UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)
 
[ x ]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

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

For the transition period ______________ to ______________

Commission file number: 001-33588

CHINA FIRE & SECURITY GROUP, INC.
(Exact name of registrant as specified in its charter)

Florida
 
65-1193022
(State of incorporation)
 
(I.R.S. Employer Identification No.)

B-2502 TYG Center, C2 Dongsanhuanbeilu,
Chaoyang District, Beijing 100027,
People’s Republic of China
(Address of principal executive offices)

(86-10) 8441 7400
(Issuer’s telephone number, including area code)

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

Common Stock, $.001 Par Value
 
The Nasdaq Capital Market, LLC
(Title of Class)
 
(Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Exchange Act: None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [  ] No [ x ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [  ]  No [ x ]

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 [ x ]   No [  ]

 
1

 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [  ]   No [  ]
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this Form 10-K.  [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer [  ]
Accelerated filer [ x ]
Non-accelerated filer [  ]
(Do not check if a smaller
reporting company)
Smaller reporting
company [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act):
Yes [  ]  No [ x ]

The aggregate market value of the 10,436,441 shares of voting and non-voting common equity stock held by non-affiliates of the registrant was $95,806,528 as of June 30, 2010, the last business day of the registrant’s most recently completed second fiscal quarter, based on the last sale price of the registrant’s Common Stock on such date of $9.18 per share, as reported by The NASDAQ Stock Market, Inc.

As of March 15, 2011, there were 27,855,934 shares of Common Stock of China Fire & Security Group, Inc. outstanding.

Except as otherwise indicated by the context, references in this Form 10-K to:

 
[  ]
“China Fire & Security Group,” the “Company,” “CFSG,” “we,” “us” or “our” are references to the combined business of China Fire & Security Group, Inc. and its direct and indirect subsidiaries.

 
[  ]
“U.S. Dollar,” “$” and “US$” means the legal currency of the United States of America.
 
[  ]
“RMB” means Renminbi, the legal currency of China.

 
[  ]
“China” or the “PRC” are references to the People’s Republic of China.
  [  ] "U.S" is a reference to the United States of America
 
[  ]
“SEC” is a reference to the Securities & Exchange Commission of the United States of America.

 
2

 

TABLE OF CONTENTS
 
     
Page
 
 
    4  
    12  
    20  
    21  
    21  
         
 
    21  
    22  
    23  
    38  
    39  
    39  
    39  
    41  
         
 
    42  
    45  
    50  
    52  
    52  
         
 
    54  

 
3

 
PART  I

Item  1. Business

Overview
 
We are engaged primarily in the design, development, manufacture and sale of a variety of fire safety products for the industrial and special purpose infrastructure industries and the design and installation of industrial fire safety systems in which we primarily use our own fire safety products. To a minor extent, we provide maintenance services on our industrial fire safety systems for our customers. Our business is primarily in China, where we operate sales and liaison offices in more than 20 cities; we are also expanding our business overseas by providing integrated fire safety systems to industrial clients globally.
 
We market our industrial fire safety products and systems primarily to major companies in the iron and steel, traditional power generation, nuclear power generation and petrochemical industries in China. In the last two years, we also secured several contracts with power generation plants in India. We are further developing our business in the transportation sector, which includes projects involving subways, highway tunnels, high speed trains and marine transportation, and telecommunications.
 
We have internal research and development facilities engaged primarily in furthering fire safety technologies. We believe that our technologies allow us to offer cost-effective and high-quality fire safety products and systems. We have developed products for industrial fire detecting and extinguishing. We believe that we are the leading manufacturer in China of such systems having successfully developed a comprehensive line of linear heat detectors.
 
Our company is the result of a share exchange completed on October 27, 2006 between Unipro Financial Services, Inc., a Florida corporation (“Unipro”) and the shareholders of China Fire Protection Group, Inc., a limited liability company organized under the laws of the British Virgin Islands (“CFPG”). The share exchange resulted in a change of control of Unipro, with the former shareholders of CFPG owning approximately 80.5% of the company on a fully diluted basis after the share exchange. The directors and officers of CFPG became our directors and officers in conjunction with the share exchange. Effective as of January 31, 2007 we changed our name to China Fire & Security Group, Inc.
 
We have twice been ranked as the leading Chinese industrial fire safety company by the China Association for Fire Prevention based on six major factors including total revenue, growth rate, net profit, return on assets, investment in research and development and intellectual property. During the last three years, we were also continuously ranked as the leading fire protection brand in China in a survey conducted by www.HC360.com . HC360 is a leading B2B electronic commerce services provider in China and runs the largest commercial website in China's fire protection industry (www.fire.HC360.com).  Our key products include linear heat detectors and water mist extinguishers.

Our Strategies:
 
We aim to further leverage our total solution business model, proprietary core technology and products, and strong management team to seek innovations in total solution sales, systems and technologies, and project management and to achieve accelerated growth while significantly lowering costs. We intend to achieve our goals through the following key strategies:
 
 
We plan to continue to develop and capture opportunities in providing fire protection total solutions to high end customers in industrial and special purpose infrastructure industries.

 
o
In the iron and steel industry, we will utilize our breakthroughs in the retrofitting and maintenance services area to win more contract opportunities in 2011 and 2012 and to capitalize on the industry’s continued consolidation.
 
 
o
We plan to promptly and selectively expand into new verticals and international markets.  New targeted verticals include: conventional power plants, power transmission (grid), nuclear power plants, petroleum and natural gas, petrochemical, transportation (subways, highway tunnels, high speed trains), ships and marine transportation, telecommunications carriers.
 
 
We plan to further enhance proprietary product research and development, standardization, industrialization and intellectual property protection, in order to broaden our product portfolio, improve profitability, help penetrate new
 
 
4

 
   
verticals, and increase product sales through direct and independent third-party channels.
 
 
o
We plan to further enhance fire codes in the iron and steel industry and other new verticals and initiate improvements on certain current product standards at the national and international levels.

 
o
In addition to core products in industrial fire detection and suppression systems, we plan to expand our product portfolio through internal development and partnership with third parties, and to provide our customers with integrated product development and scaled product manufacturing.

 
o
We aim to increase the market share of our integrated products by offering total solutions to our customers as well as by product sales through independent channels.
 
 
We plan to build a stronger management platform to support accelerated business growth by improving corporate management capabilities in contract budgeting, financial control and auditing, and human resources management.
 
 
We will be strategic in joint venture and mergers and acquisition opportunities. Our objective in potential selective and strategic joint ventures and mergers and acquisitions is to augment our organic growth strategy.
 
Our Industry

The Industrial Fire Safety Industry
 
The fire safety industry can be generally divided into three major segments: residential, commercial and industrial. The industrial fire safety business requires greater technical expertise than the residential or commercial fire safety businesses due to the hazardous conditions of the industrial environment. Designers must consider a myriad of complex technologies, safety factors and unique fire hazard risks associated with various areas of production. Designers must also contend with adverse environmental problems such as humidity and dust and electro-magnetic interference to develop solutions to analyze and mitigate the spread of fire and chain reactions that are more likely to occur in the automated industrial production environment.
 
Along with China’s modernization drive, its economy has witnessed significant growth in the past three decades, which brought about rapid growth in various industrial sectors, including the iron and steel as well as the power and petrochemical industries. Moreover, due to its investment environment and relatively low cost labor, China has attracted many manufacturers from developed countries. China’s increasing industrial capacity has caused, and is anticipated to continue to cause, a high level of demand for industrial fire safety products and services.
 
Due to the increased loss of lives and properties as a result of fires, the Chinese government began to attach increasing importance to industrial fire safety in the 1990’s. The government enacted various laws and issued regulations on fire safety, of which the most important included the Fire Safety Law of 1998 and the Safe Production Law of 2002. On May 1, 2009, the government released the amendment to the Fire Safety Law in which it stressed that the principal of an enterprise or a building is personally liable for fire casualties. These laws, while expressing the government’s increased emphasis on fire safety, can be vague and are not in and of themselves responsible for the increase in demand. More important to the demand for products and services are fire codes for various industrial sectors. In April 2007, China’s Ministry of Construction published a fire code entitled “Code of Design on Fire Protection and Prevention for Iron and Steel Metallurgy Enterprises”, which became effective on January 1, 2008. This fire code is applicable to all new build-out of plants, and the expansion and renovation of the existing facilities of any iron and steel company.
 
The fire safety industry has historically used foreign products, which have been superior in technology and quality. In recent years, Chinese products have improved in terms of technology and quality and are being increasingly accepted. The competitive price of Chinese products has also become a competitive advantage.
 
The industry for the design, manufacture and installation of fire safety systems is fragmented with no dominant players. As a result, we believe that there is an opportunity for consolidation and expansion which will allow major players to emerge.

Our Leadership Position in the Industry
 
We began in 1995 as the first Chinese company specializing in industrial fire safety. We believe that we have established ourselves as the recognized leader in the industrial fire safety business in China based on the following competitive advantages:
 
5

 
A large number of mid-to-high end loyal customers in various industries:

China Fire has been issued the top level certificates for both System Contracting and Engineering from the Ministry of Construction of China. China Fire was ranked No. 1 in the survey of System Contracting Enterprises undertaken by China Fire Association in 2001. Leveraging its own products with proprietary technologies and comprehensive design experience, China Fire has superior capabilities and expertise in providing total fire protection systems to industrial customers. China Fire serves a long list of mid-to-high end loyal customers in various industries including iron and steel, petrochemical, traditional power, nuclear power, and transportation. We receive repeat business from these customers when they build new projects or rebuild their existing plants.

Technological leadership; several high valued proprietary intellectual properties:

China Fire has developed a series of proprietary technologies for industrial fire safety products including linear heat detectors which have been awarded dozens of patents worldwide. These technologies have enabled the Company to become one of the chief editors for relevant national fire product standards. Leading technologies, proprietary patent protection and our influence over fire safety standard have contributed to China Fire’s unique market leading position with sustainable advantages.

Lead and influence the enhancement of various national fire codes and product standards:

China Fire is an editorial member of the national Codes of Fire Protection Standards for Metallurgy, Iron & Steel Enterprises, and of the “Linear Heat Detector” and participates in various other fire codes at the national and provincial level. These enhancements have improved fire safety standards in China and created larger market demand for many products including our proprietary products which have better prices and reliability.

Specialized research and development centers and manufacturing bases for fire detection products and fire suppression products:

China Fire has a specialized research and development center and manufacturing base for fire detection products in Beijing and another research and development center and manufacturing base for fire suppression products in Tianjin. Recognized by the government as a high-tech enterprise, China Fire has ample manufacturing capacity to support its future business growth in specialized fire detection and suppression products.

Experienced management team with established track record for sustained growth:

China Fire has a strong management team which consists of experts in technology, sales and marketing and general management. The core team has both domestic experience and international vision with a strong track record in the fire protection industry.

Our Products and Services
 
Our major customers are in the iron and steel (contributing approximately 77.7% of revenues), traditional power generation (contributing approximately 6.9% of revenues) and petrochemical (contributing approximately 5.8% of revenues) industries. Our revenues are mainly from three sources: Total Solutions, Product Sales, and Maintenance Services. In 2010, revenues from total solutions accounted for approximately 74.5% of total revenues and the sale of products integrated accounted for approximately 21.0% of total revenues, while maintenance services accounted for approximately 4.5% of total revenues.

Total Solutions
 
We design and install total fire protection systems for our clients. A fire protection system consists of three major components: fire detectors, fire alarm control and network supervisory systems, and fire extinguishing systems. In most cases, we design and install all three components. The price of systems varies with the size and complexity of the installation, ranging from $10,000 to $92 million. In 2010, we designed and installed more than 220 systems. The design and installation of a system can take one month to three years, depending on the complexity of the system. Approximately 11% of the systems take less than one year to complete, while approximately 89% of the systems require more than one year. Revenues from total solutions typically can be broken down as follows: 50-65% of revenues from products manufactured by us; 25-40% of revenues from products manufactured by third parties; and 10% of revenues from services (the design and installation). The price of our own products incorporated into the total solution
 
 
6

 
systems we design and install is similar to that sold directly to our customers. The markup for third party products is approximately 20-30%.
 
