially based on intelligence feedback from these networks. We retain a team of former senior government officials with considerable influence on local and central governments in the PRC. We identify this team through introduction and conferences/conventions that we attend. This team identifies and helps to secure major environmental projects for the group. The team also provides timely feedback of market conditions and deals with our existing and potential customers regularly. Though we do not have any contract with this team, we give incentives/commissions for each successful project secured.

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Long-Term Relationships with Academic Institutions. We have good long-term relationships with Guangdong Province Environmental Protection Design Institute and North-Eastern Environmental Protection Design Institute, who provide important technical support in design and project execution. North-Eastern Environmental Protection Design Institute will provide technical support in the design of waste water treatment facilities and preparation for the tendering of projects while Guangdong Province Environmental Protection Design Institute will evaluate the feasibility and acceptability of the blue prints of the facilities. Compensation for both institutions are based on amount of work done.

Customers, Sales and Marketing

Many of our principal customers are local governments, food and beverage processing companies and industrial companies that use our technologies to treat their waste water.

In 2006, the Group’s major customers are Beijing Jinqiao Luyuan Environment Protection Investment Development Company Limited and The Management Committee of Yongji Economic Development Zone, both independent third parties, which, accounted for approximately 48.6% and 22.9%, respectively, of the Group’s total revenue of 2006. Revenue from Beijing Jinqiao Luyuan Environment Protection Investment Development Company Limited was in relation to the turnkey engineering project of China Environment Industrial Park Wastewater Treatment Plant while revenue from The Management Committee of Yongji Economic Development Zone was for the turnkey engineering project of Yongji Development Zone Wastewater Treatment Plant (Phase 2).

We market and sell our products through our direct sales force and independent sales representatives throughout the PRC. Our sales and marketing team is responsible for evaluating the marketplace, generating leads and creating sales programs. We use a “Project-Company” strategy for each BOT project, establishing a company in the location of the project, responsible for construction and operation of the project. Through establishing a good relationship with the local government, the Project-Company markets its business in the location. Our on-site direct service organization provides ongoing services to customers using our products.

In order to compete effectively, we focus on projects of a scale between 10,000 tons and 50,000 tons of waste water per day, where we can achieve a balance between economies of scale arising from our technology and our available capital base.

Research and Development

Our research and development efforts are directed toward enhancing our existing technology and products and developing our next generation of technology.

We have the exclusive rights to MHA biological treatment processes technologies (“MHA”) and GM Bio-carriers. Both are the subject of patents owned by our Chairman, Mr. Pu, and we have acquired the exclusive rights pursuant to a license agreement with Mr. Pu. We have applied both technologies to improve the efficiency and effectiveness of waste water treatment processes as well as to reduce the initial investment and on-going operating cost of waste water treatment facilities. The advantages of MHA are:

	•	Proprietary design of water flow control mixer to ensure even distribution of waste treatment bacteria in the treatment facility.
	•	Proprietary design of no-oxygen, low-oxygen and oxygen tanks to reduce energy consumption and ensure low sludge build up in the treatment process.

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•

Proprietary blend of waste water treatment bacteria (i.e., photosynthetic, lactobacillus, yeast, streptonyces, etc.) of over 50 types of different degradation and effectiveness to achieve toxic, aromatic and micro-organism-free water of release.

We have spent approximately $85,500 and $77,500 on research and development activities during the fiscal years ending December 31, 2006 and 2005, respectively.

GM Bio-carrier is a natural, chemical-free, biological and mineral-based process that facilitates the rapid growth of bacteria in order to improve the efficiency of degrading the micro-organism materials in the waste water. Installation of such carriers into the waste treatment process facilitates bacterial growth for more efficient operation and reduced energy consumption.

Currently we are developing technology with universities and research institutions in Guangdong Province and have on staff a chief scientist, who is a researcher in the field of environmental protection, and two research fellows. We are planning to invite additional experts in the waste water treatment field to join our company. The technology that we are developing with these universities and research institutions is for the improvement of quality of treated water, increase in efficiency, reduction in costs in the waste water treatment process and to further enhance the current technologies that we have.

Quality Control

Our quality control department is headed by Ying Mo Zhang, who has more than 30 years of relevant experience. Mr. Zhang has been an engineer and a general manager at several companies, and Vice Chairman of our company, and he is familiar with resource allocation, quality control and environmental facility management control.

To ensure the quality of our products and services, we carry out stringent quality control checks at every stage of project execution.

Quality Control During Design, Research and Development. The design of every project is carried out by our experienced staff following strict guidelines. We have also established a three-tier examination and verification system. A strict examination and approval system is also adopted in respect of any design changes.

Quality Control During Procurement. To ensure the quality of equipment and materials procured, we maintain a list of suppliers and sub-contractors whose goods and services meet our quality control standards. We purchase our materials and equipment only from these suppliers, and such materials and equipment are subject to further inspection and checks by our quality control staff upon arrival at our production facilities. Goods which do not meet our quality control standards are rejected.

Quality Control During Assembly and Integration. As a general policy, our sub-contractors selected and appointed by us to carry out engineering, assembly and integration works should be long established and have good track records.

Quality Control During Delivery and Installation. To ensure that our qualified sub-contractors comply with our quality control standards during delivery and installation, we also task our engineers with formulating a quality control and progress plan, and to identify the key quality control points of the delivery and installation procedure. Such engineers will supervise our sub-contractors during delivery and installation.

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Quality Control During Operation for BOT Projects. Our operation team starts their training prior to the commencement of operation. After test run and commissioning, the operation team will take over the operation. We have very strict guidelines for the operating team to ensure quality of clean water. A production report is to be faxed to the head office everyday and we will perform regular tests to ensure the treated water meet high quality standard. We also conduct regular training to ensure that our operation teams are equipped with the latest know-how.

Cooperative Partners and Suppliers

We outsource the design and construction of our subsystems to a number of cooperative partners and key suppliers and maintain close relationships with them. Our cooperative partners include North-Eastern Environmental Protection Design Institute, Guangdong Province Environmental Protection Design Institute, and the 20^th Group of China Railway Company. We have signed cooperative agreements with these cooperative partners. North-Eastern Environmental Protection Design Institute provides technical support in the design of waste water treatment facilities and preparation for the tendering of projects, 20^th Group of China Railway Company evaluates all documents and information required for tendering while Guangdong Province Environmental Protection Design Institute evaluates feasibility and acceptability of the blue prints of the facilities. Compensation for our cooperative partners are based on amount of work done.

North-Eastern Environmental Protection Design Institute was established in 1961 in the city of Changchun. The institute focuses on design of, research in and provision of consultancy services for municipal infrastructure construction works including water supply, waste water treatment, waste treatment, energy supply, construction of road and bridges, public transport and afforestation of city etc. The institute also provides other services in relation to civil construction works for municipal projects like feasibility studies for projects, evaluation of projects, project management and project supervision.

The Guangdong Province Environmental Protection Design Institute was established in 1990. Over the years, the institute has gained experiences in the design, management, treatment and turn-key engineering of waste water, air pollution, noise pollution and waste residue. The institute has achieved remarkable results especially in waste water treatment for the printing and dyeing, electroplating, brewing, pharmaceutical, chemical and food & beverages industries.

The 20^th Group of China Railway is a large-scale construction company in the PRC. The history of the 20^th Group of China Railway dated back to the year 1949. The company has enormous experience in the construction of railway systems in the PRC and related infrastructure including road construction, water supply, energy supply, waste water treatment, urban and rural planning, municipal projects etc. The company is also involved in many large scale construction projects overseas.

There are three main types of equipment for our waste water treatment and potable water projects: (i) electrical equipment which includes various types of sewage pumps, slush pumps and other water pumps, separators, sludge scrapers, mixers, air compressors, filters, dehydrators, blow fans, etc; (ii) automated control systems and electrical parts; and (iii) various test, analysis, detection and monitoring instruments. All purchases from foreign companies are made through their authorized dealers/agents in the PRC. We adhere closely to the principles of total quality management. Our customers, suppliers and employees are encouraged to provide feedback and suggestions for improvements in products and services.

The following table sets forth our major suppliers of equipment and materials:

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Component, Raw Materials and Equipments		Our Major Suppliers
Waste water treatment analytical instruments		Hach Company

Blow fan systems		HV-Turbo A/S

Sewage pumps, slush pumps, other water pumps and mixers		Nanjing Airs Pump Industry Group

PLC automated control systems		Mitsubishi Electric

Electrical parts		Schneider Electric Low Voltage (Tianjin) Co.

Automated systems		GuangZhou SaiDi Automated Engineering Company

Intellectual Property

We seek to protect our intellectual property by way of our license rights to patents on proprietary features of our advanced bio-chemical treatment technology and processing systems for waste water treatment and by challenging third parties that we believe infringe on our licensed patents. We have obtained the exclusive right to use two patents owned by our Chairman, Mr. Pu, for our MHA and GM Bio-carriers technologies. We also protect our intellectual property rights with nondisclosure and confidentiality agreements with employees, consultants and key customers.

Specifically, we have registered the following patents with the State Intellectual Property Office of the PRC:

•

MHA biological treatment process technology (PRC Patent No. ZL 01 1 07637.2) applied on March 14, 2001, declared effective on March 3, 2004 with a duration of 20 years from the date of application; and

•

GM Bio carriers (PRC Patent No. ZL 01 1 07624.0) applied on March 8, 2001, declared effective on September 10, 2003 with a duration of 20 years from the date of application.

Employees

As of March 29, 2007, we had 48 employees, of whom 8 were engaged in sales, marketing and service, 9 in research, development and engineering, 15 in finance and administration and 16 in operations. None of our employees is represented by a collective bargaining agreement, and we believe that we have satisfactory relations with our employees.

Environmental

One of our core values is protecting the environment in which we operate and the environment in which our equipment operates. Compliance with laws and regulations regarding the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had any material effect on our capital expenditures, earnings or competitive position. We do not anticipate any material capital expenditures for environmental control facilities in 2007.

Regulation

The PRC’s numerous ongoing water reforms are moving toward a user-pay, market-driven sector. Legislation serves as the basis to regulate and enforce these reforms. The Water Resource Law, amended and put into effect on October 1, 2002, significantly changes water resource management systems, water resource protection, water conservation, and legal responsibilities.

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Environmental Laws and Regulations

In the PRC, environmental laws and regulations are stipulated and implemented through legislation and through administrative authorities at various levels of government. Current environmental laws and regulations can be classified into two categories: environmental management and environmental pollution prevention and control. All environmental laws and regulations are stipulated on the basis of the Environmental Protection Law (EPL). EPL, effective in December 1989, sets the framework for environmental management and pollution control legislation in the PRC.

Environmental Management Law and Regulation. The PRC’s environmental management measures include environmental impact assessment (EIA), the Three Synchronies Policy, permitting requirements, and reporting requirements. Each of these is described below:

Environmental impact assessment. The 1989 Environmental Impact Assessment Law was revised in October 2002. These revisions became effective in September 2003 and apply to all construction projects that may negatively impact the environment. An EIA must be prepared during the project feasibility stage to assess the project’s environmental impact. EIA approval is necessary to secure a construction and operating permit.

Three Synchronies Policy. Article 26 of the EPL defines the Three Synchronies Policy as the installation of pollution prevention and control facilities in a construction project to be undertaken concurrently with the main construction phase. The pollution prevention and control facilities are to be installed and commissioned only after they are inspected and approved by the Environmental Protection Bureau (EPB).

Permitting requirements. Pollution discharges in the PRC are subject to registration and permitting requirements. The EPL defines requirements for pollution discharge registration and permits. Pollution discharges must be registered with the relevant environmental authority. A pollution discharge permit is issued after registration. The Management Regulation on the Registration of Discharged Pollutants, issued by the State Environmental Protection Administration (SEPA), effective Oct. 1, 1992, details requirements for pollution discharge registration. At the state level, the Department of Pollution Control under SEPA implements pollution discharge registration and permitting policies. Pollution control departments under local EPBs are in charge of the registration procedures and issue a pollution discharge permit.

Reporting requirements. According to Article 31 of the EPL, any organization that causes or has a potential to cause an accident resulting in environmental pollution must promptly take measures to prevent and control the pollution hazard and notify the relevant authorities. In addition, enterprises and institutions that have a greater likelihood to cause severe pollution accidents must adopt effective pollution prevention measures.

Environmental Pollution Law and Regulation. Environmental pollution prevention and control measures in the PRC apply to various environmental media, including water, water supply, wastewater discharge, air emissions, hazardous waste management, noise, and soil and groundwater. In November 2004, the management rules regarding environmental pollution prevention facilities operation permit was enacted and it set forth the requirements for getting a permit and how the facilities must be operated.

The following is a summary of environmental pollution laws and regulations regarding water, water supply and waste water discharge in the PRC:

Three laws apply to the water sector:

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The Water Resources Law emphasizes the uniform management of river basins and the macro-management of water distribution and consumption. In addition, the law identifies a water quality management system.

The 1984 Water Pollution Prevention and Control Law (WPL) applies to discharges to rivers, lakes, canals, reservoirs, and groundwater. The WPL contains sections pertaining to water quality and discharge standards, pollution prevention, surface water, and groundwater. Amendments in 1996 introduced further controls on river basins, including requirements for cities and towns to establish central sewage treatment plants and to set treatment fees, mass-loading controls, provisions for strengthening the supervision and management of water pollution, and non-point-source pollution controls.

The Implementation Regulation of Water Pollution Prevention and Control Law was enacted on March 20, 2000. This law regulates the supervision and management of surface and ground water pollution, prevention, and control measures.

Water supply. In urban areas, water is usually supplied by the municipal water utility companies, which are responsible for ensuring that water quality complies with the National Drinking Water Standard (GB5749-85). A groundwater abstraction permit is required if any company intends to use groundwater directly. In the northern part of the PRC, however, the use of groundwater is strictly controlled because of significant water shortages and ground settlement issues. Users must apply to provincial or higher level administrative committees for a groundwater abstraction permit.

Wastewater discharge. Two types of wastewater discharge systems are defined in the PRC: (1) polluted wastewater discharges (typically industrial and domestic wastewater) and (2) non-polluted wastewater discharges (for example, storm water). Separate drainage systems for polluted and non-polluted discharges are required for a facility in which a municipal sewer system is available.

Environmental Enforcement

In the PRC, methods of enforcing environmental legislation include discharge fees, surcharge fees, fines, and administrative sanctions. Pollutant discharge activity is subject to a discharge permit, which must be registered and obtained before the pollutants are generated.

In major pollution control areas, such as Shanghai and Beijing, mass-loading targets are established and allocated to major emission facilities by the local EPB. In some pilot locations, emission quotas can be traded among facilities.

In areas with significant pollution problems, such as those impacted by sulfur dioxide emissions, acid rain, and water quality deterioration, specific discharge limitations are adopted to prevent further degradation.

There are specific items within the Constitution of the People’s Republic of China and the PRC Criminal Law to strengthen the enforcement of environmental legislation by disciplinary sanction, civil liability, and even criminal liability. Disciplinary sanctions may come in the form of a warning, a fine, a requirement to install environmental protection equipment, or a requirement to cease operations. Criminal liability can also be passed on to the legal representative of an enterprise if the polluting activity caused severe damage to property, health, or interests of the state or its citizens. In these cases, the individual deemed responsible may be prosecuted. Civil liability also exists and is aimed at activities that may result in civil disputes. Generally, the dispute may be settled through financial compensation by the facility that caused the damage.

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Risk Factors

We make written and oral statements from time to time regarding our business and prospects, such as projections of future performance, statements of management’s plans and objectives, forecasts of market trends, and other matters that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements containing the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimates,” “projects,” “believes,” “expects,” “anticipates,” “intends,” “target,” “goal,” “plans,” “objective,” “should” or similar expressions identify forward-looking statements, which may appear in documents, reports, filings with the Securities and Exchange Commission, news releases, written or oral presentations made by officers or other representatives made by us to analysts, stockholders, investors, news organizations and others, and discussions with management and other representatives of us. For such statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Our future results, including results related to forward-looking statements, involve a number of risks and uncertainties. No assurance can be given that the results reflected in any forward-looking statements will be achieved. Any forward-looking statement made by or on behalf of us speaks only as of the date on which such statement is made. Our forward-looking statements are based upon assumptions that are sometimes based upon estimates, data, communications and other information from suppliers, government agencies and other sources that may be subject to revision. Except as required by law, we do not undertake any obligation to update or keep current either (i) any forward-looking statement to reflect events or circumstances arising after the date of such statement, or (ii) the important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or which are reflected from time to time in any forward-looking statement which may be made by or on behalf of us.

In addition to other matters identified or described by us from time to time in filings with the SEC, there are several important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or results that are reflected from time to time in any forward-looking statement that may be made by or on behalf of us. Some of these important risk factors, but not necessarily all important factors, include the following:

We are dependent on the state of the PRC’s economy as all of our business is conducted in the PRC. All of our business operations are conducted in the PRC and all of our customers are also located in the PRC. Accordingly, any significant slowdown in the PRC economy may cause the waste water treatment industry to reduce expenditure or delay the building of new facilities or projects for waste water treatment. This may in turn lead to a decline in the demand for our products and services, and may reduce our profitability and the return on your investment.

We may not be able to secure new customers. Our business is project-based, though our BOT projects customers are bound to us for the contractual periods of twenty to twenty five years, our other customers are non-recurring customers and we do not expect them to continue to be our customers because of the nature of the industry. If we fail to secure projects from new customers, our revenues and profitability may decline and the return on your investment may be reduced.

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Our business could be affected by cost overruns, project delays and/or incorrect estimation of project costs. As our business is project-based, it is important that we manage our projects efficiently in terms of time, procurement of materials and allocation of resources. If our initial cost estimates are incorrect or delays occur in a project resulting in cost overruns, the profitability of that project will be adversely affected. Currently, we offer some of our customers a warranty period of up to 12 months after the commissioning of the water treatment projects, during which we are obliged to provide free rectification work against any manufacturing defects. Cost overruns due to additional rectification work and delays in completion of projects would adversely affect our profitability. We may also face potential liability from legal suits brought against us by our customers for causing loss due to any delay in completing a project. Mismanagement of or mistakes made during our projects will adversely affect our profitability as well as our reputation among our customers. We may also face potential liability from legal suits brought against us by our customers who have suffered loss due to such mismanagement or mistakes. This would also reduce our profitability and the return on your investment.

Failure to retain services of key personnel will affect our operations and results. Our success to date has been largely due to the contributions of our executive officers. The continued success of our business is very much dependent on the goodwill that they have developed in the industry over the past several years.

Our continued success is dependent, to a large extent, on our ability to retain the services of our executive officers. The loss of any of our executive officers’ services due to resignation, retirement, illness or otherwise without suitable replacement or the inability to attract and retain qualified personnel would affect our operations and may reduce our profitability and the return on your investment.

We may not be able to protect our processes, technologies and systems against claims by other parties. Although we have two registered patents in respect of the processes, technologies and systems we use frequently in our systems, we have not purchased or applied for any patents other than these as we are of the view that it may not be cost-effective to do so. For such other processes, technologies and systems for which we have not applied for or purchased or been licensed to use patents, we may have no legal recourse to protect our rights in the event that they are replicated by other parties. If our competitors are able to replicate our processes, technologies and systems at lower costs, we may lose our competitive edge and our profitability may be reduced.

We may face claims for infringement of third-party intellectual property rights. We may face claims from third parties in respect of the infringement of any intellectual property rights owned by such third parties. There is no assurance that third parties will not assert claims to our processes, technologies and systems. In such an event, we may need to acquire licenses to, or to contest the validity of, issued or pending patents or claims of third parties. There can be no assurance that any license acquired under such patents would be made available to us on acceptable terms, if at all, or that we would prevail in any such contest. In addition, we would incur substantial costs and spend substantial amounts of time in defending ourselves in or contesting suits brought against us for alleged infringement of another party’s patent rights. As such, our operations and business may be adversely affected by such civil actions.

We rely on trade secrets, technology and know-how, which we seek to protect, in part, by confidentiality provisions in contracts with our customers and our employees. There can be no assurance that these agreements will not be breached, or that we will have adequate remedies for any breach, or that other parties may not obtain knowledge of our trade secrets and processes, technology and systems. Should these events occur, our business would be affected and hence, our profitability, may be reduced.

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We may require additional funding for our future growth. Our future growth will depend, to a large extent, on our ability to secure and invest in BOT projects which require a higher amount of capital investment. In order to obtain additional capital to develop these growth opportunities, we may issue additional shares of our equity securities. If new shares placed to new and/or existing shareholders are issued, they may be priced at a discount to the then prevailing market price of our shares, in which case, existing shareholders’ equity interests may be diluted. If we fail to utilize the new equity to generate a commensurate increase in earnings, our earnings per share will be diluted, and this could lead to a decline in our share price. Any additional debt financing may, apart from increasing interest expense, contain restrictive covenants with respect to dividends, future fund-raising exercises and other financial and operational matters.

Our customers may make claims against us and/or terminate our services, in whole or in part, prematurely should we fail to implement projects that fully satisfy their requirements and expectations. Failure to implement projects that fully satisfy the requirements and expectations of our customers or defective system structure or products as a result of design or workmanship or due to acts of nature may lead to claims against us and/or termination of our services, in whole or in part, prematurely. This may arise from a variety of factors including unsatisfactory design or implementation, staff turnover, human errors or misinterpretation of and failure to adhere to regulations and procedures. This may adversely affect our reputation and may reduce our profitability.

We are exposed to credit risks of our customers. Defaults in payment by our customers will affect our financial position and our profitability. As of December 31, 2006, accounts receivables of $2.14 million accounted for approximately 14.4% of our current assets. Therefore, our financial position and profitability are dependent on the credit worthiness of our customers. Generally, our credit terms vary from 90 days to 180 days. Defaults in payment by our customers would adversely affect our profitability and cash flow. There was no allowance for doubtful amounts for the years ended December 31, 2005 and 2006. We are unable to provide assurance that risks of default by our customers would not increase in the future, or that we will not experience cash flow problems as a result of such defaults. Should these develop into actual events, our operations will be adversely affected and our profitability may be reduced.

We are reliant on a few major suppliers. We are dependent on our major suppliers for the timely delivery of materials and equipment that we require for the equipment and systems we install. Should our major suppliers fail to deliver the materials and equipment on time, and if we are unable to source these materials and equipment from alternative suppliers on a timely basis, our project timeline will be delayed, thereby affecting delivery to our customers. This, in turn, would adversely affect our reputation if our customers lose confidence in our services and as a result, reduce our revenue and profitability.

We are subject to risks relating to BOT projects in which we have started to invest. We have begun to invest capital in BOT projects which require high up-front capital expenditures. Our returns from BOT projects are derived from fees paid by the PRC government and such BOT projects are able to generate a steady and recurring source of income for us over a sustained period of time between 20 and 25 years. However, our BOT projects are exposed to risks such as the occurrence of natural disasters or the imposition of more stringent government regulations, which may result in the disruption of our BOT projects. Our investment returns from these BOT projects may thus be reduced should any of such risks materialize.

We rely on subcontractors for our projects. As we may, from time to time, subcontract some parts of our projects to subcontractors, such as engineering, assembly and integration works, we face the risk of unreliability of work performed by our subcontractors. Should our subcontractors default on their contractual obligations and work specifications, our ability to deliver the end product or service to our customers in accordance with quality and/or timing specifications may, in turn, be compromised. Furthermore, if we are unable to secure competitive rates from our subcontractors, our profitability may be reduced.

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The registered capital of our PRC subsidiaries may, in some cases, limit the size of the projects we bid for. We tender for projects in the normal course of business. There are instances where the projects that we intend to tender for require tendering companies to have a minimum registered share capital which is more than the registered share capital of our PRC subsidiaries. Under applicable PRC law, registered capital is defined as the total amount of capital contributions subscribed to by the parties and registered with the PRC authorities. Therefore, the quantum of our capital contributions to the PRC subsidiaries may limit the size of the projects that we are able to successfully tender for, even if we could show that we have other sources of fund. Although some customers may take into account other factors like our trading status and our track record, we are unable to assure you that we would be able to secure projects which are valued at more than our registered capital. Consequently, our revenue, business and financial results may decline.

We are subject to foreign exchange risks. Our dominant transactional currency is the Chinese RMB, including the cost of materials which are imported by our suppliers. With costs mainly denominated in RMB, our transactional foreign exchange exposure for the past few years has been insignificant. However, as our suppliers take into account the fluctuations in foreign exchange rates when they price the imported materials which we procure from them, such fluctuations in foreign exchange rates may result in changes in the purchase price of imported materials. Any future significant fluctuations in foreign exchange rates may have a material impact on our financial performance in the event that we are unable to transfer the increased costs to our customers.

We may be adversely affected by slow downs in the PRC economy owing to unforeseen circumstances, such as an outbreak of infectious diseases. Our business is dependent on the number of contracts we are able to secure from our customers. Unforeseen circumstances such as an outbreak of infectious diseases may lead to a decline in global and regional business, which may, in turn, lead to a decline in demand for our services.

Furthermore, should such unforeseen circumstances cause disruptions to our customers’ operations, they may undertake cost-cutting measures such as cutting capital expenditure and deferring projects such as installation of water treatment systems. The demand for our business may decline as a result of such cost-cutting measures.

Since our subsidiaries, operations and significant assets are located in the PRC, shareholders may find it difficult to enforce a U.S. judgment against the assets of our company, our directors and executive officers. Our subsidiaries’ operations and significant assets are located in the PRC. In addition, all of our executive officers and our directors are non-residents of the U.S., and substantially all the assets of these persons are located outside the U.S. As a result, it could be difficult for investors to effect service of process in the U.S., or to enforce a judgment obtained in the U.S. against us or any of these persons.

Our operations could be adversely affected by changes in the political and economic conditions in the PRC. The PRC is our main market and accounted for all of our revenue in 2006. Therefore, we face risks related to conducting business in the PRC. Changes in the social, economic and political conditions of the PRC may adversely affect our business. Unfavorable changes in government policies, political unrest and economic developments may also have a negative impact on our operations.

Since the adoption of the “open door policy” in 1978 and the “socialist market economy” in 1993, the PRC government has been reforming and is expected to continue to reform its economic and political systems. Any changes in the political and economic policies of the PRC government may lead to changes in the laws and regulations or the interpretation of the same, as well as changes in the foreign exchange regulations, taxation and import and export restrictions, which may, in turn, adversely affect our financial performance. While the current policy of the PRC government seems to be one of imposing economic reform policies to encourage foreign investments and greater economic decentralization, there is no assurance that such a policy will continue to prevail in the future.

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Introduction of new laws or changes to existing laws by the PRC government may adversely affect our business. The PRC legal system is a codified legal system made up of written laws, regulations, circulars, administrative directives and internal guidelines. Unlike common law jurisdictions like the U.S., decided cases (which may be taken as reference) do not form part of the legal structure of the PRC and thus have no binding effect. Furthermore, in line with its transformation from a centrally-planned economy to a more free market-oriented economy, the PRC government is still in the process of developing a comprehensive set of laws and regulations. As the legal system in the PRC is still evolving, laws and regulations or the interpretation of the same may be subject to further changes. For example, the PRC government may impose restrictions on the amount of tariff that may be payable by municipal governments to waste water treatment service providers like us. Also, more stringent environmental regulations may also affect our ability to comply with, or our costs to comply with, such regulations. Such changes, if implemented, may adversely affect our business operations and may reduce our profitability.

We may be subject to foreign exchange controls in the PRC. Our PRC subsidiaries are subject to PRC rules and regulations on currency conversion. In the PRC, the State Administration for Foreign Exchange (“SAFE”) regulates the conversion of the RMB into foreign currencies. Currently, foreign investment enterprises (“FIEs”) are required to apply to SAFE for “Foreign Exchange Registration Certificate for FlEs”. All of our subsidiaries are FIEs. With such registration certifications (which need to be renewed annually), FlEs are allowed to open foreign currency accounts including the “recurrent account” and the “capital account”. Currently, conversion within the scope of the “recurrent account” can be effected without requiring the approval of SAFE. However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE. Our operations and business may be adversely affected if conversion of currency in the “capital account” is not approved by the SAFE.

Item 2. Description of Property

Our principal executive office consists of approximately 400 square meters of office space that we lease and which are located at Suite 7A01, Baicheng Building, 584 Yingbin Road, Dashi, Panyu District, Guangzhou, Guangdong, China. We lease this space pursuant to a three year lease at a rate of approximately $19,000 per year commencing April 1, 2006.

Our BOT facilities are located at the following locations:

BOT Facilities		Location
Waste water treatment plant of TianJin		Dinan Road, Wuqing Development Zone, Tianjin, PRC.
Waste water treatment plant of XinLe		South west of Matoupu Village, Xinle City, Hebei, PRC.
Waste water treatment plant of HaiYang		Hexi, Zangjia Village, Yaiyang Touring and Vacationing Area, Haiyang City, Shandong, PRC.
Waste water treatment plant of HanDan		West of Qianpuzi Village, Mafeng Road, Fengfeng Mining Area, Handan, Hebei, PRC.

Each of the above BOT facilities consists of waste water treatment plants, office buildings and staff facilities. Apart from the waste water treatment plant of HanDan which is still under construction, constructions of the waste water treatment plants of TianJin, XinLe and HaiYang are completed.

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Item 3. Legal Proceedings.

Neither our company nor any of our properties are currently subject to any pending legal proceedings.

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

No matters were submitted to a vote of shareholders during the fourth quarter of the year ending December 31, 2006.

Part II

Item 5. Market for Common Equity and Related Shareholder Matters.

Market Information

Our common stock is traded on the OTC Bulletin Board (“OTCBB”) under the symbol “CEEC”. The following table sets forth, for the periods indicated, the high and low sale prices of our common stock as reported on the OTCBB. We consider our common stock to be thinly traded and that any reported bid or sale prices may not be a true market-based valuation of the common stock.