We maintain long-term relationships with the majority of our customers. In 2010, the top-five projects for total solution systems that we implemented for our customers (based on its revenue recognized and the percentage contribution) were as follows:

Top-Five Customers of Our Total Solutions in 2010
 
Name
 
Industry
 
Amount of
Revenues
(in thousands)
($)
   
Percentage of
Total Solution
Revenues
 
Wuhan Iron & Steel Group
 
Metallurgy
   
32,951
     
55.3
%
Capital Iron & Steel Group (Caofeidian Project)
 
Metallurgy
   
5,067
     
8.5
%
Anshan Iron & Steel Group Chaoyang Company
 
Metallurgy
   
2,116
     
3.5
%
Handan Iron & Steel Baogang
 
Metallurgy
   
2,035
     
3.4
%
Anshan Iron & Steel Group Bayuquan Company
 
Metallurgy
   
1,777
     
3.0
%
Total
       
43,946
     
73.8
%

Products
 
Depending on the requirements of our clients, we provide integrated fire protection products. By selling products we manufacture and incorporating products outsourced from third parties we provide a complete system for our clients. Such revenues do not include the sale of our products in connection with our total solution business or the design and installation of fire protection systems. We manufacture the following products, which can be divided into three categories according to their functions:

Fire Detectors. The products include:

   - Linear Heat Fire Detectors
   - Multi-Frequency Infrared Flame Detectors
   - Infrared and Ultraviolet Composite Flame Detector
   - Long Range Infrared Combustible Gas Detectors
   - Fixed Point Combustible Gas Detectors
   - Point Fire Detectors

Fire Alarm Control and Network Supervisory Systems. The products include:

   - Fire Alarm Control Unit
   - Electric Fire Monitoring System
   - Fire Control Room Display System
   - Fire Safety Monitoring Center System
   - Remote Customer Service System

Fire Extinguishing Systems. The products include:

   - Water Mist Fire-Extinguishing System
   - Anti-False-Spray Water Spray Fire-Extinguishing System
   - Gas-Based Fire-Extinguishing System
   - Foam-Based Fire-Extinguishing System
   - Portable and Transportable Fire Extinguishers
   - High-Pressure Cylinders
 
We focus on the production and sales of our proprietary products, which are associated with our technologies and intellectual properties. The sales of our proprietary products, which include our liner heat detectors and water mist fire-extinguishing systems, contribute a higher gross margin than the products outsourced from the third parties.

 
7

 
In 2010, we developed new products, including infrared and ultraviolet composite flame detectors, electric fire monitoring system and high-pressure water mist fire-extinguishing system. We believe that the development of these new products will enhance our product offerings and strengthen our competitive position.
 
We have established quality assurance systems throughout the company and achieved ISO9001:2000 certification since 2001. ISO9001:2000 refers to a quality management system which demonstrates the company’s ability to consistently provide products that meet applicable regulatory requirements and aim to enhance customer satisfaction. We believe these certifications are recognition of our commitment to and efforts in implementing and maintaining a quality management system in the design, manufacturing and sales of our fire safety products.
 
The tables below list our top-five Products Sales customers as of December 31, 2010. The amounts and percentages do not include the sales of our products as part of total solutions:

Top-Five Customers of Our Product Sales in 2010

Name
 
Industry
 
Sales in
(in thousands)
($)
   
Percentage of
Total Product
Sales
 
Shenhua Group Baotou Coal Chemical Corporation
 
petrochemical
   
2,504
     
14.8
%
China Nuclear Power Engineering Co., Ltd.
 
Nuclear
   
1,417
     
8.4
%
Dongfang Electric Corporation
 
Power
   
989
     
5.9
%
Wuxi Tianyou Special Detector Technology Corporation
 
Others
   
736
     
4.4
%
Anshan Iron & Steel Group
 
Metallurgy
   
566
     
3.4
%
Total
       
6,212
     
36.8
%
 
Our Intellectual Property
 
We develop our own technologies for our products and services. We own 88 patents and have 16 pending applications in China and internationally. These patents are related to fire detecting, system control, and fire extinguishing technologies as listed in the table below.

Our Intellectual Properties
Product
  
Patents
Issued
 
Patents
Pending
  
Linear Heat Fire Detectors
 
70
   
14
 
Infrared Flame Detectors
 
1
   
 
Water Mist Nozzles
 
8
   
 
Remote System Control Device
 
0
   
0
 
Fire Alarm Control Device
 
0
   
 
Foamed-Based Fire Extinguishing Device
 
2
   
 
Others
 
7
   
 
Total
 
88
   
16
 
 
We own seven copyrights for software used for detecting assembly and control modules. We have developed proprietary software to provide localized and network-based fire detection and monitoring solutions. We believe that we are the first company in China to provide customers with remote system monitoring services based on our network-based solutions. From our centralized monitoring center, we can detect any status change (major alarm, critical alarm, fire alarm, etc.) in the major components of each system, upload information, and take appropriate actions if needed. We have been granted copyrights for such software by China’s State Bureau of Copyrights.
 
We have thirteen registered trademarks for our products and services approved by the State Administration for Industry and Commerce of China,.  In addition, we currently own three internet domain names “www.sureland.com.cn”, “www.sureland.com.” and “www.chinafiresecurity.com”.

 
8

 
Our Research and Development Efforts
 
We currently have approximately 21 members on our research and development  (“R&D”) team. Most of our R&D staff have been working in the field of fire safety products for over five years. Research and development costs were $1,966,557 and $1,631,435 during the years ended December 31, 2010 and 2009, respectively.
 
Our research and development activities involve improving upon existing products, developing new products, designing better and more efficient fire safety systems, and developing new applications for such products and systems. We are currently developing new technologies for anti-explosive gas bottles, alternate foam storage and mix device and high-pressure water mist systems. We plan to conduct R&D to develop infrared flame detectors and industrial fire protection monitoring and control systems in the future. Our R&D activities also involve further developing and improving our core manufacturing technologies so that we can expand our product lines and reduce overall costs. We have entered into joint research and development agreements with some universities whereby we have exclusive ownership to any technology developed. These efforts have led to the successful development of numerous peripheral products for our fire safety systems.  For example, we have enhanced our network based fire protection system monitoring software through a joint development program between the Company and Wuhan Iron and Steel University. In 2008, we established a Fire Safety Research Center with Wuhan Technology University.
 
To enhance our R&D capabilities, we completed the construction of a new R&D center in 2006, consisting of a 1,800 square meter building with new R&D equipment. The total spending for the construction and equipment was approximately $1 million. The center is devoted to our research and development efforts and to the development of integrated manufacturing practice and processes. The center is a base for training research and technical personnel and for developing additional proprietary technologies.

Our Marketing Efforts
 
Currently, we have established our position as the leading Chinese supplier of fire safety products and services in the iron and steel, power and petrochemical industries. We have installed 80% of the large systems in the iron and steel industry. Our business plan is to maintain our leadership and expand our market share in the iron and steel, power and petrochemical markets, while targeting several new market segments which we believe offer expansion opportunities, including transportation (highways, subways and railways) and nuclear power generation. We also have installed fire safety systems for the warehouses of distilleries and cigarette factories.
 
Our marketing efforts have made us one of the leading suppliers of fire safety products and services in China. All of our products and services are marketed and sold through our direct sales force. Under Chinese laws and regulations, a company which plans to install fire safety systems must apply to the relevant government agency for the approval of the project. Due to our relationship with these agencies, we are able to receive information about projects under consideration in advance and prepare for the bidding accordingly. Our sales force regularly visits the research and design institutes under those agencies to educate them with our products and to share with them our experiences in the design and deployment of fire protection systems for industrial facilities. These marketing efforts better position us for receiving contracts for fire safety systems when they design a new plant or facility. Almost all of our contracts are procured through an open bidding or invitation only bidding process.  Contracts secured without bidding usually provides us with higher margins.
 
Our linear heat detectors and water/mist extinguishers have received the UL certification. We have an OEM arrangement with Xi’an System Sensor Electronics Co., Ltd., a China subsidiary of Honeywell, for OEM manufacturing of linear heat detectors for Honeywell. We have signed an additional three OEM manufacturing agreements with another two multinational companies under confidential terms.
 
We are actively expanding our marketing network into other parts of China. We have established sales offices and liaison offices in more than 26 locations. Mainly through internal growth, we project an increase in the number of sales and liaison offices.  In April 2009, we entered into an agreement with Jinan Iron & Steel, China’s eighth-largest steel producer and a leading exporter of medium and thick steel plates, to serve as the turn-key fire protection solution provider and to implement Jinan Iron & Steel’s automated fire protection system.
 
Our sales team has approximately 60 members. To expand distribution channels and increase our market share, we regularly attend industrial exhibitions organized by local and national industrial associations. We run advertisements in major industry journals, magazines and catalogues. We also run advertisements on industry websites including www.china-fire.com and www.fire.hc360.com .

 
9

 
Material and Parts Supply
 
We manufacture products that provide higher margins and subcontract products with comparatively lower margins. Given the importance to our business of key materials and parts, the purchasing and management of these important functions are top priorities. We carefully manage our purchasing efforts and have established company policies involving materials and parts procurement. The cost of materials for our own products is approximately 80-90% of the total production cost.

Supplier Management System
 
We have adopted measures to reduce risks in materials and parts supply, including 1) obtaining better services and higher quality, 2) diversifying suppliers and supply sources, and 3) seeking long-term contracts with suppliers.

Purchasing Procedures
 
Our production department collaborates with our quality and procurement department to produce a list of qualified suppliers that is based on quality, price, technical competency and capacity. Purchasing transactions are sometimes conducted in accordance with procedure for bidding invitations. Potential suppliers are evaluated on their proposed terms, technical specifications, price, payment terms and timing for delivery. After validation of the various suppliers’ service stable supply capabilities, we acquire the needed materials and parts from the supplier offering the best terms. Our procurement department establishes an oversight process by appointing individuals to conduct periodic market research of key price points. There is a standard procedure for conducting said bidding process and accepting the bids to insure that all of the purchasing procedures are being strictly followed. We enter into long-term contracts with certain suppliers to lock in prices and send purchase orders for each delivery when necessary. Our long-term supply contracts do not contain any minimum unconditional purchase requirements.

Major Suppliers

The tables below list our top five suppliers as of December 31, 2010

Major Suppliers of Materials and Parts for Our Own Products
 
Item
 
Suppliers
 
Amount
Purchased
in 2010
(in thousands)
($)
   
Percentage
of Total
Purchase
 
Electronic parts
 
Beijing Huataichuang Technology Co., Ltd.
   
220
     
11.5
%
Electric box
 
Beijing Qingxianfangzheng Electric Box Co., Ltd.
   
211
     
11.0
%
Infra red flame detectors
 
Shandong Automatic System Engineering Co., Ltd.
   
167
     
8.7
%
Cable
 
Nanjing Xianbang Technology Co, Ltd.
   
168
     
8.8
%
Copper
 
Xinlide (Tianjin) Metal Manufacture Co, Ltd.
   
68
     
3.5
%
Total
       
835
     
43.6
%
 
 
10

 
Major Suppliers for Third Party Products of Our Fire Safety Systems
 
Item
 
Suppliers
 
Amount
Purchased
in 2010
(in thousands)
($)
   
Percentage
of Total
Purchase
 
Sprayer, valves, gas extinguishers
 
Tianjin Tianxiao Security Equipment Corporation
   
3,887
     
20.6
%
Fire prevention materials
 
Wuhan Chenjie Technology Co., Ltd.
   
2,956
     
15.6
%
Cable
 
Beijing Kexun Cable Co., Ltd
   
650
     
3.5
%
Fire prevention materials
 
Shanghai Pudong Special Fire Safety Equipment Corporation
   
573
     
3.1
%
Pipes
 
Tianjin Shengdefa Metal Material Co., Ltd
   
471
     
2.6
%
Total
       
8537
     
45.4
%
 
Our Competition
 
The fire safety market in China is intensely competitive and includes thousands of companies. We compete primarily in providing total fire safety solutions including engineering and installations to end customers. We also compete in the market for providing fire safety products.
 
The market for the design and installation of fire safety systems includes numerous small and mostly regional competitors.  Consequently, we believe that our leading position in the industry has enabled us to win a high percentage of our bids (e.g., around 60-70% of bids in the iron and steel industry). We compete on design, technology, track record, price, quality of products, expertise and ability to complete the job in time. We believe that the fact that we use our own products also adds to our competitive positioning.  While these factors play a less significant role in bidding for smaller jobs, we have twice been recognized as the industry leader by the China Association of Fire Prevention based on numerous significant factors including total revenue and profit. Foreign competitors normally do not engage in system integration due to their disadvantage in labor costs and the requirement of Chinese certificates.
 
We compete with both foreign competitors and local manufacturers for our products. Foreign-made products have historically had an advantage over Chinese-made products because of superior technology and quality. We believe that the demand for foreign products has begun to decline because of improvements in Chinese technology and as the technology and quality gaps narrow, the price advantage that Chinese-made products typically have has increased demand for Chinese-made products. We have developed numerous patented products with technological superiority over our competitors. Our China-based competitors tend to focus on low-end and technologically less sophisticated products that have lower quality and are not suitable for large projects. Most of the China-based companies have lower operating expenses and often compete with lower pricing.
 
Although we are currently successful in providing total fire safety solutions to our customers, there is no assurance that we will continue to be able to do so in the future. We have been successful in the iron and steel, power and petrochemical industries, but as we move into new industrial sectors, our lack of proprietary products that may be required by those industries may limit our market acceptance.

Our Employees
 
As of December 31, 2010, we employed 465 full-time employees. Approximately 10.1% of our employees are management personnel, 4.5% are R&D staff members and 12.7% are sales staff members. Approximately 57.0% of our employees have college degrees or higher.
 
Under Chinese law, our employees have formed labor unions which serve to protect employees’ rights, aim to assist in the fulfillment of our economic objectives, encourage employee participation in management decisions and assist in mediating disputes. We believe that we maintain a satisfactory working relationship with our employees and have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations.

 
11

 
 
As required by applicable Chinese law, we have entered into employment contracts with all of our employees. We have also entered into confidentiality agreements with all of our employees under which our employees are prohibited from disclosing confidential information of the Company or using it for purposes other than the benefit of the Company. Directors, officers, mid-level managers and certain key employees in sales and R&D are required to sign a non-compete agreement that prohibits them from competing with the Company while they are employees of the Company and within two years after their employment with the Company is terminated.
 
Our employees in China participate in a state pension arrangement organized by Chinese municipal and provincial governments. We are required to contribute to this arrangement at the rate of 20% of the average monthly salary. In addition, we are required by Chinese law to cover employees in China with other types of social insurances. Our total contribution may amount to 30% of the average monthly salary of an employee. We have purchased social insurance for all of our employees. In the event that any current employee, or former employee, files a complaint with the Chinese government, we may be required to purchase insurance for said employee, and we may be subject to administrative fines. We believe that such fines, if imposed, are immaterial.

Item 1A. Risk Factors

Cautionary Statement Regarding Future Results, Forward-Looking Information And Certain Important Factors

In this report we make, and from time to time we will otherwise make, written and oral statements regarding our business and its 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 of our representatives. 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 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.

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. Some of these important factors include the risk factors below.

An investment in our Common Stock is speculative and involves a high degree of risk. You should carefully consider the risks described below and the other information in this Form 10-K before purchasing any of our Common Stock. If any of the events described in the risk factors below actually occur, our business, financial condition or results of operations could suffer significantly. In such case, the value of your investment could decline and you may lose all or part of the money you paid to buy our Common Stock.

Risks Related To Our Business

Disruptions in the capital and credit markets related to the current national and worldwide financial crisis, which may continue indefinitely or intensify, could adversely affect our results of operations, cash flows and financial condition, or those of our customers and suppliers.
 
12

 
The current disruptions in the capital and credit markets may continue indefinitely or intensify, and adversely impact our results of operations, cash flows and financial condition, or those of our customers and suppliers. These disruptions could adversely affect our ability to draw on our bank revolving credit facility, which is dependent on the ability of the banks that are parties to the facility to meet their funding commitments. Those banks may not be able to meet their funding commitments to us if they experience shortages of capital and liquidity. Disruptions in the capital and credit markets as a result of uncertainty, changing or increased regulation, reduced alternatives or failures of significant financial institutions could adversely affect our access to liquidity needed to conduct or expand our businesses or conduct acquisitions or make other discretionary investments, as well as our ability to effectively hedge our currency or interest rate. Such disruptions may also adversely impact the capital needs of our customers and suppliers, which, in turn, could adversely affect our results of operations, cash flows and financial condition.

Our products and services have relied on a few industries. We may not be able to increase the market for our products and services in other industries.

Presently, our products and services are mainly sold to the iron and steel, traditional power generation, petrochemical and nuclear power industries. Our products and services, therefore, depend heavily on a limited number of industries. Our growth potential may be limited if we cannot expand the market for our products and services. Although we have increased our research and development to expand the range of application of our products and services, there is no assurance that we will succeed in our effort.

Price increases of raw materials such as copper and steel could increase the cost of our products and reduce our profit margin.

Copper is the major material for our linear heat detectors and stainless steel is the major material for our fire extinguishing nozzles. In the last three years, the prices of copper and steel have fluctuated substantially as have other raw materials. Although we have managed to minimize the impact of such fluctuation in the past by passing the cost increase on to our customers, there is no assurance that we will be able to do so in the future. If the price for copper and steel increases more significantly and we cannot increase our selling price, our profit margin could decrease significantly.

We may not be able to secure financing needed for future operating needs on acceptable terms, or on any terms at all.

From time to time, we may seek additional financing to provide the capital required to maintain or expand our design and production facilities, research and development initiatives and equipment and/or working capital, as well as repay outstanding loans if cash flow from operations is insufficient to do so. We cannot predict with certainty the timing or amount of any such capital requirements. If such financing is not available on satisfactory terms, we may be unable to expand our business or to develop new business as the rate desired, and our operating results may suffer. If we are able to incur debt, we may be subject to certain restrictions imposed by the terms of the debt and the repayment of such debt may limit our cash flow and our ability to grow. If we are unable to incur debt, we may be forced to issue additional equity, which could have a dilutive effect of the then current holders of equity.

Our strategic alliances may not achieve their objectives.

Currently, we have agreements with two multinational companies to supply our linear heat detectors. The strategic alliances are intended to enhance or complement our technology or work in conjunction with our technology, increase our manufacturing capacity, provide additional components or materials, and develop, introduce and distribute products using our technology and know-how. If these alliances do not achieve their objectives or parties to our strategic alliances do not perform as contemplated, our growth may be adversely affected.

Expansion of our business may put added pressure on our management and operational infrastructure impeding our ability to meet any increased demand for our products and services and possibly hurting our operating results.

Our business plan is to significantly grow our operations to meet anticipated growth in demand for our products and services. Our planned growth includes the increase of our line of products and expansion of sales in our existing markets as well as entry into new markets over the next few years. Growth in our business may place a significant strain on our personnel, management, financial systems and other resources. The evolution of our business also presents numerous risks and challenges, including:
 
 
the continued acceptance of our products and services by the iron and steel, power and petrochemical industries;

 
our ability to successfully and rapidly expand sales to potential customers in response to potentially increasing demand;

 
13

 
 
the costs associated with such growth, which are difficult to quantify, but could be significant;

 
rapid technological change; and

 
the highly competitive nature of the industrial fire safety industry.

If we are successful in obtaining rapid market growth of our products and service, we will be required to deliver large volumes of quality products and services to customers on a timely basis at a reasonable cost. Meeting any such increased demands will require us to expand our manufacturing facilities, to increase our ability to purchase raw materials, to increase the size of our work force, to expand our quality control capabilities and to increase the scale upon which we provide our products and services. Such demands would require more capital and working capital than we currently have available and we may be unable to meet the needs of our customers.

Our business depends on our ability to protect our intellectual property effectively. If any of our patents are not protected, or any of our trade secrets are divulged, we may lose our competitive edge.

The success of our business depends in substantial measure on the legal protection of the patents and other proprietary rights in the technology we hold. We hold issued patents and pending patent applications in China related to technologies important to our business. Monitoring infringement of intellectual property rights is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our intellectual property and know-how in China where, in comparison to the United States, the laws may be difficult to enforce to fully protect our proprietary rights. The validity and breadth of claims in patents and trade secrets involve complex legal and factual questions and, therefore, the extent of their enforceability and protection is highly uncertain. Issued patents or patents based on pending patent applications or any future patent applications or trade secrets may not exclude competitors or may not provide a competitive advantage to us. In addition, patents issued or licensed to us may not be held valid if subsequently challenged and others may claim rights in or ownership of such patents. Furthermore, we cannot ensure that our competitors have not developed or will not develop similar products, will not duplicate our products, or will not design around any patents issued to or licensed by us.

We claim proprietary rights in various unpatented technologies, know-how, trade secrets and trademarks relating to products and manufacturing processes. We protect our proprietary rights in our products and operations through contractual obligations, including nondisclosure agreements. If these contractual measures fail to protect our proprietary rights, any advantage those proprietary rights provided to us would be negated. Some of our products are based on formulas. The formulas are maintained as trade secrets and are revealed only to a small number of technical and management personnel. The trade secrets provide us with a competitive edge in the linear heat technology and to the best of our knowledge, no other manufacturers have successfully developed such technology. If any of the trade secrets are divulged, we could lose our competitive edge in the linear heat technology and others.

We receive a significant portion of our revenues from a small number of customers. Our business will be harmed if our customers reduce their orders from us or if significant orders are not completed successfully.

A significant amount of our revenues are derived from only a small number of customers mainly in the iron and steel, traditional power, petrochemical and nuclear power industries. In aggregate, our five largest customers in our total solutions and products businesses accounted for approximately 73.8% and 36.8%, respectively, of our revenues from these segments in fiscal 2010. Dependence on a few customers could make it difficult to negotiate attractive prices for our products and could expose us to the risk of substantial losses if a single dominant customer stops purchasing our products. If we lose any customers and are unable to replace them with other customers that purchase a similar amount of our products and services, our revenues and net income would decline considerably.
 
In February 2010, we entered into an agreement with Wuhan Iron and Steel (Group) Corporation (“WISCO”), pursuant to which we have agreed to complete the retrofitting total solution project of the fire protection facilities for WISCO’s thirty-two plants located in Qingshan, Hubei Province, by the end of 2011 for approximately $92 million.  We believe that this total solution project for WISCO will account for a significant portion of our total revenue in the near future.  Any unexpected disruption or slowdown in the execution of the obligations of this agreement could result in a material adverse affect on our business, financial condition and results of operations and cause us to fall short of our financial guidance in the future.

 
14

 
We extend relatively long payment terms for accounts receivable. If any of our customers fails to pay us, our revenues may be affected as a result.

Our standard practice is to charge our customers 10%-30% of the contract amount up front and collect the balance according to a schedule based on the progress of a project. However, many of our customers are state-owned enterprises and may be slow in their payment process. As a result of the size of many of our contracts, their delayed payments adversely affect our cash flow and our ability to fund our operations out of our operating cash flow. In addition, although we attempt to establish appropriate reserves for our receivables, those reserves may not prove to be adequate in view of actual levels of bad debts. The failure of our customers to pay us in a timely manner could negatively affect our working capital, which could, in turn, adversely affect our cash flow. Although, on occasion payments have been delayed, no customer has failed to pay us however, there is no assurance that they will be able to pay in the future.

Our business may be severely disrupted if we lose the services of our key executives and employees or fail to add new senior and middle managers to our management.

Our future success is heavily dependent upon the continued service of our key executives, particularly Mr. Weigang Li, our Chairman, Mr. Brian Lin, our Chief Executive Officer, Tongzhuo Qin, our Chief Financial Officer, Mr. Weishe Zhang, our Vice President of Strategic Planning, Mr. Robert Yuan, our Principal Accounting Officer and several other key sales and project management executives in our subsidiary Sureland Industrial Fire Safety Limited. Our future success is also dependent upon our ability to attract and retain qualified senior and middle managers to our management team. If one or more of our current or future key executives and employees are unable or unwilling to continue in their present positions, we may not be able to easily replace them, and our business may be severely disrupted. In addition, if any of these key executives or employees joins a competitor or forms a competing company, we could lose customers and suppliers and incur additional expenses to recruit and train personnel. Each of our executive officers has entered into an employment agreement with us. We also rely on a number of key technology staff for the operation of our Company. Given the competitive nature of our industry, the risk of key technology staff leaving our Company is high and could disrupt our operations.