Quarter Ended	High		Low

March 31, 2005	$	0.48	$	0.30
June 30, 2005	$	0.37	$	0.15
September 30, 2005	$	0.43	$	0.14
December 31, 2005	$	0.32	$	0.20
March 31, 2006	$	0.43	$	0.20
June 30, 2006	$	0.28	$	0.28
September 30, 2006	$	0.28	$	0.18
December 31, 2006	$	0.13	$	0.11
March 31, 2007	$	0.10	$	0.09

Holders

As of March 28, 2007, there were 65 record holders of our common stock.

Dividends

Our policy is to retain earnings to provide funds for the operation and expansion of our business. We have not paid cash dividends on our common stock and do not anticipate that we will do so in the foreseeable future. The payment of dividends in the future will depend on our growth, profitability, financial condition and other factors that our board of directors may deem relevant.

Securities Authorized for Issuance Under Equity Compensation Plans

We did not have any securities underlying outstanding options and securities remaining available for issuance under any equity compensation plans as of December 31, 2006.

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Sales of Unregistered Securities

In April 2005, we conducted a private placement of 20 investment units, at $25,000 per unit, for gross proceeds of $500,000. Each unit consisted of (a) a 12% convertible debenture in the original principal amount of $25,000, convertible into shares of our common stock at the rate of the lesser of (i) $0.20 per share or (ii) a 10% discount to the price per share of common stock (or conversion price per share of common stock) of the next private placement conducted by us prior to any conversion of the debenture, and (b) 125,000 detachable warrants to purchase one share each of our common stock at an exercise price of $0.20 per share, expiring ten years from their date of issuance. The debentures were due and payable August 1, 2005 and later extended to September 30, 2005. We granted the investors limited registration rights for the common shares underlying their debentures and warrants. Westminster Securities Corporation acted as placement agent for this offering on our behalf. On October 1, 2005, all debenture holders converted the debentures into 3,703,701 shares of our common stock. As of January 9, 2006, none of the detachable warrants issued with the convertible debenture had been exercised. The issuances were made in reliance on Section 4(2) of the Securities Act of 1933 and Rule 506 of thereunder, and were made without general solicitation or advertising. The recipient was a sophisticated investor with access to all relevant information necessary to evaluate the investment, and who represented to us that the warrants and the underlying shares were being acquired for investment purposes.

On September 14, 2005, we closed the private placement sale to accredited investors of units consisting of shares of our common stock and warrants to purchase shares of our common stock for aggregate gross proceeds of $4.83 million. Pursuant to the subscription agreements entered into with the investors, we issued to the investors 161 units at a price of $30,000 per unit. Each unit consisted of 200,000 shares of our common stock, priced at $0.15 per share, and warrants to purchase 200,000 shares of our common stock over a five-year period at an exercise price of $0.20 per share. Pursuant to the terms of the subscription agreements, we granted the investors limited registration rights for all common shares comprising the units, including the common shares issuable on exercise of the warrants. Westminster Securities Corporation acted as placement agent for this offering on our behalf. As of December 8, 2005, none of the detachable warrants issued with the issuance of shares of our common stock had been exercised. The issuances were made in reliance on Section 4(2) of the Securities Act of 1933 and Rule 506 of thereunder, and were made without general solicitation or advertising. The recipients were sophisticated investors with access to all relevant information necessary to evaluate the investments, and who represented to us that the shares were being acquired for investment purposes.

Item 6. Management’s Discussion and Analysis or Plan of Operation.

General

We design, construct, and invest in waste water treatment projects in the PRC. We sell materials and products related to environmental protection. We also operate waste water treatment facilities and tap water facilities under our BOT model.

We invest in waste water treatment facilities through BOT arrangements. BOT projects provide us with a stable and guaranteed income source under a long-term (usually 20-25 year) contract granted by municipal governments to build and operate waste water plants. BOT project land is typically contributed by the municipal government with the operator providing investment and daily management. After the contract period, the project is transferred to the local government. After we secure a contract for a BOT project from a municipal government and the financing for such project is in place, we will proceed to construct the facility. After the completion of construction and testing and commissioning, we will operate the waste water treatment facility for a period of 20-25 years as stipulated in the BOT contract.

We also provide turn-key waste water treatment engineering services to both public and private sectors. Our public sector clients include municipal governments at the city, district and town levels. Our private sector clients include heavy industries, such as steel, car manufacturing, electronic; light industries, such as chemical, food and beverage, paper, printing and breweries; and others, including hospitals and the pharmaceutical industry. The industrial wastewater qualities differ due to the different industrial products and manufacturing processes. These turn-key waste water treatment contracts are awarded either by public tender or by direct contract. A typical turn-key waste water treatment project can be classified into three phases; (1) survey and design, (2) construction and equipment installation, and (3) operation and management services.

- 23 -

Many of our principal customers are local governments, food and beverage processing companies and industrial companies that use our technologies to treat their waste water.

In 2005, the Group’s major customers are Beijing Jinqiao Luyuan Environment Protection Investment Development Company Limited and Shenzhen Jukeyuan Industrial Development Company Limited, both independent third parties, which, accounted for approximately 25.2% and 23.4%, respectively, of the Group’s total revenue of 2005. Revenue from Beijing Jinqiao Luyuan Environment Protection Investment Development Company Limited was in relation to the turnkey engineering project of China Environment Industrial Park Wastewater Treatment Plant while revenue from Shenzhen Jukeyuan Industrial Development Company was for the turnkey engineering project of Lechang City Lecheng Wastewater Treatment Plant and the sale of environment protection related products.

For more information on our business, see “Our Business” section.

- 24 -

For the two years prior to a reverse acquisition in September 2004, we had not generated significant revenues and were considered a development stage company as defined in Statement of Financial Accounting Standards No. 7. We were seeking business opportunities or potential business acquisitions. Pursuant to a securities purchase agreement and plan of reorganization dated September 9, 2004, as amended, between our company, Evergreen Asset Group Limited, an International Business Company organized under the laws of the British Virgin Islands (“Evergreen” or “EGAG”), and the stockholders of Evergreen, we acquired 100% of the issued and outstanding shares of Evergreen’s capital stock. We issued 83,500,000 shares of our common stock in exchange for all the 300 issued and outstanding shares of Evergreen capital stock which had an estimated value of $4.24 million at the time of such issuance, valued based on the fair market value of the net assets of Evergreen. Since the stockholders of Evergreen acquired approximately 83.5% of our outstanding shares and the Evergreen management team and board of directors became the management team and board of directors of our company, according to FASB Statement No. 141 – “Business Combinations”, this acquisition has been treated as a recapitalization for accounting purposes, in a manner similar to reverse acquisition accounting. In accounting for this transaction:

- 25 -

•	Evergreen is deemed to be the purchaser and surviving company for accounting purposes. Accordingly, its net assets are included in the balance sheet at their historical book values and the results of operations of Evergreen have been presented for the comparative prior period;
•	Control of the net assets and business of our company was acquired effective October 15, 2004. This transaction has been accounted for as a purchase of the assets and liabilities of our company by Evergreen. The historical cost of the net liabilities assumed was $0.00.

As a result of the transaction described above we changed our name from Discovery Investments, Inc. to China Evergreen Environmental Corporation.

Due to the reverse acquisition mentioned above, EGAG, pursuant to a group reorganization which was completed in July 2004, acquired 90% equity interests in each of XinXingMei, XianYang, HaiYang and BeijingHaoTai for cash consideration of RMB12,601,000 (approximately $1,521,860), RMB18,000,000 (approximately $2,173,913), RMB2,700,000 (approximately $326,087) and RMB1,800,000 (approximately $217,391) respectively, all of which are domestic incorporated companies established in the PRC with limited liability.

In March 2003, GDXS entered into a BOT agreement with Xian Yang City Environment Protection Bureau. The BOT agreement was later transferred to Xian Yang Bai Sheng Water Purifying Company Limited (“XianYang”), after XianYang was incorporated. The construction of the wastewater plant of XY started in the beginning of 2004. Due to the group reorganization in July 2004, 90% of GDXS’s interest in XianYang was transferred to EGAG. In October 2004, EGAG entered into a tri-party framework agreement with True Global Limited (“TGL”), an independent party and Guang Dong Xin Sheng Environmental Protection Company Limited (“GDXS”) for the disposal of its 90% interest in XianYang to TGL at a total consideration of $13,246,377. A gain on disposal of $5,220,299 was recorded in 2004 for the disposal of our entire 90% attributable interest in XianYang to TGL.The gain represents the difference between the disposal proceeds and our attributable share of net assets of XianYang at the date of disposal.

- 26 -

On December 18, 2006, Evergreen entered into an agreement with Hong Kong Water Utility Holdings Limited, an independent third party, to dispose of its entire 90% direct interest in Beijing Hao Tai at a consideration of US$1,442,567. The transaction was consummated on December 28, 2006. No revenue was generated from Beijing HaoTai prior to the date of disposition as the waste water treatment plant was still under construction.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. We consider our critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following:

Use of estimates. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting years. Although management believes that the estimates and assumptions used in preparing the accompanying consolidated financial statements and related notes are reasonable in light of known facts and circumstances, actual results could differ from those estimates.

Significant estimates include the useful lives of property and equipment, revenue recognition based on percentage of completion and Black Scholes assumptions to measure the value of warrants and options. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. Actual results could differ from those estimates. Future estimates and assumptions will be based upon information available to us at the time of the estimate.

Property, plant and equipment. Property, plant and equipment are stated at cost less accumulated depreciation and amortization and impairment loss. Maintenance, repairs and betterments, including replacement of minor items, are charged to expense; major additions to physical properties are capitalized. Depreciation and amortization are provided using the straight-line method over the following estimated useful lives:-

Office equipment	5 years
Furniture and fixtures	5 years
Tools and equipment	5 years
Motor vehicles	10 years
Waste water treatment plant	20 years

- 27 -

Revenue recognition. We recognize revenue using various revenue recognition policies based on the nature of the sale and the terms of the contract.

Revenues from turn-key engineering projects are recognized on the percentage of completion method for individual contracts. We follow the guidance of American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, for our accounting policy relating to the use of the percentage-of-completion method, estimated costs and claim recognition for construction contracts. Revenues are recognized in the ratio that costs incurred bear to total estimated contract costs to the extent we believe related collection is probable. The use of the percentage of completion method of revenue recognition requires estimates of percentage of project completion. Changes in job performance, estimated profitability and final contract settlements may result in revisions to costs and income in the period in which the revisions are determined. Provisions for any estimated losses on uncompleted contracts are made in the period in which such losses are determinable. In instances when the work performed on fixed price agreements is of relatively short duration, we use the completed contract method of accounting whereby revenue is recognized when the work is completed. 5% to 10% of the total contract value will be treated as retention monies withheld to ensure performance of contract during the warranty period of up to 12 months as stipulated in the fixed price contracts, both long term and short term.

Revenues arising from waste water treatment are recognized based on waste water treated as recorded daily by meters read at rates, in RMB/ton, as prescribed under the BOT agreements in accordance with SEC Staff Accounting Bulletin, ("SAB") Topic 13 “Revenue Recognition”. We meet the following four criteria for revenue recognition outlined in SAB Topic 13:

There is sufficient evidence to support that sales arrangements exist;

The price to the buyer is fixed through signed contracts;

Meter readings illustrate that delivery of treated waste water has occurred; and

Collectibility is reasonably assured through one or more of the following:

due diligence prior to contract signing; historical payment practices; or required upfront payments.

Revenues from sale of environment protection related products and bottled water and provision of technical services are recognized when goods are delivered or as services are performed. The contractual terms of the purchase agreements or consultancy agreements dictate the recognition of revenues by us. We recognize revenue in accordance with Staff Accounting Bulletin No. 104. Accordingly, four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the selling prices of the products or services delivered and the collectibility of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. We defer any revenue for which the product has not been delivered or is subject to refund until such time that we and our customer jointly determine that the product has been delivered or no refund will be required.

- 28 -

Recent accounting pronouncements. In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments: and amendment of FASB Statements No. 133 and 140”. SFAS No. 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is permitted, provided the Company has not yet issued financial statements, including for interim periods, for that fiscal year. The Company does not expect the adoption of SFAS No. 155 to have a material impact on its financial statements, as it currently has no financial instruments within the scope of SFAS No. 155.

In March 2006, the FASB released SFAS No. 156 “Accounting for Servicing of Financial Assets: an amendment of FASB Statement No. 140” to simplify accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 permits an entity to choose either the amortization method or the fair value measurement method for measuring each class of separately recognized servicing assets and servicing liabilities after they have been initially measured at fair value. SFAS No. 156 applies to all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006. The Company does not anticipate the adoption of SFAS No. 156 will have a material impact on its financial statements.

In July 2006, the FASB issued FIN 48 “Accounting for Uncertainty in Income Taxes”. This interpretation requires that we recognize in our financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of our 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the effect of FIN 48 on its financial statements.

In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurement” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This Statement shall be effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year. The provisions of this statement should be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except in some circumstances where the statement shall be applied retrospectively. The Company is currently evaluating the effect, if any, of SFAS 157 on its financial statements.

In September 2006, the FASB released SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans: an amendment of FASB Statements No. 87, 88, 106, and 132(R)” which requires an employer to recognize the over funded or under funded status of defined benefit and other postretirement plans as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through an adjustment to comprehensive income. This statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The Company is currently evaluating the impact of adopting SFAS No. 158 on its financial statements.

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Results of Operations

For The Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

The following table summarizes the results of our operations during the year ended on December 31, 2006 and December 31, 2005, and provides information regarding the dollar and percentage increase or (decrease) from the year ended on December 31, 2006 to the year ended on December 31, 2005.

All amounts, other than percentages, in U.S. dollars

	For The Year Ended					For The Year Ended
		December 31, 2006					December 31, 2005
		Dollars in		As a percentage			Dollars in		As a percentage
		Thousands		of net revenues			Thousands		of net revenues
Sales revenue		4,797		100.0	%		6,984		100.0	%
Cost of revenue		3,489		72.7	%		3,757		53.8	%
Gross profit		1,308		27.3	%		3,227		46.2	%
General and administrative expenses		660		13.8	%		820		11.7	%
(Loss)/Income before income taxes and minority interests		(3,177	)	-66.2	%		437		6.3	%
Income taxes		1,495		31.2	%		(920	)	-13.2	%
Net loss		(1,504	)	-31.3	%		(761	)	-10.9	%

	For The Year Ended					Dollar ($)		Percentage
		December 31, 2006		December 31, 2005		Increase (Decrease)		Increase/ (Decrease)
	Dollars in thousands					in thousands

Sales revenue		4,797		6,984		(2,187	)	-31.3	%
Cost of revenue		3,489		3,757		(268	)	-7.2	%
Gross profit		1,308		3,227		(1,919	)	-59.5	%
General and administrative expenses		660		820		(160	)	-19.5	%
(Loss)/Income before income taxes and minority interests		(3,177	)	437		(3,614	)	-827	%
Income tax		1,495		(920	)	2,415		262.5	%
Net loss		(1,504	)	(761	)	(743	)	97.6	%

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Sales revenue. Sales revenue decreased $2.19 million, or approximately 31.3%, to $4.8 million for the year ended December 31, 2006 from $6.98 million for the year ended December 31, 2005. The decrease was driven by the lack of additional turn key engineering project in 2006. The sales revenue was mainly result from the projects which were commenced in 2005 and still progressing in 2006.