We may seek to make acquisitions that prove unsuccessful or strains or diverts our resources.

We may seek to expand our business through the acquisition of related businesses and assets. We may not be able to complete any acquisitions on favorable terms or at all. Acquisitions present risks that could materially and adversely affect our business and financial performance, including:
 
 
the diversion of our management’s attention from our everyday business activities;

 
the contingent and latent risks associated with the past operations of, and other unanticipated problems arising in, the acquired business; and

 
 the need to expand management, administration, and operational systems.

If we make such acquisitions we cannot predict whether:
 
 
we will be able to successfully integrate the operations and personnel of any new businesses into our business;

 
we will realize any anticipated benefits of completed acquisitions; or

 
there will be substantial unanticipated costs associated with acquisitions, including potential costs associated with environmental liabilities undiscovered at the time of acquisition.

In addition, future acquisitions by us may result in:
 
 
potentially dilutive issuances of our equity securities;

 
the incurrence of additional debt;

 
restructuring charges; and

 
15

 
 
the recognition of significant charges for depreciation and amortization related to intangible assets.

We will incur increased costs as a result of changes in laws and regulations relating to corporate governance matters.

As a public reporting company, we will need to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations adopted by the SEC and by The NASDAQ Capital Market, including expanded disclosures, accelerated reporting requirements and more complex accounting rules. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and other requirements will increase our costs and require additional management resources. Additionally, these laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We are presently evaluating and monitoring developments with respect to these laws and regulations and cannot predict or estimate the amount or timing of additional costs we may incur to respond to their requirements.

We may not be able to achieve and maintain an effective system of internal control over financial reporting, a failure which may prevent us from accurately reporting our financial results or detecting and preventing fraud.

We are subject to reporting obligations under the U.S. securities law. Beginning with our annual report on Form 10-KSB for the fiscal year ending December 31, 2007, we will be required to prepare a management report on our internal control over financial reporting containing our management’s assessment of the effectiveness of our internal control over financial reporting. In addition, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over our financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may still decline to attest to the effectiveness or may issue a report that is qualified if it is not satisfied with our controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. Our reporting obligations as a public company will place a significant strain on our management, operational and financial resources and systems for the foreseeable future.

Risks Related To Our Industry

Our market will open to foreign companies. China’s commitments under the World Trade Organization (“WTO”) may intensify competition.

In connection with its accession to the WTO, China made many commitments including opening its markets to foreign products and services, allowing foreign companies to conduct distribution businesses and reducing customs duties. As a result, foreign manufacturers may ship more industrial fire safety products into China or they may establish manufacturing facilities and service centers in China. Competition from foreign companies may squeeze our profit margins and our business results will suffer as a result.

The fire protection total solution market is fragmented and susceptible to consolidation, which could adversely affect us.

We engage in providing fire protection total solutions that consist of the design and installation of fire safety systems. The market is fragmented in the sense that there are many, typically small, suppliers. The market may be subject to consolidation and, if so, we may not be a major player. If so, our fire protection total solution business could suffer and this business is a major source of sales of our own products and profitability.

Our customers will decrease their capital expenditure if China’s economy slows down. Such a slowdown may affect our growth.

Our industry is cyclical in nature and highly dependent on economic conditions. Over the last three decades, China’s economy has been growing at an average annual rate of 9-10%. There can be no assurance that China’s economy will continue to grow at such pace in the future. If the economy slows down, our customers will cut their capital expenditure and, hence, order less of our products and services. Our growth may suffer as a result.

High margins for the industrial fire safety business will attract more businesses to enter this field. Our business could suffer as a result of more competition.

 
16

 
So far, our business has enjoyed relatively high profit margins due to the fact that we have concentrated in industrial fire safety. Such high margins will attract more businesses to enter into this field. As a result, competition may intensify and our profits may drop significantly.

If we cannot compete successfully for market share against other industrial fire safety products companies, we may not achieve sufficient product revenues, and our business will suffer.

The market for our products and services is characterized by intense competition and rapid technological advances. Our products and services compete with a multitude of products and services developed, manufactured and marketed by others and we expect competition from new market entrants in the future, including as a result of the WTO. Existing or future competing products may provide better quality and technology, greater utility or lower cost or other benefits from their intended uses than our products, or may offer comparable performance at a lower cost. If our products fail to capture and maintain market share, we may not achieve sufficient product revenues, and our business could suffer.

Gross margins could be lower in new industrial sectors.

We enjoy relatively high margins in our main markets including iron and steel, power generation and petrochemical. As we start bidding for projects in new industrial sectors including subways, highway tunnels, and nuclear plants, we might not be able to sell our products at the gross margins that we enjoy in our main markets. Our overall gross margin could be adversely affected.

Risks Related To Doing Business in China

Changes in China’s political or economic situation could harm us and our operational results.

Economic reforms adopted by the Chinese government have had a positive effect on the economic development of the country, but the government could change these economic reforms or any of the legal systems at any time. This could either benefit or damage our operations and profitability. Some of the things that could have this effect are:
 
 
level of government involvement in the economy;

 
control of foreign exchange;
 
 
methods of allocating resources;

 
balance of payments position;

 
international trade restrictions;

 
international conflict; and

 
tax policy.

The Chinese economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development, or OECD, in many ways. The economic reforms in China have been conducted under a tight grip of the Chinese government. As a result of these differences, we may not develop in the same way or at the same rate as might be expected if the Chinese economy were similar to those of the OECD member countries.

Our business is largely subject to the uncertain legal environment in China and your legal protection could be limited.

The Chinese legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which precedents set in earlier legal cases are not generally used. The overall effect of legislation enacted over the past 20 years has been to enhance the protections afforded to foreign invested enterprises in China. However, these laws, regulations and legal requirements are relatively recent and are evolving rapidly, and their interpretation and enforcement involve uncertainties. These uncertainties could limit the legal protections available to foreign shareholders, such as the right of foreign invested enterprises to hold licenses and permits such as requisite business licenses. In addition, all of our executive officers and our directors are residents of China and not of
 
 
17

 
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 shareholders to affect service of process in the U.S., or to enforce a judgment obtained in the U.S. against us or any of these persons.

You may face difficulties in protecting your interests, and your ability to protect your rights through the U.S. federal courts may be limited. Our operating subsidiaries are incorporated in non-U.S. jurisdictions, we conduct substantially all of our operations in China, and all of our officers reside outside the United States.

We conduct substantially all of our operations in China through our wholly owned subsidiaries in China. All of our officers reside outside the United States and some or all of the assets of those persons are located outside of the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in China in the event that you believe that your rights have been infringed upon under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the PRC may render you unable to enforce a judgment against our assets or the assets of our directors and officers. As a result of all of the above, our public stockholders may have more difficulty in protecting their interests through actions against our management, directors or major stockholders than would stockholders of a corporation doing business entirely within the United States.

The Chinese government exerts substantial influence over the manner in which we must conduct our business activities.

China has only recently permitted provincial and local economic autonomy and private economic activities. The Chinese government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of these jurisdictions may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations. Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof, and could require us to divest ourselves of any interest we then hold in Chinese properties.

Future inflation in China may inhibit our activity to conduct business in China.

In recent years, the Chinese economy has experienced periods of rapid expansion and high rates of inflation. During the past ten years, the rate of inflation in China has been as high as 20.7% and as low as -2.2%. These factors have led to the adoption by the Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. While inflation has been more moderate since 1995, high inflation may in the future cause the Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products.

We have limited insurance coverage and may incur losses due to business interruptions resulting from natural and man-made disasters, and our insurance may not be adequate to cover liabilities resulting from accidents or injuries that may occur. 

The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited commercial insurance products. We carry auto insurance on our vehicles. We do not carry any product liability insurance or property insurance on our office buildings, our industrial sites or other property. We believe that current facilities are adequate for our current and immediately foreseeable operating needs. We do not have any policies regarding investments in real estate, securities or other forms of property. We have determined that balancing the risks of disruption or liability from our business, or the loss or damage to our property, including our facilities and equipment, the cost of insuring for these risks on the one hand, and the difficulties associated with acquiring such insurance on commercially reasonable terms on the other hand, makes it impractical for us to have such insurance.

Should any natural catastrophes such as earthquakes, floods, or any acts of terrorism occur in city of Beijing, PRC, where our primary operations are located and most of our employees are based, or elsewhere, we might suffer not only significant property damage, but also loss of revenues due to interruptions in our business operations. The occurrence of a significant event for which we are not fully insured or indemnified, and/or the failure of a party to meet its underwriting or indemnification obligations, could materially and adversely affect our operations and financial condition. Moreover, no assurance can be given that we will be able to maintain adequate insurance in the future at rates we consider reasonable.

 
18

 
Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.

The majority of our revenues will be settled in Renminbi and any future restrictions on currency exchanges may limit our ability to use revenue generated in Renminbi to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that foreign-invested enterprises may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of Renminbi for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot be certain that the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of the Renminbi.

Cessation of the income tax reduction and exemption for our subsidiaries may have an adverse impact on our net profits.

From January 1, 2008, under new Chinese income tax law, a company would ordinarily be subject to the PRC income tax rates of 25%. However, the law also provides tax exemption or reduction for high-tech businesses and foreign invested enterprises (“FIE”). As a result, some of our subsidiaries are currently enjoying a tax reduction of and/or exemption from state and local income tax. For details, please see the income taxes section of “Management Discussion and Analysis.” If the Chinese government decides to change the tax law, our revenues and profit could suffer.

A new Chinese law may impact our ability to make acquisitions of Chinese businesses.

On August 8, 2006, six PRC regulatory agencies namely, the PRC Ministry of Commerce, the State Assets Supervision and Administration Commission, the State Administration for Taxation, the State Administration for Industry and Commerce, the China Securities Regulatory Commission (“CSRC”), and the State Administration of Foreign Exchange, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the “New M&A Rule”), which became effective on September 8, 2006. The New M&A Rule purports, among other things, to require offshore Special Purpose Ventures, formed after the effective date, for overseas listing purposes, through acquisitions of PRC domestic companies and controlled by PRC companies or individuals, to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange.

The Company intends to make acquisitions of Chinese businesses in the future. There are uncertainties regarding the interpretation and application of the current or future PRC laws and regulations, including the New M&A Rule and these uncertainties could make it difficult or impossible to make acquisitions of Chinese businesses in the future.

Foreign investment policy changes may adversely affect our income and results of operations.

On March 16, 2007, China’s parliament, the National People’s Congress, adopted the Enterprise Income Tax Law, which took effect on January 1, 2008. The new income tax law sets unified income tax rates for domestic and foreign companies at 25% and abolishes the favorable policy for foreign invested enterprises. After January 1, 2008, newly established foreign invested enterprises will not enjoy favorable tax treatment permitted under prior tax laws. Some of our subsidiaries are benefiting from the preferred tax rates for foreign companies and will follow the new tax rate when their respective term of preferred tax rates expires. Our net income margin will be affected at that time.

If the government changes its policies on the value added tax rebate, our revenues and profit could be adversely affected.

Under Chinese tax law, businesses should pay a value added tax at a 17% rate. To support the development of the software industry, the Chinese government has instituted policies to rebate value added tax charged for software certified by the government up to 14%. As a result, our subsidiary Hua An Limited, is paying its value added tax at an effective rate of 3% for the software they sell. However, the Chinese government changes its policies from time to time. If the Chinese government changes the policies currently in place for the value added tax rebate, our revenues and our profit could suffer.

The value of our securities will be affected by the foreign exchange rate between U.S. dollars and Renminbi.

The value of our Common Stock will be affected by the foreign exchange rate between U.S. dollars and Renminbi, and between those currencies and other currencies in which our sales may be denominated. For example, to the extent that we need to convert U.S.
 
 
19

 
dollars into Renminbi for our operational needs and should the Renminbi appreciate against the U.S. dollar at that time, our financial position, the business of the company, and the price of our Common Stock may be harmed. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of declaring dividends on our Common Stock or for other business purposes and the U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of our earnings from our subsidiaries in China would be reduced.

Risks Related to the Market for Our Stock

The trading prices of many companies that have business operations only in China have been volatile which may result in large fluctuations in the price of our Common Stock and losses for shareholders.

The stock market has experienced significant price and volume fluctuations that have particularly affected the trading prices of equity securities of many companies that have business operations only in China. These fluctuations have often been unrelated or disproportionate to the operating performance of many of these companies. Any negative change in the public’s perception of these companies could depress our stock price regardless of our operating results. The market price of our Common Stock has been and may continue to be volatile. We expect our stock price to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include:
 
 
actual or anticipated variations in our quarterly operating results;

 
announcements of technological innovations or new products or services by us or our competitors;

 
announcements relating to strategic relationships or acquisitions;

 
additions or terminations of coverage of our Common Stock by securities analysts;

 
statements by securities analysts regarding us or our industry;

 
 conditions or trends in the our industry; and,

 
 changes in the economic performance and/or market valuations of other industrial fire safety companies.

The prices at which our Common Stock trades will affect our ability to raise capital, which may have an adverse affect on our ability to fund our operations.
 
We do not intend to pay any dividends on our Common Stock in the foreseeable future.

We currently intend to retain all future earnings, if any, to finance our current and proposed business activities and do not anticipate paying any cash dividends on our Common Stock in the foreseeable future. We may also incur indebtedness in the future that may prohibit or effectively restrict the payment of cash dividends on our Common Stock.

Certain stockholders can exert control over the Company and may not make decisions that further the best interests of all stockholders.

Our officers, directors and principal stockholders (greater than 5% stockholders) together will own an aggregate of approximately 59.9% of our outstanding Common Stock on a fully diluted basis. Consequently, these stockholders, if they act individually or together, may exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change of control of us and might affect the market price of our Common Stock, even when a change of control may be in the best interest of all stockholders. Furthermore, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders, and accordingly, they could cause us to enter into transactions or agreements which we would not otherwise consider.

Item 1B. Unresolved Staff Comments
 
There are no unresolved comments from the SEC.

 
20

 
Item 2. Properties
 
All land in China is owned by the State. Individuals and companies are permitted to acquire rights to use land or land use rights for specific purposes. In the case of land used for industrial purposes, the land use rights are granted for a period of 50 years. This period may be renewed at the expiration of the initial and any subsequent terms. Granted land use rights are transferable and may be used as security for borrowings and other obligations.
 
We currently own approximately 23,573 square meters of land in Beijing, consisting of manufacturing facilities, employee quarters, warehouses, and office buildings. We also own approximately 945 square meters of office space in downtown Beijing, which serves as our headquarters.

Item 3. Legal Proceedings
 
In 2009, we filed four lawsuits against four different companies for the infringement of our intellectual properties in linear heat detectors and three of these four lawsuits had been settled in our favor. We expect the one pending case will be settled in our favor. In 2009, we were counter-sued by one of the companies we filed suit against in two cases for the invalidation of our intellectual properties in linear heat detectors. As of March 10, 2011, these two cases are pending. We expect these two pending cases to be settled in our favor.
 
In 2010, we filed six lawsuits against five different companies for the infringement of our intellectual properties in linear heat detectors. By March 10, 2011, three of these six lawsuits had been settled in our favor and the other three cases are still pending. We expect the three pending cases filed in 2010 will be settled in our favor in the future. In 2010, we were counter-sued by two of the companies we filed suits against for the invalidation of our intellectual properties in linear heat detectors and all three cases were settled in our favor.
 
Although we cannot predict with certainty the result of the litigation matters, we believe that the outcomes of the above described matters will not have a material adverse effect on our business or results of operations.

PART II

Item 5. Market For Registrant’s Common Equity, Related Shareholder Matters, And Issuer Purchases Of Equity Securities

Market Price Information
 
Our Common Stock has been quoted on The NASDAQ Capital Market under the symbol “CFSG” since July 16, 2007. The following table provides the high and low sales prices for our Common Stock as reported for the periods indicated.

Year ending December 31,
2011
  
High
  
  
Low
  
First Quarter (up to March 11)
 
$
7.33
   
$
5.45
 

Year ending December 31,
2010
 
High
   
Low
 
First Quarter
 
$
15.80
   
$
10.94
 
Second Quarter
 
$
14.60
   
$
9.18
 
Third Quarter
 
$
9.60
   
$
6.67
 
Fourth Quarter
 
$
8.76
   
e
6.40
 

Year ending December 31,
2009
 
High
   
Low
 
First Quarter
 
$
8.73
   
$
6.11
 
Second Quarter
 
$
14.87
   
$
7.69
 
Third Quarter
 
$
21.72
   
$
10.33
 
Fourth Quarter
 
$
19.60
   
e
12.14
 

 
21

 
On March 11, 2011, the last reported sale price of our Common Stock on The NASDAQ Capital Market was $6.24 per share.

Shareholders
 
As of March 11, 2011, we had outstanding 27,855,934 shares of Common Stock, held by approximately 1,000 stockholders of record and beneficially.
 
Dividend Policy
 
To date, we have neither declared nor paid any cash dividends on shares of our Common Stock. We presently intend to retain earnings to finance the operation and expansion of our business and do not anticipate declaring cash dividends in the foreseeable future.

Repurchases of Equity Securities
 
No repurchases of our Common Stock were made in any month within the fourth quarter of the fiscal year covered by this report.

Item 6.   Selected Financial Data
 
You should read the following selected consolidated financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the financial statements and related notes, and the other financial information included in this report.
 
CONSOLIDATED STATEMENTS OF INCOME
 
Years Ended December 31
 
  
 
2010
   
2009
   
2008
   
2007
   
2006
 
Revenues
    79,976,682     $ 81,181,198     $ 69,079,119     $ 46,753,837     $ 32,455,036  
Cost of revenues
    38,698,240       34,127,922       29,581,246       21,090,854       16,226,307  
Gross profits
    41,278,442       47,053,276       39,497,873       25,662,983       16,228,729  
Operating expenses
    23,776,073       19,468,840       15,931,124       10,776,553       8,250,285  
Income from operations
    17,502,369       27,584,436       23,566,749       14,886,430       7,978,444  
Other income (expenses)
    1,060,616       940,704       1,184,526       1,920,287       (926,597 )
Income before provision for income taxes and noncontrolling interest
    18,562,985       28,525,140       24,751,275       16,806,717       7,051,847  
Provision for income taxes
    3,210,378       4,165,548       47,423       5,081       82,206  
Less:  Net income  (loss) attributable to noncontrolling interest
    (85,328 )     (55,244 )     -       -       -  
Net income attributable to controlling interest
    15,437,935       24,414,836       24,703,852       16,801,636       6,969,641  
Comprehensive income
    19,464,303     $ 24,433,912     $ 28,440,879     $ 19,304,231     $ 7,551,573  
Weighted average number of shares
    27,618,465       27,590,523       27,568,214       26,873,742       24,340,196  
Earnings per share
    0.56     $ 0.88     $ 0.90     $ 0.63     $ 0.29  
Weighted average number of shares Diluted
    29,568,429       28,311,955       28,210,620       27,721,171       24,539,414  
Earnings per share Diluted
    0.52     $ 0.86     $ 0.88     $ 0.61     $ 0.28  
 
CONSOLIDATED BALANCE SHEETS
 
Years Ended December 31
 
  
 
2010
   
2009
   
2008
   
2007
   
2006
 
Cash and cash equivalents
    28,151,689       34,976,880       26,655,333       17,110,449       9,426,091  
Accounts receivables – current, net of allowance
    41,840,062       30,989,569       25,826,343       16,525,161       13,211,721  
Receivables from related party
    2,448,066       551,792       466,223       -       -  
 
 
22

 
Inventories
    6,713,448       5,360,520       6,538,938       4,048,283       4,190,830  
Total current assets
    150,033,254       121,046,728       91,449,840       62,190,368       43,295,272  
Plant and equipment, net
    9,641,119       8,617,521       8,445,254       6,568,250       3,529,808  
Total assets
    171,535,816       138,366,191       105,408,918       71,646,427       48,308,828  
Total current liabilities
    43,556,150       33,966,635       26,719,771       21,438,311       20,649,342  
Total shareholder’s equity
    127,979,666       104,366,814       78,689,147       50,208,116       24,978,675  

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The following discussion and analysis provides information which the management of China Fire & Security Group, Inc. believes to be relevant to an assessment and understanding of the Company’s results of operations and financial condition. This discussion should be read together with the Company’s financial statements and the notes to financial statements, which are included in this report.

Overview

We are engaged in the design, development, manufacturing and sale of fire protection products and services for large industrial firms in China and international markets. We have developed a proprietary product line that addresses all aspects of industrial fire safety from fire detection to fire system control and extinguishing. The Company is one of the first companies in China to utilize high technology for fire protection and safety of its clients including iron and steel companies, power plants, petrochemical plants, as well as, special purpose construction companies in China and other international markets.

Reorganization

We were organized as a Florida corporation on June 17, 2003.

On September 1, 2006, we entered into a share exchange agreement, pursuant to which we acquired all of the outstanding capital shares of China Fire Protection Group Inc. (“CFPG”) in exchange for a controlling interest in our Common Stock. The transaction was completed on Oct 27, 2006.

CFPG was organized on June 2, 2006 for the purpose of acquiring all of the capital shares of Sureland Industrial Fire Safety Limited (“Sureland Industrial”), a Chinese corporation, and, Sureland Industrial Fire Equipment Co., Ltd. (“Sureland Equipment”), a Chinese corporation, which collectively engage in the design, development, manufacturing and sale of fire protection products and services for large industrial consumers in China. As a result of the transactions described above, both Sureland Industrial and Sureland Equipment became wholly-owned subsidiaries of China Fire Protection Group Limited (“CFPG”), and CFPG is a wholly-owned subsidiary of Unipro Financial Services, Inc., a Florida corporation (“Unipro”).

On February 9, 2007, Unipro changed its name to China Fire & Security Group, Inc. and started trading on OTC Bulletin Board under its new ticker symbol CFSG. On July 16, 2007, China Fire & Security Group, Inc. began trading on Nasdaq Capital Market and retained the ticker symbol CFSG.

CFSG owns, through its wholly owned subsidiary China Fire Protection Group, Inc., Sureland Industrial and Sureland Equipment (jointly “Sureland”). Sureland is engaged primarily in the design, development, manufacture and sale in China of a variety of fire safety products for the industrial fire safety market as well as the design and installation of industrial fire safety systems that utilize a combination of fire safety products including its own fire safety products. To a minor extent, it also provides maintenance services for customers that use its industrial fire safety systems. Its business is primarily in China, but it has gradually increased its business in other countries like India and Indonesia.
 
Sureland markets its industrial fire safety products and systems primarily to major companies in the iron and steel, power and petrochemical industries in China and international market. It has also completed projects for highway and railway tunnels, wine distilleries, tobacco warehouses and a nuclear reactor. It is expanding its business in the transportation, marine transport, nuclear energy, and public space markets. Its products can be readily adapted for use on marine transportation and in exhibition halls and theatres. It plans to expand its marketing efforts to secure business in these industries.

 
23

 
Sureland has internal research and development facilities engaged primarily in furthering fire safety technologies. It believes that its technologies allow it to offer cost-effective and high-quality fire safety products and systems. It has developed products for industrial fire detecting and extinguishing. It believes that it is the largest manufacturer in China that has successfully developed a comprehensive line of linear heat detectors.

In May 2009, Beijing Shian Kexin Technology Co., Ltd. (“Shian Kexin”) was incorporated in Beijing, China under the laws of the PRC with registered capital of RMB5,000,000 or approximately $748,500. Shian Kexin is 100% owned by Sureland Industrial.
 
In May 2009, Shenyang Hongshida Electronics Co., Ltd. (“Hongshida”) was incorporated in Shenyang, Liaoning Province, China under the laws of the PRC with registered capital of RMB10,000,000 or approximately  $1,497,000. Hongshida is 80% owned by Beijing Hua An Times Fire Safety Technology Co., Ltd. (“Beijing Hua An”) with a 20% non-controlling interest owned by an unrelated party. Beijing Hua An is 100% owned by Sureland Industrial.