Cost of revenue. Our cost of revenue increased $0.22 million to $3.49 million for the year ended December 31, 2006 from $3.27 million for the year ended December 31, 2005. As a percentage of net revenues, the cost of revenue increased approximately 18.9 % to 72.7% for the year ended December 31, 2006 from 53.8% for the year ended December 31, 2005. The increase of such percentage was mainly due to the fact that the actual cost of the projects was larger than the budget cost and the payment for the commission fee for the projects while the revenue was decreased for the year.

Gross profit. Our gross profit decreased $1.92 million to $1.31 million for the year ended December 31, 2006 from $3.23 million for the year ended December 31, 2005. This decrease was mainly attributable to lack of additional Turn-key engineering projects . Gross profit as a percentage of net revenues was 27.3% for the year ended December 31, 2006, as compared to 46.2% for the year ended December 31, 2005. The decrease of such percentage was mainly due to the fact that the actual cost of the projects was larger than the budget cost while the revenue was decreased.

General administrative expenses. Our General administrative expenses decreased $0.16 million, or approximately 19.5%, to $0.66 million for the year ended December 31, 2006 from $0.82 million for the year ended December 31, 2005. The decrease in the amount of general and administrative expenses was partly attributable to the decrease of operating activities for the year. As a result, the administrative expenses was decreased accordingly. As a percentage of net revenues, administrative expenses increased to 13.8% for the year ended December 31, 2006 as compared to 11.7% for the year ended December 31, 2005.

(Loss)/Income before income taxes and minority interests. Loss before income taxes and minority interests totaled $3.17 million for the year ended December 31, 2006, a decrease of 827% from $0.44 million for the year ended December 31, 2005, This decrease was primarily attributable to the decrease of gross profit for the year for the factors described above.

Income taxes. Income tax provision was $1.5 million for the year ended December 31, 2006, an increase of 262.5% as compared to income tax refund $0.92 million for the year ended December 31, 2005. This increase was attributable to the provision of income tax for one of the subsidiary, Hai Yang City Sheng Shi Environment Protection Company Limited, which is provided for the income incurred in 2005.

Net loss. Net loss decreased to approximately $1.50 million for the year ended December 31, 2006 as compared to approximately $0.76 million for the same period of 2005, a decrease of approximately $0.74 million or approximately 97.6%. This decrease is due to the factors described above.

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Liquidity and Capital Resources

General. As of December 31, 2006, we had cash and cash equivalents of $4.1 million. The following table provides detailed information about our net cash flow for all financial statements periods presented in this report.

	The Year Ended December 31,
	2006			2005
	(Dollars in thousands)

Net cash provided by operating activities		2,584			3,635
Net cash provided by/(used in) investing activities		1,388			(6,878	)
Net cash provided by/(used in) financing activities		(88	)		3,075
Net cash inflow/(outflow)		3,969			(161	)

Operating Activities. Net cash provided by operating activities was $2.58 million for year ended December 31, 2006, which is a decrease of $1.05 million from $3.63 million net cash provided by operating activities for the same period in 2005. The net inflow from the operating activities was mainly due to the collection of other receivable.

Investing Activities. Net cash provided by investing activities was $1.39 million for the year ended December 31, 2006, which is mainly due to the receipt of deposit paid for acquisition of a subsidiary in 2005 and cash inflow arising from disposal of interest in a subsidiary, Beijing Hao Tai Shi Yuan Water Purifying Company Limited, during the year.

On December 18, 2006, Evergreen entered into an agreement with Hong Kong Water Utility Holdings Limited, an independent third party, to dispose of its entire 90% direct interest in Beijing Hao Tai at a consideration of US$1,442,567. The transaction was consummated on December 28, 2006. No revenue was generated from Beijing Hao Tai prior to the date of disposition as the waste water treatment plant was still under construction.

The gain represents the difference between the disposal proceeds of US$1,442,567 and the Group’s attributable share of net assets of Beijing Hao Tai at the date of disposal of US$1,114,342 and receivable from Beijing Hao Tai of US$283,353.

Financing Activities. Net cash used in financing activities was $0.09 million for the year ended December 31, 2006 which is a decrease of $3.16 as compared to net cash provided by financing activities for the same year ended in 2005. The decrease of the net cash used in financing activities is mainly because the Company did not issue financial instrument or dispose its investment during the year.

Off-Balance Sheet Arrangements. Management has assessed the fair value of the obligation arising from the above financial guarantees and considered it as nil for our Company. Therefore, no obligation in respect of the above guarantees was recognized as of December 31, 2006.

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Off-Balance Sheet Arrangements

We do not have any off-balance sheet financing arrangements.

- 33 -

Item 7. Financial Statements

INDEX TO FINANCIAL STATEMENTS


Report of Independent Registered Public Accounting Firm	F-1

Consolidated Statements of Operations and Comprehensive Income (Loss)	F-2

Consolidated Balance Sheets	F-3

Consolidated Statements of Cash Flows	F-4-F-5

Consolidated Statements of Stockholders’ Equity	F-6

Notes to Consolidated Financial Statements	F-7 - F-29

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

China Water Group, Inc.

We have audited the accompanying consolidated balance sheets of China Water Group, Inc. (the “Company”) and its subsidiaries as of December 31, 2006 and 2005 and the related consolidated statements of operations and other comprehensive income (loss), stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

PKF

Certified Public Accountants

Hong Kong, China

F-1

CHINA WATER GROUP, INC.

CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME

	*Year ended December 31,*
	*2006* *US$*			*2005* *US$*

Revenue from turn-key engineering projects		3,893,176			4,830,613
Revenue from BOT wastewater treatment services		898,970			302,011
Revenue from provision of technical services		-			600,734
Revenue from sales of environment protection related products		-			1,250,611
Revenue from sales of bottled water		5,178			-
Total revenue (Note 27)		4,797,324			6,983,969

Cost of revenue for turn-key engineering projects		(2,707,515	)		(2,784,341	)
Cost of revenue for BOT wastewater treatment services		(317,235	)		(175,077	)
Cost of revenue for provision of technical services		-			(2,406	)
Cost of revenue for sales of environment protection related products		-			(310,379	)
Cost of revenue from sales of bottled water		(3,237	)		-
Depreciation and amortization		(246,499	)		(115,737	)
Sales taxes		(214,884	)		(369,052	)
Total cost of revenue		(3,489,370	)		(3,756,992	)

Gross profit		1,307,954			3,226,977
Provision for doubtful accounts		(7,229,682	)		-
Other general and administrative expenses		(659,731	)		(820,170	)
(Loss) income from operations		(6,581,459	)		2,406,807
Other income (Note 22)		149,890			54,622
Interest expense (Note 23)		(2,908	)		(42,991	)
Penalty for late effectiveness of registration statement (Note 18)		(899,078	)		-
Non-cash financing charges (Note 18)		-			(8,001,211	)
Gain on fair value of derivative instruments (Note 18)		3,843,520			5,440,454
Gain on disposal of interest in a subsidiary - Beijing Hao Tai (Note 7)		44,872			-
Gain on disposal of construction project		80,282			635,941
Loss on disposal of property, plant and equipment		(45,243	)		-
Loss on disposal of investment		-			(472,643	)
Share of results in an associated company - Xin Le (Note 8)		233,305			416,218

(Loss) income before income tax and minority interests		(3,176,819	)		437,197
Income tax benefit (expense) (Note 24(a))		1,494,869			(920,001	)

Loss before minority interests		(1,681,950	)		(482,804	)
Minority interests (Note 19)		177,714			(277,700	)

Net loss		(1,504,236	)		(760,504	)
Other comprehensive income
Foreign currency translation adjustment		230,235			221,156

Comprehensive loss		(1,274,001	)		(539,348	)

Basic net loss per share (Note 20)		(0.01	)		(0.01	)
Diluted net loss per share (Note 20)		(0.01	)		(0.01	)

see the accompanying notes to consolidated financial statements

F-2

CHINA WATER GROUP, INC.

CONSOLIDATED BALANCE SHEETS

	*As of December 31,*
	*2006* *US$*		*2005* *US$*
ASSETS
Current assets
Cash and cash equivalents		4,144,484		175,224
Accounts receivable (Note 9)		2,140,575		5,220,940
Prepayment, deposits and other receivables (Note 10)		1,494,039		5,942,751
Amounts due from related companies (Note 11)		3,423,961		887,277
Amount due from an associated company (Note 13)		1,824,529		1,772,052
Deferred tax assets (Note 24(b))		1,796,377		187,267
Total current assets		14,823,965		14,185,511
Property, plant and equipment, net (Note 5)		4,739,533		2,636,892
Construction in progress (Note 6)		3,619,559		5,480,302
Deposits paid for acquisition of property, plant and equipment		-		635,500
Deposit paid for acquisition of a subsidiary (Note 31)		-		2,047,527
Interests in an associated company (Note 8)		1,080,562		815,613

Total assets		24,263,619		25,801,345

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Warrant liability (Note 18)		2,305,880		6,149,400
Unsecured loan (Note 14)		-		86,741
Note payable (Note 15)		25,600		24,783
Accounts payable		6,854,174		6,804,711
Accrued liabilities (Note 16)		3,062,829		1,493,035
Amounts due to directors (Note 12)		1,371,627		716,598
Amounts due to related companies (Note 17)		1,779,943		230,836
Income tax payable		1,680,094		1,557,167

Total current liabilities		17,080,147		17,063,271

Commitments (Note 28)

Minority interests (Note 19)		541,105		821,704

Stockholders' equity
Preferred stock, US$0.001 par value, 50,000,000 authorized shares, no shares issued and outstanding (Note 21)		-		-
Common stock, US$0.001 par value, 200,000,000 shares authorized; 135,903,698 and 135,903,698 shares issued and outstanding (Note 21)		103,704		103,704
Additional paid-in capital		4,837,392		4,837,392
Retained earnings		1,249,882		2,754,118
Accumulated other comprehensive income		451,389		221,156

Total stockholders' equity		6,642,367		7,916,370

Total liabilities and stockholders' equity		24,263,619		25,801,345

see the accompanying notes to consolidated financial statements

F-3

CHINA WATER GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year ended December 31,
	2006 US$			2005 US$
Cash flows from operating activities :
Net loss		(1,504,236	)		(760,504	)
Adjustments to reconcile net loss to net cash flows provided by operating activities :
Depreciation and amortization		246,499			115,737
Non-cash financing charges		-			8,001,211
Gain on fair value of derivative instruments		(3,843,520	)		(5,440,454	)
Provision for doubtful accounts		7,229,682			-
(Increase) decrease in deferred tax assets		(1,574,642	)		17,677
Minority interests		(177,714	)		277,700
Gain on disposal of interest in a subsidiary - Beijing Hao Tai		(44,872	)		-
Loss on disposal of investment		-			472,643
Loss on disposal of property, plant and equipment		45,243			-
Gain on disposal of construction project		(80,282	)		-
Share of results in an associated company - Xin Le		(233,305	)		(416,218	)

Changes in operating assets and liabilities :
(Increase) decrease in accounts receivable		(1,120,997	)		4,427,952
Decrease (increase) in prepayment, deposits and other receivables		1,909,849			(5,102,193	)
(Increase) decrease in amounts due from related companies		(1,759,128	)		2,321,593
Decrease in amounts due from directors		-			27,122
Increase (decrease) in accounts payable		1,010,595			(2,148,974	)
Increase in accrued liabilities		1,791,700			846,754
Increase in amounts due to directors		618,785			92,900
Increase in income tax payable		70,171			902,322
Net cash provided by operating activities		2,583,828			3,635,268

Cash flows used in investing activities :
Decrease (increase) in deposit paid for acquisition of a subsidiary		2,072,723			(2,019,993	)
Cash inflow (outflow) arising from disposal of interest in a subsidiary		1,442,567			(76,832	)
Acquisition of property, plant and equipment		(2,127,075	)		(4,443,983	)
Decrease in amount due from an associated company		-			17,882
Decrease in deposit received for disposal of a subsidiary		-			(354,799	)
Net cash flows provided by (used in) investing activities		1,388,215			(6,877,725	)

Cash flows used in financing activities :
Net proceeds from disposal of investment		-			911,065
Net proceeds from issuance of warrant liability		-			4,623,207
Repayment of unsecured loans		(87,808	)		(146,699	)
Initial capital injection of Han Dan		-			260,223
Additional capital injection of Beijing Hao Tai		-			99,133
Decrease in amount due to a related company		-			(2,671,793	)
Net cash flows (used in) provided by financing activities		(87,808	)		3,075,136

Effect of foreign currency translation on cash and cash equivalents		85,025			6,466
Net increase (decrease) in cash and cash equivalents		3,969,260			(160,855	)

Cash and cash equivalents, beginning of year		175,224			336,079

Cash and cash equivalents, end of year		4,144,484			175,224

See the accompanying notes to consolidated financial statements.

F-4

CHINA WATER GROUP, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

											*Accumulated*
						*Additional*					*other*		*Total*
	*Common stock*					*paid-in*		*Retained*			*comprehensive*		*stockholders’*
	*No. of*		*Amount*			*capital*		*earnings*			*income*		*equity*
	*shares*		*US$*			*US$*		*US$*			*US$*		*US$*

At January 1, 2005		99,999,997		100,000			3,841,096		3,514,622			-		7,455,718
Issue of shares in September (Notes 18 and 21)		32,200,000		32,200			-		-			-		32,200
Share issued in October for conversion of convertible debenture		3,703,701		3,704			996,296		-			-		1,000,000
Shares issued accounted for as liability (Notes 18 and 21)		-		(32,200	)		-		-			-		(32,200	)
Foreign currency translation adjustments		-		-			-		-			221,156		221,156
Net loss		-		-			-		(760,504	)		-		(760,504	)
At December 31, 2005		135,903,698		103,704			4,837,392		2,754,118			221,156		7,916,370
Foreign currency translation adjustments		-		-			-		-			230,233		230,233
Net loss		-		-			-		(1,504,236	)		-		(1,504,236	)
At December 31, 2006		135,903,698		103,704			4,837,392		1,249,882			451,389		6,642,367

see the accompanying notes to consolidated financial statements

F-5

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. CHANGE OF COMPANY NAME

The Company was incorporated in the State of Nevada on September 10, 1996.

Following a reverse takeover transaction as detailed in note 2(ii), the Company has ended its development stage and is now engaging in the provision of the business as set out in note 3.

On November 12, 2004, the name of the Company was changed from Discovery Investment Inc. to China Evergreen Environmental Corp., with all the required filings submitted to the United States Securities and Exchange Commission.

On November 7, 2006, the name of the Company was changed from China Evergreen Environmental Corp. to China Water Group, Inc. (“the Company" and “CHWG”), with all the required filings submitted to the United States Securities and Exchange Commission.