During the first quarter of 2010, our wholly-owned subsidiary, China Fire Protection Group, Inc. entered into an agreement with Zeetech System Private Limited (“Zeetech”), our subsidiary in which we control 100% (99% direct holding, 1% through nominee holding where the nominee agrees to hold the shares on behalf of CFPG), pursuant to which China Fire Protection Group Inc.’s entire interest (75%) in Sureland Industrial shall be transferred to Zeetech. On March 12, 2010, the restructuring transaction was approved by the Chinese Ministry of Commence. Subsequent to the transfer, China Fire & Security Group, Inc. still holds 100% of the interest in Sureland Industrial through its subsidiaries.

During the fourth quarter of 2010, our wholly-owned subsidiary, China Fire Protection Group, Inc. entered into an agreement with Zeetech System Private Limited (“Zeetech”) pursuant to which Zeetech’s entire interest (75%) in Sureland Industrial shall be reverted back to China Fire Protection Group, Inc.  On December 9, 2010, the reverse transaction was approved by the Chinese Ministry of Commence. Subsequent to the transaction, China Fire & Security Group, Inc. still holds 100% of the interest in Sureland Industrial through its subsidiaries.

As of December 31, 2010, Sureland operated more than 26 sales and liaison offices in China.

Sureland has twice been ranked as the leading Chinese industrial fire safety company and the largest contractor by the China Association for Fire Prevention based on six major factors including total revenue, growth rate, net profit, return on assets, investment in research and development and intellectual property. Its key products include linear heat detectors and water mist extinguishers, whose sales volumes are the largest in China. Customers in over 20 provinces have utilized its products.

Critical Accounting Policies and Estimates

While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements appearing at the end of this report, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating our reported financial results.

Certain of the Company’s accounting policies require higher degree of judgment than others in their application. We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements:

Revenue recognition

Revenue is recognized when it is probable that the economic benefits will flow to the Company as follows:
 
1.
Revenue recognition of total solution contracts : Historically more than 70% of our revenues are derived from long-term, fixed price total solution contracts for which revenues and estimated profits are recognized using the percentage of completion method of accounting. Under this method revenue recognized based upon the ratio that incurred costs to date bear to total estimated contract costs at completion with related cost of sales recorded as costs are incurred. Contract costs include all direct material and labor costs and those indirect costs related to contract performance. Selling and administrative costs are charged to expense as incurred. Risks and uncertainties inherent in the estimation process could affect the amounts reported in our financial statements. The key assumptions used in the estimate of costs to complete relate to the unit material cost, the quantity of materials to be used, the installation cost and those indirect costs related to contract performance. The estimate of unit material cost is reviewed and updated on a quarterly basis, based on the updated information available on the supply markets. The estimate of material quantity to be used for completion and the installation cost is also reviewed and updated on a quarterly basis, based on the updated information on the progress of projection execution. If the supply market conditions or the progress
 
 
24

 
 
of projection execution were different, it is likely that materially different amounts of contract costs would be used in the percentage of completion method of accounting. Thus the uncertainty associated with those estimates may impact our consolidated financial statements.
 
2.
Revenue from product sales is recognized when the goods are delivered and title has passed. Product sales revenue is presented net of a value-added tax (“VAT”). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished product.

3.
Revenue from the rendering of Maintenance Services is recognized over the service period on a straight-line basis.
 
In accordance with ASC 605-15, “Revenue Recognition when Right of Return Exists,” revenue is recorded net of an estimate of markdowns, price concessions and warranty costs. Such reserve is based on management’s evaluation of historical experience, current industry trends and estimated costs.

Foreign currency translation

The reporting currency of the Company is the U.S. dollar. The Company uses their local currency, Renminbi and Indian Rupee (“INR”), as their functional currency. Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the consolidated statement of changes in equity.

Asset and liability accounts at December 31, 2010 were translated at 6.59 RMB to $1.00 and 45.45 INR to $1.00 as compared to 6.82 RMB to $1.00 and 46.89 INR to $1.00 at December 31, 2009 respectively.  Equity accounts were stated at their historical rate.  The average translation rates of RMB applied to income statements accounts for the year ended December 31, 2010, 2009 and 2008 were 6.78 RMB, 6.82 RMB and 6.94 RMB, respectively. The average translation rates of INR applied to income statements accounts for the years ended December 31, 2010 and 2009 were 45.87 INR and 48.85 INR, respectively. Cash flows are also translated at average translation rates for the period, therefore, amounts reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheets.

Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. Historically, the Company has not engaged in any currency trading or hedging transactions, although there is no assurance that the Company will not enter into such transactions in the future.

Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles of the United States of America requires management to make estimates and assumptions that affect the amounts reported in the combined financial statements and accompanying notes. Management believes that the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results could differ from these estimates.

Certain of the Company’s accounting policies require higher degrees of judgment than others in their application. These include the recognition of revenue and earnings from system contracting projects under the percentage of completion method, impairment of long-lived assets and the allowance for doubtful accounts. Management evaluates all of its estimates and judgments on an on-going basis.

Accounts receivable

Accounts receivable represents amounts due from customers for products sales, maintenance services and system contracting projects. The credit term is generally for a period of three months for major customers. Each customer has a maximum credit limit. The Company seeks to maintain strict control over its outstanding receivables. Overdue balances are reviewed regularly by senior management.  In order to mitigate the adverse liquidity impact of the delays in customer payments, we can negotiate with our suppliers for a better payment term, in order to slow down our payments to our suppliers in the future. However, due to the limited
 
 
25

 
number of qualified suppliers available in the market, the potential delay in our payments to suppliers cannot significantly offset the adverse liquidity impact of the delays from our customer payments.
 
Allowance for doubtful accounts

We establish an allowance for doubtful accounts based on management’s assessment of the collectability of our account receivables. A considerable amount of judgment is required in assessing the amount of the allowance. We consider the historical level of credit losses, apply percentages to aged receivable categories, make judgments about the creditworthiness of each customer based on ongoing credit evaluations, and monitor 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.

Based on the above assessment, during the reporting years, the management establishes the general provision policy to make allowance equivalent to the sum of 3% of amount of account receivables less than 1 year, 15% of amount of account receivable between 1 year to 2 years, 40% of amount of account receivable between 2 years to 3 years and 100% of amount of account receivable above 3 years. Additional specific provision is made against account receivables to the extent which they are considered to be doubtful.

Bad debts are written off against allowance for doubtful accounts when identified. We do not accrue any interest on accounts receivable. Historically, losses from uncollectible accounts have not deviated from the general allowance estimated by the management and no bad debts have been written off against allowance for doubtful accounts directly to the profit and loss. This general provisioning policy has not changed in the past since establishment and the management considers that the aforementioned general provisioning policy is adequate and does not expect to change this established policy in the near future. Any changes on the estimates on our general provision policy could have a material effect on our results of operations.
 
Valuation of Long-Lived Assets

We assess the impairment of long-lived assets, which include goodwill, identifiable intangible assets, and property and equipment (“P&E”), at least annually for goodwill or whenever events or changes in circumstances indicate that the carrying value may not be recoverable for all long-lived assets. Changes in the underlying business could adversely affect the fair value of the enterprise and intangible asset and P&E asset groups. Important factors which could require an impairment review include: (i) underperformance relative to expected historical or projected future operating results; (ii) changes in the manner of use of the assets or the strategy for our overall business; (iii) negative industry or economic trends; (iv) our enterprise fair value relative to net book value.
 
Our impairment evaluation of identifiable intangible assets and P&E includes an analysis of estimated future undiscounted net cash flows expected to be generated by the assets over their remaining estimated useful lives. If the estimated future undiscounted net cash flows are insufficient to recover the carrying value of the assets over the remaining estimated useful lives, we record an impairment loss in the amount by which the carrying value of the assets exceeds the fair value. We determine fair value based on either market quotes, if available, or discounted cash flows using a discount rate commensurate with the risk inherent in our current business model for the specific asset being valued. Major factors that influence our cash flow analysis are our estimates for future revenue and expenses associated with the use of the asset. Different estimates could have a significant impact on the results of our evaluation. If, as a result of our analysis, we determine that our amortizable intangible assets or other long-lived assets have been impaired, we will recognize an impairment loss in the period in which the impairment is determined. Any such impairment charge could be significant and could have a material negative effect on our results of operations.

Share-based Compensation

We applied ASC 718, Compensation - Stock Compensation (formerly SFAS No. 123R, Share-Based Payment). ASC 718 requires that all share-based compensation be recognized as an expense in the consolidated financial statements and that such cost be measured at the fair value of the award and requires compensation cost to reflect estimated forfeitures. The determination of the fair value of share-based compensation awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including our expected stock price volatility over the term of the awards, actual and projected share option exercise behaviors, risk-free interest rate and expected dividends. The volatility of the Company’s common stock was estimated by management based on the historical volatility of our common stock, the risk free interest rate was based on Treasury Constant Maturity Rates published by the U.S. Federal Reserve for periods applicable to the expected life of the
 
 
26

 
share option, the expected dividend yield was based on the Company’s current and expected dividend policy, and the projected share option exercise behaviors is based on one-half of the sum of the vesting period and the contractual life of each share option.  This is the same as assuming that the options are exercised at the mid-point between the vesting date and expiration date.
 
Any uncertainty associated with these assumptions may impact our consolidated financial statements might affect our valuation when the options are granted.

Inventories

Inventories are stated at the lower of cost or market, using the weighted average method. Raw materials consist primarily of materials used in production. Finished goods consist primarily of equipment used in product sales and system contracting projects. The costs of finished goods include direct costs of raw materials as well as direct labor used in production. Indirect production costs such as utilities and indirect labor related to production such as assembling, shipping and handling costs are also included in the cost of inventory. The Company reviews its inventory periodically to determine if any reserves are necessary for potential obsolescence.

Costs and estimated earnings in excess of billings

The current asset, “Costs and estimated earnings in excess of billings” on contracts, represents revenues recognized in excess of amounts billed.

Billings in excess of costs and estimated earnings

The current liability, “Billings in excess of costs and estimated earnings” on contracts, represents billings in excess of revenues recognized.
 
Plant and equipment

Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets with a 5% residual value.
 
Recently issued accounting pronouncements
 
In January 2010, FASB issued ASU No. 2010-01- “Accounting for Distributions to Shareholders with Components of Stock and Cash.” The amendments in this Update clarify that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS prospectively and is not a stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings Per Share). The amendments in this update are effective for interim and annual periods ending on or after December 15, 2009, and should be applied on a retrospective basis. Adoption of this ASU did not have material impact on the Company’s consolidated financial statements.

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

In January 2010, FASB issued ASU No. 2010-06 – “Improving Disclosures about Fair Value Measurements.” This update provides amendments to Subtopic 820-10 that requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2.  A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers.  2)  Activity in Level 3 fair value measurements.  In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances,
 
 
27

 
and settlements (that is, on a gross basis rather than as one net number). This update provides amendments to Subtopic 820-10 that clarifies existing disclosures as follows: 1) Level of disaggregation. A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. A reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities. 2) Disclosures about inputs and valuation techniques. A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. These disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Adoption of this ASU did not have material impact on the Company’s consolidated financial statements.

 In February 2010, the FASB issued Accounting Standards Update 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements,” or ASU 2010-09. ASU 2010-09 primarily rescinds the requirement that, for listed companies, financial statements clearly disclose the date through which subsequent events have been evaluated. Subsequent events must still be evaluated through the date of financial statement issuance; however, the disclosure requirement has been removed to avoid conflicts with other SEC guidelines. ASU 2010-09 was effective immediately upon issuance and was adopted in February 2010.
In April 2010, the FASB issued Accounting Standards Update 2010-13, “Compensation—Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades,” or ASU 2010-13. This Update provides amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in currency of a market in which a substantial porting of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. Adoption of this ASU did not have material impact on the Company’s consolidated financial statements.
 
In April 2010, the FASB issued Accounting Standard Update 2010-17, “Revenue Recognition—Milestone Method (Topic 605): Milestone Method of Revenue Recognition” or ASU 2010-17. This Update provides guidance on the recognition of revenue under the milestone method, which allows a vendor to adopt an accounting policy to recognize all of the arrangement consideration that is contingent on the achievement of a substantive milestone (milestone consideration) in the period the milestone is achieved. The pronouncement is effective on a prospective basis for milestones achieved in fiscal years and interim periods within those years, beginning on or after June 15, 2010. Adoption of this ASU did not have material impact on the Company’s consolidated financial statements.
 