2. BASIS OF PRESENTATION

(i)

The accompanying consolidated financial statements of CHWG and its subsidiaries - Evergreen Asset Group Limited (“Evergreen”), Evermaster Group Limited (“Evermaster”), Everbury Holdings Limited (“Everbury”), Guang Dong Xin Xing Mei Biology Company Limited (“Xinxingmei”), Tian Jin Shi Sheng Water Treatment Company Limited (“Tian Jin”), Hai Yang City Sheng Shi Environment Protection Company Limited (“Hai Yang”), Beijing Hao Tai Shi Yuan Water Purifying Company Limited (“Beijing Hao Tai”) and Han Dan Cheng Sheng Water Affairs Company Limited (“Han Dan”) (the “Group”) have been prepared in accordance with generally accepted accounting principles in the United States of America. All significant intercompany transactions and balances have been eliminated in consolidation. The results of subsidiaries acquired or disposed during the years are included in the consolidated statement of operations and comprehensive income (loss) from the effective date of acquisition or up to the effective date of disposal.

(ii)

On October 15, 2004, CHWG completed a share exchange with the stockholders of Evergreen which was incorporated in the British Virgin Islands on April 20, 2004 under the International Business Companies Act, British Virgin Islands (the “Exchange”). In the Exchange, CHWG acquired 300 shares representing all the issued and outstanding common stock of Evergreen from the stockholders of Evergreen (the “Shareholders”) in exchange for the issuance of 83,500,000 shares of common stock of CHWG to the Shareholders.

The Exchange has been accounted for as a recapitalization of Evergreen whereby the assets and liabilities and operations of Evergreen become the assets and liabilities and operations of CHWG with no adjustments to the historical basis of assets and liabilities of Evergreen and the operations consolidated. The 16,499,997 shares of CHWG outstanding prior to the Exchange are accounted for at the net book value at the time of the transaction, approximately $148,705. The accompanying financial statements reflect the recapitalization of the shareholders equity as if the transaction occurred as of the beginning of the first period presented.

F-6

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3. DESCRIPTION OF BUSINESS

The principal activities of the Group are the research and development of waste water, garbage treatment and aqueous purifying techniques, investment and construction of waste water treatment plant and sales of environment protection related products.

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting years. Although management believes that the estimates and assumptions used in preparing the accompanying consolidated financial statements and related notes are reasonable in light of known facts and circumstances, actual results could differ from those estimates.

Cash and cash equivalents

Cash equivalents are highly liquid investments and have maturities of three months or less at the date of purchase.

Property, plant and equipment

Property, plant and equipment are stated at cost less accumulated depreciation and amortization and impairment loss. Maintenance, repairs and betterments, including replacement of minor items, are charged to expense; major additions to physical properties are capitalized. Depreciation and amortization are provided using the straight-line method over the following estimated useful lives:-

Office equipment	5 years
Furniture and fixtures	5 years
Tools and equipment	5 years
Motor vehicles	10 years
Waste water treatment plant	20 years

F-7

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Construction in process

Construction in process represent the cost of construction of the waste water treatment plants under the Build-Operate-Transfer (“BOT”) agreements with the People’s Republic of China (“PRC”) government. The cost includes development and construction expenditure incurred and other direct costs attributable to the development. The construction in progress that was completed during the year was transferred to property, plant and equipment on a monthly basis, with monthly completion and inspection reports. No depreciation and amortization is provided until such time as the relevant assets are completed, ready for use and transferred to property, plant and equipment.

BOT agreements for the three waste water treatment plants in PRC include the following terms :-

*Subsidiaries*	*Treatment* *capacity per day* *(tons)*		*Term* *(years)*		*Total investment as per* *BOT agreement*
					*RMB*		*US$*

Tian Jin*		10,000		20		9,000,000		1,086,957
Hai Yang*		20,000		22		30,000,000		3,623,188
Han Dan		33,000		22		29,250,000		3,532,609

At December 31, 2006, waste water treatment plants of Tian Jin and Hai Yang were in use and depreciation and amortization are provided using the straight-line method over 20 years commencing on the date the waste water treatment plants were ready for use. Waste water treatment plants of Han Dan were not ready for use at December 31, 2006.

Impairment of assets

The Group’s policy is to periodically review and evaluate whether there has been a permanent impairment in the value of long-lived assets. Factors considered in the evaluation include current operating results, trends and anticipated undiscounted future cash flows. An impairment loss is recognized to the extent that the sum of undiscounted estimated future cash flows that is expected to result from the use of the asset, or other measure of fair value, is less than the carrying value.

F-8

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Allowance of doubtful accounts

The Group establishes an allowance for doubtful accounts based on management’s assessment of the collectibility of accounts receivables and other receivables. A considerable amount of judgment is required in assessing the amount of the allowance, the Group considers the historical level of credit losses and applies percentages to aged receivable categories. The Group makes judgments about the creditworthiness of each customer based on ongoing credit evaluations, and monitors current economic trends that might impact the level of credit losses in the future. If the financial condition of the customers were to deteriorate, resulting in their inability to make payments, a larger allowance may be required.

Bad debts are written off when identified. The Group extends unsecured credit to customers ranging from three to six months in the normal course of business. The Group does not accrue interest on accounts receivables.

Historically, losses from uncollectible accounts have not significantly deviated from the general allowance estimated by the management and no significant additional bad debts have been written off directly to the profit and loss.

Associated company

An associated company is one, not being a subsidiary or a joint venture, in which the Company is in a position to exercise significant influence, including participation in financial and operating policy decisions. Details of the associated company are set out in note 8 to the consolidated financial statements.

Interests on an associated company is accounted for by the equity method of accounting and is initially recognized at cost.

F-9

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Goodwill on acquisition of an associated company represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired associated company at the date of acquisition is included in interests in an associated company. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold.

The Group’s share of its associated company’s post-acquisition profits or losses is recognized in the statement of operations, and its share of post-acquisition movements in reserves is recognized in reserves. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the Group’s share of losses in an associated company equals or exceeds its interest in the associated company, including any other unsecured receivables, the Group does not recognize further losses, unless it has incurred obligations or made payments on behalf of the associated company.

Unrealized gains on transactions between the Group and its associated company are eliminated to the extent of the Group’s interest in the associated company. Unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of an associated company have been changed where necessary to ensure consistency with the policies adopted by the Group.

Research and development costs

Research and development costs are recognized as an expense in the period in which they are incurred.

Concentration of credit risk

Concentration of credit risk is limited to accounts receivable and is subject to the financial conditions of a major customer which is stated in note 27 to the consolidated financial statements. The Group does not require collateral or other security to support client’s receivables. The Group conducts periodic reviews of its clients’ financial condition and customer payment practices to minimize collection risk on accounts receivable.

Financial instruments

The carrying amounts of all financial instruments approximate fair value. The carrying amounts of cash, accounts receivable, related parties receivable, unsecured loans, accounts payable and related parties payable approximate fair value due to the short-term nature of these items. The carrying amounts of borrowings approximate the fair value based on the Group’s expected borrowing rate for debt with similar remaining maturities and comparable risk.

F-10

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Revenue recognition

We recognize revenue using various revenue recognition policies based on the nature of the sale and the terms of the contract.

There is sufficient evidence to support that sales arrangements exist;

The price to the buyer is fixed through signed contracts;

Meter readings illustrate that delivery of treated waste water has occurred; and

Collectibility is reasonably assured through one or more of the following:

due diligence prior to contract signing; historical payment practices; or required upfront payments.

F-11

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Cost of revenues

Cost of revenues comprises labor and other cost of personnel directly engaged in providing the services, subcontracting and attributable overhead costs. Cost of revenues does not include any allocation of depreciation or amortization expense.

Segment reporting

Management believes that it has only a single segment consisting of waste water treatment with related services and support. The information presented in the consolidated statement of operations reflects the revenues and costs associated with this segment that management uses to make operating decisions and assess performance.

Income taxes

The Group utilizes the asset and liability method of accounting for income taxes whereby deferred taxes are determined based on the temporary differences between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

F-12

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Foreign currency translation and transactions

The Group uses China Renminbi (“RMB”) as the functional currency, which is not freely convertible into foreign currencies. Transactions denominated in currencies other than RMB are translated into RMB at the applicable rates of exchange prevailing at the dates of the transactions, quoted by the People’s Bank of China (“the PBOC”). Monetary assets and liabilities denominated in other currencies are translated into RMB at rates of exchange quoted by the PBOC prevailing at the balance sheet date. Exchange gains or losses arising from changes in exchange rates subsequent to the transactions dates for monetary assets and liabilities denominated in other currencies are included in the determination of net income for the respective period.

For financial reporting purposes, RMB has been translated into USD as the reporting currency. Assets and liabilities are translated at the exchange rate in effect at period end. Income statement accounts are translated at the average rate of exchange prevailing during the period. Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders’ equity as “Accumulated other comprehensive income - foreign currency translation adjustments”. Gains and losses resulting from foreign currency transactions are included in other income (loss).

Income (loss) per share

Basic income (loss) per share is computed by dividing the net income (loss) for the year by the weighted average number of common shares outstanding during the year. Diluted income (loss) per share is computed by dividing the net income (loss) for the year by the weighted average number of common and common equivalent shares outstanding during the year. Common equivalent shares, composed of incremental common shares issuable upon the exercise of stock options, unvested restricted common stock and contingently issuable shares that are probable of being issued, are included in diluted income (loss) per share to the extent such shares are dilutive. In accordance with SFAS 128, “Earnings Per Share”, the Company uses income (loss) from continuing operations, net of income taxes as the “control number” in determining whether common equivalent shares are dilutive or anti-dilutive in periods where discontinued operations are reported.

Reclassification of accounts

Certain reclassifications have been made to prior-year comparative financial statements to conform to the current year presentation. These reclassifications had no effect on previously reported results of operations or financial position.

F-13

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Recently issued accounting pronouncements

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments: and amendment of FASB Statements No. 133 and 140”. SFAS No. 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is permitted, provided the Company has not yet issued financial statements, including for interim periods, for that fiscal year.

In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This Statement shall be effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year. The provisions of this statement should be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except in some circumstances where the statement shall be applied retrospectively.

F-14

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Recently issued accounting pronouncements (cont’d)

In September 2006, the SEC issued SAB No. 108, which provides guidance on the process of quantifying financial statement misstatements. In SAB No. 108, the SEC staff establishes an approach that requires quantification of financial statement errors, under both the iron-curtain and the roll-over methods, based on the effects of the error on each of the Company’s financial statements and the related financial statement disclosures. SAB No. 108 is generally effective for annual financial statements in the first fiscal year ending after November 15, 2006. The transition provisions of SAB No. 108 permits existing public companies to record the cumulative effect in the first year ending after November 15, 2006 by recording correcting adjustments to the carrying values of assets and liabilities as of the beginning of that year with the offsetting adjustment recorded to the opening balance of retained earnings.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected on an instrument-by-instrument basis, with few exceptions. SFAS 159 also establishes presentation and disclosure requirements to facilitate comparisons between companies that choose different measurement attributes for similar assets and liabilities. The requirements of SFAS 159 are effective for our fiscal year beginning January 1, 2008. We are in the process of evaluating this standard and therefore have not yet determined the impact that SFAS 159 will have on our financial statements upon adoption.

The Group has adopted all the above accounting procurements effective January 1, 2006 and considers that they have no material impact on these consolidated financial statements.

F-15

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5. PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment, net consisted of the following :-

	*December 31,*
	*2006*			*2005*
	*US$*			*US$*
Purchase cost :-

Office equipment		31,364			2,965
Furniture and fixtures		14,401			6,220
Tools and equipment		2,393			29,490
Motor vehicles		48,384			173,597
Waste water treatment plants		5,072,771			2,651,780

Total		5,169,313			2,864,052

Less : Accumulated depreciation and amortization		(429,780	)		(227,160	)

Property, plant and equipment, net		4,739,533			2,636,892

Depreciation and amortization expenses for 2006 and 2005 amounted to US$246,499 and US$115,737 respectively.

There was no impairment loss for 2006 and 2005.

F-16

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6. CONSTRUCTION IN PROGRESS

Construction in progress represents costs incurred in connection with construction of a waste water treatment plants in the PRC under the BOT agreements as follows :-

	*December 31,*
	*2006*		*2005*
	*US$*		*US$*

Construction in progress of Tian Jin		-		1,054,842
Construction in progress of Hai Yang		-		3,586,557
Construction in progress of Han Dan		3,619,559		838,903

Total		3,619,559		5,480,302

As of December 31, 2006, construction in progress of Tian Jin and Hai Yang were in use while construction in progress of Han Dan were not ready for use. The construction in progress that was completed during the year was transferred to Property, Plant and Equipment on a monthly basis, with monthly completion and inspection reports.

7. GAIN ON DISPOSAL OF INTEREST IN A SUBSIDIARY

On December 18, 2006, Evergreen entered into an agreement with Hong Kong Water Utility Holdings Limited, an independent third party, to dispose of its entire 90% direct interest in Beijing Hao Tai at a consideration of US$1,442,567. The transaction was consummated on December 28, 2006. No revenue was generated from Beijing Hao Tai prior to the date of disposition as the waste water treatment plant was still under construction.

The gain of US$44,872 represents the difference between the disposal proceeds of US$1,442,567 and the Group’s attributable share of net assets of Beijing Hao Tai at the date of disposal of US$1,114,342 and receivable from Beijing Hao Tai of US$283,353.

F-17

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8. INTERESTS IN AN ASSOCIATED COMPANY

	*December 31,*
	*2006*		*2005*
	*US$*		*US$*

Share of net assets		1,080,562		815,613

(a)

Details of the associated company, which was incorporated in the PRC, as of December 31, 2006 are as follows :-

	*Percentage*
	*of equity*
*Name of the associated company*	*attributable to*
	*The Group*			*Evergreen*
Xin Le Sheng Mei Water Purifying
Company Limited (“Xin Le”)		31.5	%		35	%

(b)

Information extracted from the unaudited financial statements of the associated company for the year ended December 31, 2006 and the audited financial statements of the associated company for the year ended December 31, 2005 is as follows :-

	*Year ended December 31,*
	*2006*		*2005*
	*US$*		*US$*
	(Unaudited)		(Audited)
(i) Statements of operations

Revenue from water treatment services per BOT agreement		1,190,431		1,160,147

Net profit		666,587		1,189,195

	*December 31,*
	*2006*			*2005*
	*US$*			*US$*
	(Unaudited)			(Audited)
(ii) Balance sheet

Construction in progress		3,809,171			3,934,652
Cash and cash equivalents		2,174			17,316
Inventories		32,011			40,086
Accounts receivable		626,926			921,812
Prepayment, deposits and other receivables		1,071,700			1,270,617
Accounts payable		(192,203	)		(272,811	)
Amounts due to CHWG’s subsidiaries		(1,824,529	)		(1,772,052	)
Other current liabilities		(437,930	)		(1,809,296	)

Net assets		3,087,320			2,330,324

The audited financial statements of the associated company for the year ended December 31, 2006 is not yet available. As such, the above information is extracted from the unaudited financial statements of the associated company for the year ended December 31, 2006.