In July 2010, FASB issued Accounting Standard Update 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses” or ASU 2010-20. This Update provides enhanced disclosures which are designed to assist financial statement users in assessing an entity’s credit risk exposure and in evaluating the adequacy of an entity’s allowance for credit losses. Public entities must apply the disclosure requirements applicable to period-end balances beginning with the first interim or annual reporting period ending on or after December 15, 2010. Adoption of this ASU did not have material impact on the Company’s consolidated financial statements

In September 2010, FASB issued Accounting Standard Update 2010-25, “Plan Accounting—Defined Contribution Pension Plans (Topic 962): Reporting Loans to Participants by Defined Contribution Pension Plans” or ASU 2010-25. The ASU clarifies how loans to participants should be classified and measured by defined contribution plans and how IFRS compare to these provisions. The amendments in this update are effective for fiscal years ending after December 15 2010. Adoption of this ASU did not have material impact on the Company’s consolidated financial statements.
 
In December 2010, the FASB issued Accounting Standard Update 2010-28, Intangibles—Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts . This ASU modified   Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity   is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. For public   entities, the amendments in the ASU are effective for fiscal years, and interim periods within those years, beginning after December   15, 2010. Adoption of this ASU did not have material impact on the Company’s consolidated financial statements.
 
 
28

 
In December 2010, the FASB issued Accounting Standard Update 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. This ASU specifies that, if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 is effective prospectively for business combinations where the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Adoption of this ASU did not have material impact on the Company’s consolidated financial statements.

Results of Operations

Comparison of the Years Ended December 31, 2010 and 2009:

     
For the Year Ended December 31,
 
     
2010
   
2009
   
Y/Y Change
 
     
Amount ($)
   
% of Total Revenue
   
Amount ($)
   
% of Total Revenue
   
Amount ($)
   
%
 
Revenue
                                   
 
System contracting projects
    59,544,090       74.5 %     62,514,475       77.0 %     -2,970,385       -4.8 %
 
Products
    16,834,582       21.0 %     15,718,815       19.4 %     1,115,767       7.1 %
 
Maintenance Services
    3,598,010       4.5 %     2,947,908       3.6 %     650,102       22.1 %
 
     Total Revenue
    79,976,682       100.0 %     81,181,198       100.0 %     -1,204,516       -1.5 %

Total revenues were approximately $80.0 million for the year ended December 31, 2010 as compared to approximately $81.2 million for the year ended December 31, 2009, a decrease of approximately $1.2 million or 1.5%. This slight decrease in our total revenue was primarily due to the decrease in our revenues from system contracting projects, offset by the increase in our product sales and sales from our maintenance services during the period. The Company recognized revenues from 436 total solution, product sales and maintenance contracts for the year ended December 31, 2010 as compared to 445 contracts for the year ended December 31, 2009.
 
Revenues from our total solution system contracting projects decreased by 4.8% to $59.5 million derived from 220 contracts for the year ended December 31, 2010, compared to $62.5 million derived from 181 contracts for the year ended December 31, 2009. This decrease in revenues from our system contracting projects was mainly attributable to the slower progress in the projects from the iron and steel industry during period, as iron and steel industry has experienced significant weakness during recent quarters. Revenues from our product sales were $16.8 million with 152 contracts executed for the year ended December 31, 2010, compared to $15.7 million with 136 contracts executed for the year ended December 31, 2009. The increase in revenues from product sales was mainly due to the increase in value of product sales contracts executed in power generation industry during the period. Revenues from maintenance service increased by 22.1% to $3.6 million derived from 64 contracts for the year ended December 31, 2010, compared to $2.9 million derived from 128 contracts for the year ended December 31, 2009. The increase in revenues from maintenance service was mainly attributable to the increase in the number of maintenance service contracts executed as a result of the expansion of our customer base during the period.

In particular, our three largest clients were Wuhan Iron & Steel Group, Capital Iron & Steel Group (Caofeidian Project), Anshan Iron & Steel Group Chaoyang Company, which collectively contributed approximately $40.2 million of revenues, representing 67.4% of total revenues for the year ended December 31, 2010.

Out of the system contracting revenue of $59.5 million for the year ended December 31, 2010, iron and steel industry contributed the majority of revenues, approximately 55.7 million or 93.3% of the revenue from system contracting projects, while traditional power generation contributed approximately $3.5 million or 5.9%. Petrochemical, nuclear and other verticals together represented the remaining $0.48 million or 0.8% of revenue.

For the twelve months ended December 31, 2010, the significant increase in reliance on one client for the Company’s operating results was due to the size of the total solution contract executed with Wuhan Iron and Steel. The value of this contract was approximately $92 million, compared to the company’s historical average of $1 million for the iron and steel industry. Therefore, with the successful implementation of this project, for the twelve months ended December 31, 2010, Wuhan Iron and Steel contributed the largest portion of the Company’s sales of any client. By the end of year 2010, the $92 million contract with Wuhan Iron and Steel will only be 36.9%
 
 
29

 
complete; as a result, the Company expects that a large portion of its revenue in future reporting periods will rely on the execution of this contract.
 
     
For the Year Ended December 31,
 
     
2010
   
2009
   
Y/Y Change
 
     
Amount ($)
   
% of Revenue
   
Amount ($)
   
% of Revenue
   
Amount ($)
   
%
 
Cost of Revenues
                                   
 
System contracting projects
    28,897,445       48.5 %     26,769,508       42.8 %     2,127,937       7.9 %
 
Products
    7,342,962       43.6 %     5,589,310       35.6 %     1,753,652       31.4 %
 
Maintenance Services
    2,457,833       68.3 %     1,769,104       60.0 %     688,729       38.9 %
 
     Total Cost of Revenues
    38,698,240       48.4 %     34,127,922       42.0 %     4,570,318       13.4 %
                                                   
Gross Profit
                                               
 
System contracting projects
    30,646,645       51.5 %     35,744,967       57.2 %     -5,098,322       -14.3 %
 
Products
    9,491,620       56.4 %     10,129,505       64.4 %     -637,885       -6.3 %
 
Maintenance Services
    1,140,177       31.7 %     1,178,804       40.0 %     -38,627       -3.3 %
 
     Total Gross Profit
    41,278,442       51.6 %     47,053,276       58.0 %     -5,774,834       -12.3 %
 
Cost of revenues for the year ended December 31, 2010 was approximately $38.7 million, as compared to $34.1 million for the year ended December 31, 2009, representing an increase of approximately $4.6 million or 13.4%. The increase in our cost of revenues was mainly driven by the increase in our material costs and our subcontractor costs related to the execution of total solution and maintenance contracts, offset by the decrease in revenues from our system contracting projects during the period. Gross profit for the year ended December 31, 2010 was approximately $41.3 million, as compared to $47.1 million for the year ended December 31, 2009, a decrease of approximately $5.8 million or 12.1%. Gross margin for the year ended December 31, 2010 was 51.6%, which is lower than the gross margin of 58.0% for the year ended December 31, 2009. The decrease in overall gross margin was mainly due to the decrease in the gross margin of system contracting projects and the gross margin of product sales during the period.

Gross margin of system contracting projects was 51.5% for the year ended December 31, 2010, compared to 57.2% for the year ended December 31, 2009. The decrease in gross margin of system contracting projects was mainly attributable to the contract mix during the period, as the gross margin of system contracting projects represents the average value of the gross margins of different system contracting projects executed in during the period.  Since our gross margins during each quarter are determined by the revenue-weighted average of gross margins which are comprised of the gross margins of different system contracting projects executed during the period, the decrease in our gross margins of our system contracting projects was primarily due to the different contract mix during the twelve months ended December 31, 2010. In a given period, if more revenues are recognized from contracts with higher gross margins, this will result in a higher gross margin for the period. During the twelve months ended December 31, 2010, the iron and steel industry contributed higher percentage revenues as compared to the twelve months ended December 31, 2009. The increase in the percentage of revenue contribution from the iron and steel industry should have resulted in higher gross margins during the period. However during the twelve months ended December 31, 2010, the revenue-weighted average of gross margins from the iron and steel industry was only 54.8%, which was lower than the 60.0% for the same period of 2009. The decrease in average gross margin of total solution projects from the iron and steel industry outweighed the increase in the percentage of revenue contribution from the iron and steel industry, which led to a decrease in the overall gross margin of our system contracting projects during the period. We attributed the decrease in the average project gross margins from the iron and steel industry during the twelve months ended December 31, 2010 to the different contract mix during the period as the gross margin of individual iron and steel contracts during certain period is determined by various factors including the complexity of project itself, competition during the bidding process as well as the variation in the project’s gross margins due to the change from clients’ requirement. However, from the aspect of overall iron and steel contracts, the gross margins of iron and steel contracts were maintained at similar levels to those of last year. Furthermore, we did not observe any trends or factors which could negatively impact gross margins from the iron and steel industry in the long run.

The gross margin of product sales was 56.4% for the year ended December 31, 2010, compared to 64.4% for the year ended December 31, 2009. The decrease in the gross margin of product sales was mainly attributable to a lower percentage of self-manufactured
 
 
30

 
proprietary products sold through our product sales contracts during the period, contributing to lower gross margin. Of the products sales in the year ended December 31, 2010, the percentage of self-manufactured proprietary products decreased to 37.8%, compared to 53.4% in fiscal year 2009. The main reason for the shift in sales from self-manufactured products to third-party manufactured products is the percentage of product sales from the petrochemical industry increased significantly to 26.7% in the twelve months ended December 31, 2010, compared to 6.9 % for the same period of last year. Since product sales contracts from the petrochemical industry typically use less self-manufactured proprietary products than those in other industries, the higher sales contribution from the petrochemical industry resulted into a lower percentage of self-manufactured proprietary products during the period. Gross margin of our maintenance services was 31.7% for the year ended December 31, 2010, compared to 40.0% for the year ended December 31, 2009.  This decrease in the gross margin of our maintenance services was primarily due to the increase in our labor costs associated with the maintenance contracts during the period.
 
     
For the Year Ended December 31,
 
      2010     2009     Y/Y Change  
     
Amount ($)
   
% of
Total
Revenue
   
Amount ($)
   
% of
Total
Revenue
   
Amount ($)
   
%
 
Operating Expenses
                                   
 
Selling Expense
    10,135,884       12.7 %     8,908,697       11.0 %     1,227,187       13.8 %
 
General Administrative
    10,822,596       13.5 %     8,154,801       10.0 %     2,667,795       32.7 %
 
Depreciation and Amortization
    851,036       1.1 %     773,907       1.0 %     77,129       10.0 %
 
R&D
    1,966,557       2.5 %     1,631,435       2.0 %     335,122       20.5 %
 
     Total Operating Expenses
    23,776,073       29.7 %     19,468,840       24.0 %     4,307,233       22.1 %
 
     Income From Operations
    17,502,369       21.9 %     27,584,436       34.0 %     -10,082,067       -36.5 %

Operating expenses were approximately $23.8 million for the year ended December 31, 2010 as compared to approximately $19.5 million for the year ended December 31, 2009, an increase of approximately $4.3 million or 22.1%.  This increase in operating expenses was mainly attributable to the slight increase in selling, general administrative and R&D expenses during the period.

Selling expenses were approximately $10.1 million for the year ended December 31, 2010 as compared to approximately $8.9 million for the year ended December 31, 2009, an increase of approximately $1.2 million or 13.8%. The increase in selling expenses was mainly attributable to the increase in sales-related activities in the iron and steel, power generation and chemical industries and efforts to expand into new industries including nuclear power, transportation and international markets. General administrative expenses were approximately $10.8 million for the year ended December 31, 2010, as compared to approximately $8.2 million for the year ended December 31, 2009, an increase of approximately $2.7 million or 32.7%. The significant increase in general administrative expenses was mainly attributable to increases in the number of total employees, every employee salary and the compensation related to the issued options and restricted stocks during the period. Depreciation and amortization expenses were approximately $0.9 million for the year ended December 31, 2010 as compared to approximately $0.8 million for the year ended December 31, 2009, an increase of $77,129 or 10.0%. The slight increase in depreciation and amortization expenses was mainly due to the increase in our plant and equipment related to business operations. R&D expenses were approximately $2.0 million for the year ended December 31, 2010 as compared to approximately $1.6 million for the year ended December 31, 2009, an increase of approximately $0.3 million or 20.5%. The increase in R&D expenses was mainly attributable to the variance in expenditures required in different new product development cycles.