F-18

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. ACCOUNTS RECEIVABLE

	*December 31,*
	*2006*			*2005*
	*US$*			*US$*

Accounts receivable		6,543,318			5,220,940
Provision for doubtful accounts		(4,402,743	)		-

		2,140,575			5,220,940

Provision for doubtful accounts in consolidated statements of operations and other comprehensive income represents the bad debts written off of US$2,826,939 and US$0 and provision for doubtful accounts of US$4,402,743 and US$0 for the year ended December 31, 2006 and 2005 respectively.

Accounts receivable as at December 31, 2006 represents mainly amounts receivable for turn-key engineering projects from the following waste water treatment plants :-

			*December 31,*
			*2006*		*2005*
*Customer*	*Turn-key engineering* *project*		*US$*		*US$*

Beijing Jinqiao Luyuan Environment Protection Investment Development Company Limited		China Environment Industrial Park Wastewater Treatment Plant		3,579,617		1,629,720
Shenzhen Jukeyuan Industrial Development Company Limited		Lechang City Lecheng Wastewater Treatment Plant		1,873,408		1,813,635

10. PREPAYMENT, DEPOSITS AND OTHER RECEIVABLES

	*December 31,*
	*2006*		*2005*
	*US$*		*US$*

Prepayment		106,767		74,624
Deposits		42,303		42,939
Other receivables:
Amounts receivable from True Global Limited		-		2,627,014
Amounts receivable from Hampton Limited		-		395,583
Amounts receivable from Zeng Xiangfeng		-		2,429,988
Amounts receivable from Beijing Hao Tai		737,284		-
Advances and miscellaneous receivables		607,685		372,603

		1,494,039		5,942,751

Amounts due from Zeng Xiangfeng, an independent party, were deposits for acquisition of waste water treatment plants. Due to a deferment in the proposed acquisition, the company has withdrawn the amounts in February 2006.

Amounts due from True Global Limited represent the remaining amount receivable from True Global Limited for the disposition of 90% direct interest in Xian Yang in 2004.

The management believes that all other receivables are collectible.

F-19

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11. AMOUNTS DUE FROM RELATED COMPANIES

At December 31, 2006, the balance mainly represents advanced cash to Guang Dong Xin Sheng Environmental Protection Company Limited (“GDXS”), Xin Sheng Environment Protection and Technology Group Limited and Tian Jin Zhong Ke Company Limited in which Mr. Pu Chongliang (“Mr. Pu”), a director who is also a principal stockholder of the Group, is also a director and has equity interests. Payment of the amount due had been guaranteed by Mr. Pu.

All amounts are interest-free, unsecured and repayable on demand.

12. AMOUNTS DUE TO DIRECTORS

The amounts are interest-free, unsecured and repayable on demand.

13. AMOUNT DUE FROM AN ASSOCIATED COMPANY

The amount is interest-free, unsecured and repayable on demand.

14. UNSECURED LOAN

The amount represents a loan borrowed from a financial institution which is interest bearing at 9.486% per annum, unsecured and repaid in 2006.

15. NOTE PAYABLE

The amount represents note payable to the government for research and development of the application of the waste water treatment system. The amount is interest-free, unsecured and repayable on demand.

16. ACCRUED LIABILITIES

At December 31, 2006 and 2005, accrued liabilities comprised of the following :-

	*December 31,*
	*2006*		*2005*
	*US$*		*US$*

PRC tax		850,774		615,415
Staff welfare		33,025		41,171
Other payable		464,900		645,834
Other accruals		132,195		95,634
Registration right liability		994,059		94,981
Deferred revenue		587,876		-

Total		3,062,829		1,493,035

17. AMOUNTS DUE TO RELATED COMPANIES

At December 31, 2006, the balance mainly represents borrowed cash from Guang Dong Ke Tai Company Limited, Long Men Ke Tai Company Limited and Beijing Zhao Cheng Chuang Zhan Investment Company Limited (“BJZC”) in which Mr. Pu has equity interests.

All amounts are interest-free, unsecured and repayable on demand.

F-20

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18. WARRANT LIABILITY

The fair values of the warrant liability as of December 31, 2006 are as below :-

	*December 31,*
	*2006*		*2005*
	*US$*		*US$*

Warrants issued in April, at fair value		200,000		450,000
Warrants issued in September, at fair value		2,073,680		5,667,200
Shares issued in September, accounted for as liability		32,200		32,200

Total		2,305,880		6,149,400

The Group has non-cash financing charges of US$8,001,211 for the year ended December 31, 2005 of which US$947,684 relates to the discounts given for the April Private Placement as described below and US$7,053,527 relates to the discounts given for the September Private Placement.

The Group has unrealized gain on warrant liability of US$3,843,520 and US$5,440,454 for the years ended December 31, 2006 and 2005 of which relates to the revaluation of the warrant liability to their fair value at year end.

The Group conducted a private placement in April 2005 (“April Private Placement”) of 20 investment units, at US$25,000 per unit, for gross proceeds of US$500,000. Each unit consisted of (a) a 12% convertible debenture in the original principal amount of US$25,000, convertible into shares of our common stock at the rate of the lesser of (i) US$0.20 per share or (ii) a 10% discount to the price per share of common stock (or conversion price per share of common stock) of the next private placement conducted by us prior to any conversion of the debenture, and (b) 125,000 detachable warrants to purchase one share each of our common stock at an exercise price of US$0.20 per share, expiring ten years from their date of issuance (“April Warrants”). As a result of the September 2005 private placement, pursuant to Section 5(d) of the warrant agreement, the exercise price has been adjusted to $0.15 per share on September 14, 2005. The debentures were due and payable August 1, 2005. The debenture holders, however, extended the payment period to September 30, 2005. The debentures were converted into 3,703,701 shares of common stock on October 1, 2005.

The Group used the Black-Scholes model in calculating the fair market value of the April Warrants and allocated US$148,531, US$74,266 and US$185,664 of the US$408,461 net proceeds to the Convertible Debenture, the Bifurcated Conversion Feature of the Debenture and the April Warrants, respectively. The differences between the fair value of each of the Convertible Debenture, the Bifurcated Conversion Feature of the Debenture and the April Warrants and the respective allocated amounts are recorded as non-cash financing charges and expensed of at the date of issuance. The principal assumptions used in the computation of the April Warrants are: expected term of 10 years; a risk-free rate of return of 4.24%; dividend yield of zero percent; and a volatility of 70%.

F-21

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18. WARRANT LIABILITY (CONT’D)

The Group granted to the holders of the April Warrants certain piggy-back and demand registration rights. Pursuant to the agreements surrounding the April Private Placement, in the event that the Group determined to undertake a registration of securities, the Group would include, at the request of the holder of “Registrable Securities”, the Registrable Securities in the registration statement. If the Group did not file a registration statement by the 120th day from the closing of such financing, and the Group shall have received a written request signed by the holders holding the majority of the Registrable Securities, then the Group was obligated to file, at its expense, a registration statement covering the Registrable Securities. Once such registration statement has been filed and declared effective, the Group is obligated to keep such registration statement effective until the earlier of (i) the date that all of the Registrable Securities have been sold pursuant to such registration statement, (ii) all Registrable Securities have been otherwise transferred to persons who may trade such shares without restriction under the Securities Act, and the Group has delivered a new certificate or other evidence of ownership for such securities not bearing a restrictive legend, or (iii) all Registrable Securities may be sold at any time, without volume or manner of sale limitations pursuant to Rule 144(k) or any similar provision then in effect under the Securities Act. As of December 31, 2006, the Group has not received any written request signed by the holders holding the majority of the Registrable Securities.

Under EITF No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, the fair value of the April Warrants should be reported as a liability. Pursuant to the related warrant agreement, because there is currently no effective registration statement covering the shares of common stock underlying these warrants, these warrants are currently subject to a cashless exercise whereby the warrant holders may surrender their warrants to the company in exchange for shares of common stock. The number of shares of common stock into which a warrant would be exchangeable in such a cashless exercise depends on both the exercise price of the warrants and the market price of the common stock, each at or near the time of exercise. Because both of these factors are variable, it is possible that we could have insufficient authorized shares to satisfy a cashless exercise. In this scenario, if we were unable to obtain shareholder approval to increase the number of authorized shares, we could be obligated to settle such a cashless exercise with cash rather than by issuing shares of common stock. Further, EITF No. 00-19 requires that we record the potential settlement obligation at each reporting date using the current estimated fair value of the warrants, with any changes being recorded through our statement of operations. We will continue to report the potential settlement obligation as a liability until such time as the warrants are exercised or expire or we are otherwise able to modify the warrant agreement to remove the provisions which require this treatment.

The conversion feature of the convertible debenture issued in April did not qualify for the scope of exception from the provisions of SFAS 133 because the convertible debentures are convertible into a variable number of shares. As such, the conversion feature was bifurcated from the convertible debenture and accounted for as a derivative at fair value with changes in fair value recorded in earnings. Upon the conversion of the convertible debentures in October 2005, the convertible debenture was recorded in equity as additional capital.

F-22

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18. WARRANT LIABILITY (CONT’D)

On September 14, 2005, the Group closed the private placement sale to accredited investors of units consisting of shares of our common stock and warrants to purchase shares of our common stock for aggregate gross proceeds of US$4.83 million (“September Private Placement”). Pursuant to the subscription agreements entered into with the investors, we issued to the investors 161 units at a price of US$30,000 per unit. Each unit consisted of 200,000 shares of our common stock, priced at US$0.15 per share, and warrants to purchase 200,000 shares of our common stock over a five year period at an exercise price of US$0.20 per share. Pursuant to the terms of the subscription agreements, we granted the investors limited registration rights for all common shares comprising the units, including the common shares issuable on exercise of the warrants. The Group also issued to Westminster Securities Corporation, as partial compensation for their placement agent services, 7,728,000 placement agent warrants to purchase one share each of our common shares, a portion of which has been assigned by Westminster Securities Corporation to certain of its officers and employees (the warrants issued in the September Private Placement together with the placement agent warrants are hereinafter referred to as “September Warrants”).

The Group used the Black-Scholes model in calculating the fair market value of the September Warrants and allocated US$4,140,535 of the US$4,172,735 net proceeds to the September Warrants. The difference between the fair value of the September Warrants and the allocated amount is recorded as non-cash financing charges and expensed of at the date of issuance. The principal assumptions used in the computation of the September Warrants are: expected term of 5 years; a risk-free rate of return of 4.24%; dividend yield of zero percent; and a volatility of 70%.

Under the subscription agreement for the September Private Placement, we agreed to prepare and file with the SEC (and did so file), at our own expense, a registration statement covering the registrable securities related to that placement. We agreed that in the event that the registration statement is not declared effective by the SEC within the earlier of 120 days from the final closing, we would pay to the investors in the September Private Placement liquidated damages in the amount of 2.0% of the purchase price of the registrable securities purchased from the Company and held by the investor for each month until the registration statement is declared effective. These liquidated damages began accruing on January 12, 2006. We agreed that if we do not remit payment of these liquidated damages, we will pay the investors in the September Private Placement interest at the rate of 12% per year until the liquidated damages are paid in full. The subscription agreement provides that if a registration statement is not effective at any time after one year following the issuance date of the September Warrants, these liquidated damages obligations will stop accruing. As of September 14, 2006 the liquidated damages obligations stopped accruing. As of December 31, 2006, we have made an accrual of $994,059 for registration right liability.

Under paragraphs 12-32 of EITF 00-19, contracts that include any provision that could require net-cash settlements cannot be accounted for as equity. Accordingly, the proceeds of the September Private Placement allocated for par value of the common stock and the September Warrants have been recorded as a liability on the balance sheet. Upon the effectiveness of the registration statement, the amount will be recorded as equity.

F-23

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

19. MINORITY INTERESTS

	*December 31,*

	*2006*			*2005*
	*US$*			*US$*

At January 1		821,704			198,015
Minority interests in the consolidated statements of operations		(177,714	)		277,700
Release on disposal of Beijing Hao Tai		(122,311	)		-
Additional capital injection of Beijing Hao Tai		-			99,133
Initial capital injection of Han Dan		-			260,223
Translation difference		19,426			(13,367	)

At December 31		541,105			821,704

20. BASIC NET LOSS PER SHARE

(i)

The basic net loss per share is calculated using the net loss and the weighted average number of shares outstanding during the year.

	*Year ended December 31,*
	*2006*			*2005*

Net loss (US$)		(1,504,236	)		(760,504	)

Weighted average number of common shares outstanding		135,903,698			110,549,423

Basic net loss per share (US$)		(0.01	)		(0.01	)

(ii)

The diluted net loss per share is calculated using the net loss and the weighted average number of shares outstanding during the year together with incremental common shares issuable upon exercise of all warrants issued.

	*Year ended December 31,*
	*2006*			*2005*

Net loss (US$)		(1,504,236	)		(760,504	)

Diluted weighted average number of common shares outstanding		135,903,698			110,549,423

Diluted net loss per share (US$)		(0.01	)		(0.01	)

As the April Warrants and the September Warrants are anti-dilutive, they are being excluded from the calculation of diluted net loss per share.

F-24

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

21. COMMON STOCK

	*No. of*		*Amount*
	*shares*		*US$*
Authorized :-

Common stock at US$0.001 par value
At December 31, 2005, and December 31, 2006		200,000,000		200,000,000

Preferred stock at US$0.001 par value
At December 31, 2005, and December 31, 2006		50,000,000		50,000,000

Issued and outstanding :-

Common stock at US$0.001 par value
At December 31, 2004 and January 1, 2005		99,999,997		100,000
Issue of shares		35,903,701		35,904
Shares issued accounted for as liability (Note 18)		-		(32,200	)

At December 31, 2005, and December 31, 2006		135,903,698		103,704

22. OTHER INCOME

	*Year ended December 31,*
	*2006*		*2005*
	*US$*		*US$*

Exchange gain		142,833		40,981
Bank interest income		842		-
Other income		6,215		13,641

		149,890		54,622

23. INTEREST EXPENSE

	*Year ended December 31,*
	*2006*		*2005*
	*US$*		*US$*

Interest on unsecured loans		2,908		12,625
Interest on debenture		-		30,366

		2,908		42,991

F-25

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

24. INCOME TAXES

(a) The income tax benefit (expense) consisted of the following :-

	*Year ended December 31,*
	*2006*			*2005*
	*US$*			*US$*
Current tax :
PRC		(79,773	)		(902,324	)
Deferred tax :
PRC		1,574,642			(17,677	)

Total income tax benefit (expense)		1,494,869			(920,001	)

The provision for income tax represents the provision for PRC enterprise income tax calculated at the standard income tax rate of 33% on the assessable profits of the PRC’s subsidiaries and the standard withholding income tax rate of 10% on the total revenue generated by Evergreen, a company incorporated in the British Virgin Islands, in the PRC.

Income tax benefit (expense) can be reconciled with the amount computed by applying the statutory income tax rate to income before income tax as follows :-

	*Year ended December 31,*
	*2006*			*2005*
	*US$*			*US$*

(Loss) income before income tax		(3,176,819	)		437,197

Expected income tax benefit (expense) at PRC statutory income tax rate of 33%		1,048,351			(144,275	)
Under provision in prior years		-			(436,804	)
Income not taxable for tax purposes		1,209,160			-
Tax rate differential		-			3,832
Tax effect of unrecognized tax losses		(987,852	)		(831,882	)
Utilization of tax loss		155,353			367,832
Others		69,857			121,296

Income tax benefit (expense)		1,494,869			(920,001	)

F-26

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

24. INCOME TAXES (CONT’D)

Note :-

The amount represents the difference of the provision for PRC enterprise income tax calculated at the standard income tax rate of 33% and the standard withholding income tax rate of 10% on the total revenue of Evergreen.

(b)

Deferred taxes result from temporary differences relating to items that are expensed/recognized as revenue for financial reporting, but are not currently deductible/taxable for income tax purposes. Significant components of our deferred tax assets and deferred tax liabilities as at December 31, 2006 and 2005 are as follows :-

	*December 31,*
	*2006*			*2005*
	*US$*			*US$*
Deferred tax assets :
Inventories		20,975			16,372
Accrued audit fee		-			409
Investment income		416,968			304,743
Cost of revenue		643,550			616,405
Depreciation		28,564			34,245
Deferred expenditure		1,667,610			181,020
Prepayment		33,919			-
Other administrative expenses		15,205			14,721
Other items		20,200			39,259

Total deferred tax assets		2,846,991			1,207,174

Deferred tax liabilities :-
Property, plant and equipment		(4,140	)		(4,007	)
Depreciation		-			(989	)
Exchange differences		(28,508	)		(11,250	)
Revenue		(985,840	)		(978,211	)
Other administrative expenses		(12,899	)		(8,833	)
Other items		(19,227	)		(16,617	)

Total deferred tax liabilities		(1,050,614	)		(1,019,907	)

Net deferred tax assets		1,796,377			187,267

F-27

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

25.

DETAILS OF COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

Costs and estimated earnings on uncompleted contracts and related amounts billed as of December 31, 2006, and December 31, 2005, are as follows:

	*December 31,*
	*2006*		*2005*
	*US$*		*US$*

Costs incurred on uncompleted contracts		334,926		2,770,093
Estimated earnings		52,953		2,060,519

		387,879		4,830,613
Less: Billings to date		387,879		4,830,613

		-		-

26. PENSION PLANS

As stipulated by the PRC government regulations, the Group is required to contribute to PRC insurance companies organized by the PRC government which are responsible for the payments of pension benefits to retired staff. The monthly contribution was equal to 12% of the salaries of the existing staff. The Group has no obligation for the payment of pension benefits beyond the annual contributions described above.

Pension contributions for 2006 and 2005 amounted to US$11,284 and US$8,409 respectively.

27. CONCENTRATION

F-28

CHINA WATER GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

28. COMMITMENTS

Capital commitment

At December 31, 2006 and 2005, capital expenditure contracted for but not recognized in these financial statements was as follows :-

	*December 31,*
	*2006*		*2005*
	*US$*		*US$*

Capital expenditures		-		5,928,800

29. RELATED PARTY TRANSACTIONS

Apart from those as disclosed in notes 11 to 13 and 17, the Group had the following transactions with its related parties :-

		*Year ended December 31,*
		*2006*	*2005*
*Related party*	*Nature of transaction*	*US$*	*US$*

GDXS	Deposit paid for acquisition of subsidiary	-	2,047,527
BJZC	Purchase of materials for construction	1,721,045	1,094,186

30. SUPPLEMENTAL CASH FLOW INFORMATION

	*Year ended December 31,*
	*2006*		*2005*
	*US$*		*US$*

(i) Interest paid		6,201		42,991

(ii) Non-cash investing activities
Conversion of Convertible debenture		-		1,000,000

31. DEPOSIT FOR ACQUISITION OF A SUBSIDIARY

On December 23, 2005, the Group entered into an agreement with GDXS for the acquisition of the equity interest in a company that owns a BOT facility in Tian Jin city for a consideration of approximately US$2,047,527 through setting off the amount due from GDXS. The amount is treated as deposit until approval from the local government of Tian Jin city is received. This acquisition was cancelled, and the deposit is treated as amount due from GDXS.

32. SUBSEQUENT EVENTS

On December 29, 2007, Evergreen disposed of its 58% equity interest in Xinxingmei to Wenming PU at a total consideration of RMB7,308,600.

On December 29, 2007, China Water Group Inc. signed a contract with Fortune Luck Global International Limited to acquire 90 percent of the equity interest of Aba Xinchen Dagu Glacier Spring Co., Limited through its subsidiary Guangzhou Xinchen Water Company. The assignment is at the consideration of 13.45 million dollars, of which 7.5 million dollars will be paid in cash, and the remaining 5.95 million dollars will be in shares.

On January 22, 2007, Evermaster signed a contract with GDXS to amend the Articles of HanDan, which is jointly owned by the two signed parties, decreasing its investment in HanDan from previous HK$ 17.86 million to HK$ 7.2 million, the equity shares Evermaster in HanDan accounted for decreased from previous 90% to 34.32% accordingly. Evermaster is 100 percent subsidiary of China Water Group Inc.

F-29

Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

Not Applicable

Item 8A. Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as this term is defined under the rules of the SEC) as of August 10, 2006. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer and Executive Chairman concluded that, as of August 10, 2006, our disclosure controls and procedures were not effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the US Securities Exchange Act of 1934 as a result of material weaknesses in our internal control over financial reporting described below.

In the process of filing our registration statement, we identified certain accounting errors in our reported US GAAP annual results for fiscal 2004 and 2005 and certain quarterly results in 2005 and 2006. As a result, we have restated the amounts and disclosures in those annual financial statements.

The financial statements which should no longer be relied upon include:

(i)

the audited consolidated financial statements contained in our report on Form 10-KSB for the fiscal year ended December 31, 2004 (the “2004 10-KSB”), filed with the SEC on April 15, 2005, Amendment No. 1 to the 2004 10-KSB filed on July 15, 2005, and Amendment No. 2 to the 2004 10-KSB filed on January 13, 2006 ;

(ii)

the audited consolidated financial statements contained in our report on Form 10-KSB for the fiscal year ended December 31, 2005 (the “2005 10-KSB”), filed with the SEC on April 17, 2006;

- 34 -

(iii)

the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended March 31, 2005 (the “March 31, 2005 10-QSB”), filed with the SEC on May 24, 2005;

(iv)

the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended June 30, 2005 (the “June 30, 2005 10-QSB”), filed with the SEC on August 15, 2005;

(v)

the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended September 30, 2005 (the “ September 30, 2005 10-QSB”), filed with the SEC on November 15, 2005 and Amendment No. 1 to the September 30, 2005 10-QSB filed on January 13, 2006; and

(vi)

the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended March 31, 2006 (the “March 31, 2006 10-QSB”), filed with the SEC on May 15, 2006.

Gain on disposal of the XY

As previously disclosed in our 2004 10-KSB, including amendments thereto, and comparative figures in our 2005 10-KSB, we recorded a gain on disposal of $2,029,720 in 2004 for the disposal of our 90% attributable interest in Xian Yang Bai Sheng Water Purifying Company Limited (“XianYang”) to True Global Limited (“TGL”), an independent party, at a consideration of $4,130,435 (RMB34.2 million). The disposal was made pursuant to a tri-party framework agreement between Evergreen Asset Group Limited (“EGAG”), TGL and Guang Dong Xin Sheng Environmental Protection Company Limited (“GDXS”) in which EGAG transferred 90% of its equity interest in XianYang to TGL while GDXS continued to own 10% of its equity interest in XianYang. The transaction was consummated on October 26, 2004 and the gain represents the difference between the disposal proceeds and our attributable share of net assets of ianXangY at the date of disposal. In the same year, we also recognized an amount of $9,115,942 for the construction revenue of XianYang using the percentage-of-completion method, estimated costs and claim recognition for construction contracts. The amount accounted for 97% of our total revenue in 2004.

In the previously filed 2004 10-KSB, as amended to date, and comparative figures in our previously filed 2005 10-KSB, the accounting treatment for the construction revenue of XianYang does not comply with SOP 81-1 or EITF 00-21. As a result, we will file an amendment to the 2004 10-KSB and 2005 10-KSB with adjusted disclosure to record the transaction as part of the gain on the disposal of the XianYang subsidiary rather than as revenue from construction of wastewater treatment plant. As such our adjusted total revenue for the fiscal year ended December 31, 2004 was $250,571 and the adjusted gain on disposal of interest in a subsidiary - XianYang was $5,220,299. Due to the same reason, account receivable from TGL amounted to $9,416,039 as of December 31, 2004 will be reclassified to prepayment, deposits and other receivables in our upcoming amendment to the 2004 10-KSB, comparative figures in this amendment to the 2005 10-KSB and comparative figures in the upcoming or recently filed amendments to the June 30, 2005 10-QSB and September 30, 2005 10-QSB.

- 35 -

Group reorganization

In Note 2(ii) and 2(iii) to the consolidated financial statements contained in the previously filed 2004 10-KSB and 2005 10-KSB and Note 2 to the consolidated financial statements contained in the previously filed March 31, 2005 10-QSB, June 30, 2005 10-QSB, September 30, 2005 10-QSB and March 31, 2006 10-QSB, we disclosed group reorganization transactions. Pursuant to rules promulgated by the SEC, the merger or acquisition of a private operating company into a non-operating public shell corporation with nominal net assets is considered a capital transaction, rather than a business combination. As such, no disclosures are required under FAS 141 because the transactions described were not business combinations. For accounting purposes, the transaction has been treated as a reverse acquisition and a recapitalization, and pro-forma information is not presented. Accordingly, the upcoming amendments to the 2004 10-KSB, this amendment to the 2005 10-KSB, and the recent or upcoming amendments to the March 31, 2005 10-QSB, June 30, 2005 10-QSB, September 30, 2005 10-QSB and March 31, 2006 10-QSB will not include references to the group reorganization transactions throughout the financial statements. We will also restate the common stock immediately after the recapitalization to $100,000 in the upcoming amended March 31, 2005 10-QSB and have done so in the recent amended June 30, 2005 10-QSB.

Reclassification of April warrants

In our previously filed 2005 10-KSB, June 30, 2005 10-QSB and March 31, 2006 10-QSB, we recorded as equity the warrants issued as part of the units sold in our April 2005 convertible debt issuance. Under EITF No. 00-19, the fair value of these warrants should be reported as a liability. Pursuant to the Warrant Agreement, because there is currently no effective registration statement covering the shares of common stock underlying these warrants, these warrants are currently subject to a cashless exercise whereby the warrant holders may surrender their warrants to the company in exchange for shares of common stock. The number of shares of common stock into which a warrant would be exchangeable in such a cashless exercise depends on both the exercise price of the warrants and the market price of the common stock, each at or near the time of exercise. Because both of these factors are variable, it is possible that the company could have insufficient authorized shares to satisfy a cashless exercise. In this scenario, if the company were unable to obtain shareholder approval to increase the number of authorized shares, the company could be obligated to settle such a cashless exercise with cash rather than by issuing shares of common stock. Further, EITF No. 00-19 requires that we record the potential settlement obligation at each reporting date using the current estimated fair value of the warrants, with any changes being recorded through our statement of operations. We will continue to report the potential settlement obligation as a liability until such time as the warrants are exercised or expire or we are otherwise able to modify the warrant agreement to remove the provisions which require this treatment. In addition to this restatement of our 2005 10-KSB, we will restate our June 30, 2005 10-QSB and our March 31, 2006 10-QSB to reclassify the April 2005 warrants as a liability.

- 36 -

April and September 2005 Private Placements—non-cash financing charges

In our June 30, 2005 10-QSB, we did not record any non-cash financing charges and in our September 30, 2005 10-QSB, as amended to date, we did not properly record the non-cash financing charges. Non-cash financing charges represent the amount by which the fair value of derivative liabilities issued exceeds the amount of proceeds received, as an expense at the date of issuance of the April convertible debenture and the September private placement. We will restate our June 30, 2005 10-QSB and our September 30, 2005 10-QSB to record the non-cash financing charges, which represent the amount by which the fair value of derivative liabilities issued exceeds the amount of proceeds received, as an expense at the date of issuance of the April convertible debenture and the September private placement. As a result of the recording of non-cash financing charges, certain expenses which were previously recorded under general and administrative expenses in our September 30, 2005 10-QSB will be reclassified under non-cash financing charges.

April 2005 Private Placements—unrealized gains or losses in financial instruments

In our June 30, 2005 10-QSB and our September 30, 2005 10-QSB, as amended to date, we did not record properly the unrealized gains or losses in financial instruments, which represent the change in fair market value of the financial instruments at each reporting date for the April warrants and the bifurcated conversion feature for the convertible debenture. The unrealized gains or losses in financial instruments should have been reported in those filings. We will restate the June 30, 2005 10-QSB and September 30, 2005 10-QSB, as amended to date, to record the unrealized gains or losses in financial instruments which represent the change in fair market value of the financial instruments at each reporting date for the April warrants and the bifurcated conversion feature for the convertible debenture.

Interest in associate

In our June 30, 2005 10-QSB and our September 30, 2005 10-QSB, as amended to date, the comparative figures for our interest in associate as of December 31, 2004 were recorded based on an effective percentage of equity attributable to the group of 31.5% instead of a direct interest of 35%. We will restate the comparative figures for our interest in associate as of December 31, 2004 in the June 30, 2005 10-QSB and September 30, 2005 10-QSB to include our interest in associate based on a direct interest of 35%.

- 37 -

Prior Restatements

On January 13, 2006, we amended our 2004 10-KSB. Prior to the January 13, 2006 amendment, in our 2004 10-KSB we recorded our interest in associate based on an effective percentage of equity attributable to the group of 31.5% instead of a direct interest of 35%. In the January 13, 2006 restatement of our 2004 10-KSB, we reported our interest in associate based on a direct interest of 35%. In addition, we have restated the common stock immediately after the recapitalization to $100,000.

On January 13, 2006, we amended our September 30, 2005 10-QSB. Prior to the January 13, 2006 amendment, the September 30, 2005 10-QSB classified as equity the proceeds of our April Debenture and September 2005 private placement allocated to the warrants issued in these transactions. For reasons both the April warrants and September warrants should have been classified as a liability. The restated financial statements in the January 13, 2006 amendment of the September 30, 2005 10-QSB reflect this reclassification. In addition, prior to the January 13, 2006 amendment, the September 30, 2005 10-QSB did not originally report the unrealized gains or losses in financial instruments, which represent the change in fair market value of the financial instruments at each reporting date. The unrealized gains or losses in financial instruments should have been reported in the original filing. Accordingly, the January 13, 2006 restatement of the September 30, 2006 10-QSB reported the unrealized gains or losses in financial instruments, which represent the change in fair market value of the financial instruments at each reporting date. The restatement to the unrealized gains or losses in financial instruments, however, required to be further restated (refer discussion above). In addition, we have restated the common stock immediately after the recapitalization to $100,000.

Material Weaknesses

In connection with the above matters, we have identified material weaknesses in our internal control over financial reporting, which weaknesses we have reported to our auditors. These material weaknesses comprise:

(a)

insufficient knowledge and experience among our internal accounting personnel regarding the application of US GAAP and SEC requirements;

(b)

insufficient written policies and procedures for accounting and financial reporting with respect to the requirements and application of US GAAP and SEC disclosure requirements; and

(c)

insufficient emphasis by management on compliance with US GAAP requirements.

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We have communicated with our auditors, PKF Hong Kong and concluded that these deficiencies constituted material weaknesses, as defined by Auditing Standard No. 2, “An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements,” established by the Public Company Accounting Oversight Board, or PCAOB.

In order to address these material weaknesses our senior management is in the process of conducting a thorough review of our US GAAP financial reporting processes and will prepare and implement a US GAAP action plan. This plan will be designed to generally improve our US GAAP reporting processes and to strengthen our control processes and procedures in order to prevent a recurrence of the circumstances that resulted in the need to restate our quarterly financial statements. Our senior management intends to complete its review and implement a US GAAP action plan as soon as practicable. The US GAAP action plan will incorporate, among other matters, the following initiatives:

arrange for our senior management and certain accounting and finance-related personnel to attend training sessions on US GAAP and financial reporting responsibilities and SEC disclosure requirements;

modify the mandate of our internal audit function to place greater emphasis on the adequacy of, and compliance with, procedures relating to internal controls over US GAAP financial reporting and engage an internationally recognized accounting firm, which is not affiliated with PKF Hong Kong, to assist our accounting department and internal audit function in the preparation of our US GAAP consolidated financial statements;

recruit an accounting staff member with US GAAP expertise and who is not affiliated with PKF Hong Kong; and

engage an internationally recognized accounting firm, which is not affiliated with PKF Hong Kong, to provide us with technical advice on US GAAP matters and SEC disclosure requirements on an ongoing basis.

Our board of directors discussed the matters disclosed in this filing with the registrant’s independent accountant. On September 25, 2006, we filed a current report on Form 8-K relating to these matters, including a response from our independent account relating to the statements contained therein.

Other than those disclosed above, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the fiscal year ended December 31, 2006.

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Item 8B. Other Information

Not applicable.

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Part III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act.

Set forth below are our executive officers and directors as of March 31, 2007.

Name	Age	Position
Chong Liang Pu	48	Chief Executive Officer, President and Director
Peh Chung Lim	39	Chief Financial Officer
Jia He Li	64	Chief Operating Officer
Shi Rong Jiang	32	Director
Lin Hong Ye	64	Director

Mr. Pu has served as our chief executive officer, president and a director since October 2004. Mr. Pu founded Evergreen and has acted as its chairman and president since April 2004. From May 1999 until April 2004, Mr. Pu was the chief executive officer and general manager of Guang Dong Xin Xing Mei Biology Company Limited, a majority-owned subsidiary of Evergreen.

Mr. Lim became our Chief Financial Officer effective December 29, 2005. Mr. Lim has more than 10 years of financial management experience with large multi-national corporations in Malaysia, Singapore, Indonesia, Taiwan and the PRC. Mr. Lim has served as our deputy chief financial officer since May 2005. Prior to joining us, Mr. Lim was the senior manager in internal audit, risk management and compliance in United Securities Investment Trust Corp. in Taiwan. Mr. Lim was the senior manager in project management and execution in Asia Pulp & Paper Ltd from 1997 to 2003. Mr. Lim is a member of CPA Australia and has a degree in Economics from Monash University in Melbourne, Australia.

Mr. Li has served as our chief operating officer since October 2004. Immediately prior to joining our company, Mr. Li was the assistant to the general manager of Evergreen and the deputy general manager of Guang Dong Xin Xing Mei Biology Company Limited, a majority-owned subsidiary of Evergreen. From March 2003 until April 2004, Mr. Li was the deputy general manager of Baijitan Hot Spring Co., Ltd., a hotel resort and spa operator in the PRC. From 1999 until March 2003, Mr. Li was a freelance project promoter, developer and designer for various development projects in the PRC.

Ms. Jiang has served as member of our board of directors since October 2004. Between June 2002 and October 2004, Ms. Jiang served as the assistant to the president of Guangdong Xinsheng Environmental Investment Group Limited. From May 1999 to June 2002, Ms. Jiang was assistant to the general manager of Guangdong Xinxingmei Environment Protection Company, a majority-owned subsidiary of Evergreen.

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Mr. Ye has served as member of our board of directors since October 2004. Between May 2000 and October 2004, Mr. Ye served as the vice president of the Guangdong Branch of the Chinese Academy of Sciences.

Audit Committee Financial Expert

We do not have an audit committee nor do we have a financial expert associated with an audit committee. Our entire board of directors performs the functions of our audit committee.

Code of Ethics

We have adopted a code of ethics that applies to the principal executive officer and principal financial and accounting officers. A copy of our code of ethics was filed as an exhibit to our annual report on Form 10-KSB for the year ended December 31, 2005. We will provide to any person without charge, upon request, a copy of our code of ethics. Requests may be directed to our principal executive offices at Suite 7A01, Baicheng Building, 584 Yingbin Road, Dashi, Panyu District, Guangzhou, Guangdong, China.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers, directors and persons who beneficially own more than 10% of a registered class of our equity securities to file reports of securities ownership and changes in such ownership with the Securities and Exchange Commission (the “SEC”). Officers, directors and greater than 10% beneficial owners are also required by rules promulgated by the SEC to furnish us with copies of all Section 16(a) forms they file.

All of our officers, directors or 10% shareholders have filed the reports required to be filed under Section 16(a), except for Mr. Peh Chung Lim and Mr. Jia He Li.

Item 10. Executive Compensation.

Cash Compensation of Executive Officers. The following table sets forth the cash compensation paid by the company to its chief executive officer for services rendered during the fiscal years ended December 31, 2006 and 2005.

	Annual Compensation								Long-Term Compensation
Name and Position	Year		Salary		Bonus		Other Annual Compensation		Restricted Stock Awards ($)		Common Shares Underlying Options Granted (# Shares)		All Other Compensation
Chong Liang Pu Chief Executive Officer		2006 2005	$	16,400 0		0 0		0 0		0 0		0 0		0 0

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Compensation of Directors. Members of our board of directors do not receive cash compensation for their services as directors, although some Directors are reimbursed for reasonable expenses incurred in attending board or committee meetings. In the future, we may have to consider compensating any outside directors that become members of our board of directors.

Item 11. Security Ownership of Certain Beneficial Owners and Management.

The following table sets forth certain information regarding the beneficial ownership of the shares of our common stock as of March 31, 2007 by (i) each person who is known by us to be the beneficial owner of more than five percent (5%) of the issued and outstanding shares of our common stock, (ii) each of our directors and executive officers and (iii) all directors and executive officers as a group. The information is determined in accordance with Rule 13(d) 3 promulgated under the Exchange Act based upon information furnished by persons listed or contained in filings made by them with the Securities and Exchange Commission by information provided by such persons directly to us. Except as indicated, the stockholders listed below possess sole voting and investment power with respect to their shares.

Name ⁽¹⁾	Number of Shares of Common Stock Beneficially Owned ⁽²⁾		Percentage Owned
Chong Liang Pu		57,489,750		42.30	%
Shi Rong Jiang		5,101,000		3.75	%
Jia He Li		-0-		0	%
Lin Hong Ye		-0-		0	%
Peh Chung Lim		-0-		0	%
Gao Yongping		10,145,250		7.47	%
Vision Opportunity Fund ⁽³⁾		13,600,000		9.53	%
All directors and executive officers as a group				53.52	%

(1)	The addresses of Chong Liang Pu, Shi Rong Jiang, Jia He Li, Lin Hong Ye, Peh Chung Lim and Gao Yongping are Suite 7A01, Baicheng Building, 584 Yingbin Road, Dashi, Panyu District, Guangzhou, Guangdong, China.

(2)

Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Ordinary shares relating to options currently exercisable or exercisable within 60 days of the date of this table, are deemed outstanding for computing the percentage of the person holding such securities but are not deemed outstanding for computing the percentage of any other person. Except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table above have sole voting and investment power with respect to all shares shown as beneficially owned by them.

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(3)	Vision Opportunity Master Fund Ltd. is the beneficial owner of the shares held of record by Vision Opportunity Master Fund Ltd.

This table is based upon information derived from our stock records. Unless otherwise indicated in the footnotes to this table and subject to community property laws where applicable, we believe that each of the shareholders named in this table has sole or shared voting and investment power with respect to the shares indicated as beneficially owned. Applicable percentages are based upon 135,903,698 shares of common stock outstanding as of April 13, 2006.

The common shares beneficially owned by Vision Opportunity Fund Ltd. include (i) 6,800,000 common shares, and (ii) 6,800,000 common shares issuable upon exercise of outstanding warrants. The address for Vision Opportunity Fund Ltd. is 253 East 77^th St., PH-F, New York, NY 10021.

Equity Compensation Plans

The following table sets forth certain information as of December 31, 2005 concerning our equity compensation plans:

Plan Category		Number of Common Shares to Be Issued Upon Exercise of Outstanding Options		Weighted- Average Exercise Price of Outstanding Options		Number of Common Shares Remaining Available for Issuance
		None

Item 12. Certain Relationships and Related Transactions.

We have the following related party transactions for the years ended December 31, 2006 and 2005:

Year ended

December 31,

Related party

Nature of transaction

2006

USD

2005

USD

GDXS

Deposit paid for acquisition of subsidiary

—

2,047,527

BJZC

Purchase of materials for construction

1,721,045

1,094,186

BJZC

Deposit paid for acquisition of property, plant and equipment

—

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“BJZC” - Bei Jing Zhao Cheng Chuang Zhan Investment Company Limited

“GDXS” - Guang Dong Xin Sheng Environmental Protection Company Limited

We hold the exclusive rights to use MHA biological treatment processes technologies and GM Bio-carriers. Both are the subject of patents owned by our Chairman, Mr. Pu, and we have acquired the exclusive rights pursuant to a license agreement with Mr. Pu.

Item 13. Exhibits.

Index To Exhibits

2.1

Securities Purchase Agreement and Plan of Reorganization (1)

2.2

Amendment No. 1 to Securities Purchase Agreement and Plan of Reorganization (1)

3.3

Certificate of Amended and Restated Articles of Incorporation (3)

3.4

Bylaws (4)

3.5

Amendments to Bylaws (3)

10.1

BOT Investment and Operation Contract for Sewage Treatment Plant between Guangdong Xinsheng Environmental Protection Co., Ltd. and City Administration of Feng Feng Mining Area of Handon City, Hebei Province (5)

10.2

Investment Management Contract dated August 14, 2002 between Guangdong Xinxingmei Environmental Protection Science and Technology Investment Co., Ltd. and The People’s Government of Wuqing District, Tianjin City (5)

10.3

BOT Investment Contract dated July 4, 2003 between Guandong Xinsheng Environmental Co., Ltd. and People’s Government of Shunyi District, Beijing (5)

10.4

Contract for BOT Project Investment and Operation between Guandong Xinsheng Environmental Co., Ltd. and Shandong Haiyang Planning and Construction Administration (5)

10.5

Agreement with Shenzhen Jukeyuan Industry Development Co., Ltd. dated July 28, 2005(5)

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10.6

Agreement with Tianjin Wuqing Huangzhuang Industrial Zone dated July 20, 2005(5)

10.7

Agreement with Tianjin Wuqing Fuyuan Economic Development Co., Ltd. dated May 28, 2005(5)

10.8

Agreement with Beijing Jinqiao Luyuan Environmental Protection Investment and Development Co., Ltd. dated August 4, 2005(5)

10.9

Agreement with Yongji Economic Development Zone Land Planning and Construction Bureau dated August 6, 2005(5)

10.10

License Agreement with Chong Liang Pu(6)

10.11

Agreement between Evergreen and Mr. Wenming Pu dated December 29, 2007(7)

Letter re Change in Certified Registered Public Account (2)

21.1

List of Subsidiaries

31.1

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1)	Previously filed as part of the Company’s current report on Form 8-K filed with the Securities and Exchange Commission on October 21, 2004.

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(2)	Previously filed as part of the Company’s current report on Form 8-K/A filed with the Securities and Exchange Commission on December 30, 2004.

(3)	Previously filed as part of the Company’s annual report on Form 10-KSB filed with the Securities and Exchange Commission on April 15, 2005.

(4)	Previously filed as part of the Company’s Form 10-SB filed with the Securities and Exchange Commission on May 24, 1999.

(5)	Previously filed as part of Amendment Number 1 to Registration Statement on Form SB-2, filed January 12, 2006, 1933 Act Number : 333-129064.

(6)	Previously filed as Exhibit 10.5 to the Company’s annual report on Form 10-KSB/A filed with the Securities and Exchange Commission on July 15, 2005.

(7)	Previously filed as part of the Company’s current report on Form 8-K filed with the Securities and Exchange Commission on January16, 2008.

Item 14. Principal Accountant Fees and Services

Our board of directors has selected PKF Hong Kong SAR as our independent accountants to audit our consolidated financial statements for the two fiscal years ended December 31, 2006 and 2005.

Audit and Non-Audit Fees

Aggregate fees for professional services rendered to us by our accountants for the years ended December 31, 2006 and 2005 were as follows:

Services Provided	2006		2005
Audit Fees	$	85810	$	50,438
Audit Related Fees		-0-		-0-
Tax Fees		-0-		-0-
All Other Fees		-0-		-0-

Total	$	85810	$	50,438

Audit Fees. The aggregate fees billed by PKF Hong Kong SAR for the years ended December 31, 2006 and 2005, respectively, were for the audits of our financial statements and reviews of our interim financial statements included in our annual and quarterly reports.

Audit Related Fees. There were no fees billed for the years ended December 31, 2005 and 2004 for the audit or review of our financial statement that are not reported under Audit Fees.

Tax Fees. There were no fees billed for the years ended December 31, 2006 and 2005 for professional services for tax compliance, tax advice and tax planning.

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All Other Fees. There were no other fees of any type billed for the years ended December 31, 2006 and 2005 for services other than the services described above.

Pre-Approval Policies and Procedures

We have implemented pre-approval policies and procedures related to the provision of audit and non-audit services. Under these procedures, our board of directors pre-approves all services to be provided by PKF Hong Kong SAR and the estimated fees related to these services.

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Signatures

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	CHINA WATER GROUP, INC.

Date: July 11, 2008	By:	/s/ Chong Liang Pu
		Chong Liang Pu, Chaorman of the Board

In accordance with the Exchange Act, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ Chong Liang Pu	Chairman of the Board and a director	July 11, 2008
CHONG LIANG PU

/s/ Ren Cai Ding	Chief Financial Officer	July 11, 2008
REN CAI DING

/s/ Lin Hong Ye	Director	July 11, 2008
LIN HONG YE

/s/ Shi Rong Jiang	Director	July 11, 2008
SHI RONG JIANG

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