Operating income was approximately $17.5 million for the year ended December 31, 2010 as compared to approximately $27.6 million for the year ended December 31, 2009, a decrease of approximately $10.1 million or -36.5%.  The decrease in our operating income was mainly attributable to the decrease in revenues and lower gross margins during this period.

 
31

 
Total other income was approximately $1.1 million for the year ended December 31, 2010 as compared to approximately $0.9 million for the year ended December 31, 2009, an increase of $119,912 million or 12.7%.

Income before income tax was approximately $18.6 million for the year ended December 31, 2010 as compared to approximately $28.5 million for the year ended December 31, 2009, a decrease of $10.0 million or -34.9%.  The reason for the decrease in income before income tax was mainly due to the decrease in revenues and operating margin during the period. Provision for income tax was approximately $3.2 million for the year ended December 31, 2010 with an effective tax rate of approximately 17.3%, as compared to a $4.2 million provision for income tax for the year ended 31, December 2009, a decrease of $0.9 million.  The decrease in provision for income tax was mainly due to a decrease in income before income tax during the period.

Our net income was approximately $15.4 million for the year ended December 31, 2010 as compared to approximately $24.3 million net income for the year ended December 31, 2009, a decrease of $9.0 million or -36.8%. The reason for this decrease in net income was mainly due to the decrease in revenue as well as decrease in gross margin during the period.

Currency translation adjustments resulting from RMB appreciation amounted to $4.0 million and $19,093 for the years ended December 31, 2010 and 2009, respectively.

The comprehensive income, which adds the currency adjustment to the net income, was approximately $19.5 million for the year ended December 31, 2010 as compared to approximately $24.4 million comprehensive income for the year ended December 31, 2009, a decrease of $5.0 million or 20.3%.

Comparison of the Years Ended December 31, 2009 and 2008:

   
For the Year Ended December 31,
 
   
2009
   
2008
   
Y/Y Change
 
   
Amount ($)
   
% of
Total
Revenue
   
Amount ($)
   
% of
Total
Revenue
   
Amount ($)
   
%
 
Revenue
                                   
System contracting projects
   
62,514,475
     
77.0
%
   
57,101,984
     
82.7
%
   
5,412,491
     
9.5
%
Products
   
15,718,815
     
19.4
%
   
9,673,922
     
14.0
%
   
6,044,893
     
62.5
%
Maintenance Services
   
2,947,908
     
3.6
%
   
2,303,213
     
3.3
%
   
644,695
     
28.0
%
     Total Revenue
   
81,181,198
     
100.0
%
   
69,079,119
     
100.0
%
   
12,102,079
     
17.5
%

Total revenues were approximately $81.2 million for the year ended December 31, 2009 as compared to approximately $69.1 million for the year ended December 31, 2008, an increase of approximately $12.1 million or 17.5%. This increase was primarily due to the increase in revenues from product sales and maintenance services during the period. The Company recognized revenues from 445 total solution, product sales and maintenance contracts for the year ended December 31, 2009 as compared to 319 contracts for the year ended December 31, 2008.
 
Revenues from total solution system contracting projects increased by 9.5% to $62.5 million derived from 181 contracts for the year ended December 31, 2009, compared to $57.1 million derived from 161 contracts for the year ended December 31, 2008. This increase in revenues from system contracting projects was mainly attributable to the increase in the number of system contracting projects we executed and the successful execution of large-size projects such as the Caofeidian Project of Capital Iron and Steel Group during the fiscal year. Revenues from product sales were $15.7 million with 136 contracts executed for the year ended December 31, 2009, compared to $9.7 million with 115 contracts executed for the year ended December 31, 2008. The increase in revenues from product sales was mainly due to the increase in value of product sales contracts executed in the power generation industry. Revenues from maintenance service increased by 28.0% to $2.9 million derived from 128 contracts for the year ended December 31, 2009, compared to $2.3 million derived from 43 contracts for the year ended December 31, 2008. The increase in revenues from maintenance service was mainly attributable to the increase in the number of maintenance service contracts executed as the result of the expansion of our customer base during the period.

 
32

 
In particular, our three largest clients were Capital Iron and Steel Group, Jiannan Iron and Steel Group and Capital Engineering & Research Inc., which collectively contributed approximately $18.9 million of revenues, representing 23.2% of total revenues for the year ended December 31, 2009.

Out of the system contracting revenue of $62.5 million for the year ended December 31, 2009, iron and steel industry was the major industry, contributing approximately $53.9 million or approximately 86.3% of the revenue from system contracting projects, while traditional power generation contributed approximately $6.7 million or approximately 10.6%. Petrochemical, nuclear and other verticals together represented the remaining $1.9 million or 3.1% of revenue.

For the year ended December 31, 2009, the significant increase in reliance on one client for the Company’s operating results was due to the size of the total solution contract executed with Capital Iron and Steel Group. The value of this contract was approximately $31 million, compared to the company’s historical average of $1 million for the iron and steel industry. Therefore, with the successful implementation of this project, for the year ended December 31, 2009, Capital Iron and Steel Group contributed the largest portion of the Company’s sales of any client. By the end of year 2009, the $31 million contract with Capital Iron and Steel Group will only be 80.2% complete; as a result, the Company expects that a large portion of its revenue in future reporting periods will rely on the execution of this contract.
 
 
   
For the Year Ended December 31,
 
   
2009
   
2008
   
Y/Y Change
 
   
Amount ($)
   
% of
Revenue
   
Amount ($)
   
% of
Revenue
   
Amount ($)
   
%
 
Cost of Revenues
                                   
System contracting projects
   
26,769,508
     
42.8
%
   
25,805,086
     
45.2
%
   
964,422
     
3.7
%
Products
   
5,589,310
     
35.6
%
   
2,558,844
     
26.5
%
   
3,030,466
     
118.4
%
Maintenance Services
   
1,769,104
     
60.0
%
   
1,217,316
     
52.9
%
   
551,788
     
45.3
%
     Total Cost of Revenues
   
34,127,922
     
42.1
%
   
29,581,246
     
42.8
%
   
4,546,676
     
15.4
%
                                                 
Gross Profit
                                               
System contracting projects
   
35,744,967
     
57.2
%
   
31,296,898
     
54.8
%
   
4,448,069
     
14.2
%
Products
   
10,129,505
     
64.4
%
   
7,115,078
     
73.5
%
   
3,014,427
     
42.4
%
Maintenance Services
   
1,178,804
     
40.0
%
   
1,085,897
     
47.1
%
   
92,907
     
8.6
%
     Total Gross Profit
   
47,053,276
     
58.0
%
   
39,497,873
     
57.2
%
   
7,555,403
     
19.1
%

Cost of revenues for the year ended December 31, 2009 was approximately $34.1 million, as compared to $29.6 million for the year ended December 31, 2008, representing an increase of approximately $4.5 million or 15.4%. The increase in cost of revenues was mainly driven by the increase in revenue as well as the increase in subcontractor cost while we executed total solution and maintenance contracts during the period. Gross profit for the year ended December 31, 2009 was approximately $47.1 million, as compared to $39.5 million for the year ended December 31, 2008, an increase of approximately $7.6 million or 18.7%. Gross margin for the year ended December 31, 2009 was 58.0%, which is slightly higher than the gross margin of 57.2% for the year ended December 31, 2008. The increase in gross margin was mainly due to the increase in the gross margin of system contracting projects, offset by a decrease in the gross margin of product sales and maintenance services during the period.

Gross margin of system contracting was 57.2% for the year ended December 31, 2009, compared to 54.8% for the year ended December 31, 2008. This increase in the gross margin of system contracting projects was due to the successful execution of total solution contacts in the iron and steel industry that contributed higher gross margins during the fiscal year. Total solution projects from the iron and steel industry contributed higher gross margins than the projects from other industries due to a higher percentage of our self-manufactured proprietary products being utilized in the iron and steel projects, partially offset by the increase in our subcontractor cost. The gross margin of product sales was 64.4% for the year ended December 31, 2009, compared to 73.5% for the year ended December 31, 2008. The decrease in the gross margin of product sales was mainly attributable to a lower percentage of self-manufactured proprietary products sold through product sales contracts during the period, contributing to lower gross margin.  Gross margin of maintenance services was 40.0% for the year ended December 31, 2009, compared to 47.1% for the year ended December 31, 2008.  This decrease in the gross margin of maintenance services was primarily due to the increase in associated labor costs  during the period.  Out of product sales of $15.7 million during the year 2009, 52% related to self-manufactured proprietary products, and 48% related to third party products.

 
33

 
In 2009, the iron and steel industry was the Company’s largest vertical contributing approximately 75% of revenue. Based on the Company’s strategy, we are working towards further expanding our business into other verticals including conventional power plants, power transmission (grid), nuclear power plants, petroleum and natural gas, petrochemical, transportation (subways, highway tunnels, high speed trains), ships and marine, telecommunications carriers. We believe that the introduction of new products and entry into new verticals may positively impact our revenue, but in the meantime negatively impacted our gross margins. The reason for the lower gross margins in other industries is a lower percentage of self-manufactured proprietary products would be used in other industries than in the iron and steel industry, since the products required in the total solutions by the fire codes for the iron and steel are our self-manufactured high-end products which are associated with and protected by the Company’s intellectual properties. Because the fire codes for other industries in China are not as strict as the fire codes in the iron and steel industry, more third-party manufactured were used than that in iron and steel industry.

   
For the Year Ended December 31,
 
   
2009
   
2008
   
Y/Y Change
 
   
Amount ($)
   
% of
Total
Revenue
   
Amount ($)
   
% of
Total
Revenue
   
Amount ($)
   
%
 
Operating Expenses
                                   
Selling Expense
   
8,908,697
     
11.0
%
   
6,434,887
     
9.3
%
   
2,473,810
     
38.4
%
General Administrative
   
8,154,801
     
10.0
%
   
6,680,992
     
9.7
%
   
1,473,809
     
22.1
%
Depreciation and Amortization
   
773,907
     
1.0
%
   
712,269
     
1.0
%
   
61,638
     
8.7
%
R&D
   
1,631,435
     
2.0
%
   
2,102,976
     
3.0
%
   
(471,541
)
   
-22.4
%
     Total Operating Expenses
   
19,468,840
     
24.0
%
   
15,931,124
     
23.1
%
   
3,537,716
     
22.2
%
     Income From Operations
   
27,584,436
     
34.0
%
   
23,566,749
     
34.1
%
   
4,017,687
     
17.0
%

Operating expenses were approximately $19.5 million for the year ended December 31, 2009 as compared to approximately $15.9 million for the year ended December 31, 2008, an increase of approximately $3.5 million or 22.2%. The increase in operating expenses was mainly due to the increase in selling and general administrative expense, offset by the decrease in R&D expenditure during the fiscal year.

Selling expenses were approximately $8.9 million for the year ended December 31, 2009 as compared to approximately $6.4 million for the year ended December 31, 2008, an increase of approximately $2.5 million or 38.4%. The significant increase in selling expenses was mainly attributable to the increase in marketing activities and efforts to expand our business into new markets including the retrofitting market in the iron and steel industry. General administrative expenses were approximately $8.2 million for the year ended December 31, 2009, as compared to approximately $6.7 million for the year ended December 31, 2008, an increase of approximately $1.5 million or 22.1%. The increase in general administrative expenses was mainly attributable to the increase in employees’ salaries and compensation and the increase in bad debt expenses during the period. Depreciation and amortization expenses were approximately $0.8 million for the year ended December 31, 2009 as compared to approximately $0.7 million for the year ended December 31, 2008, an increase of $61,638 or 8.7%. The slight increase in depreciation and amortization expenses was mainly due to the increase in plant and equipment related to business operations. R&D expenses were approximately $1.6 million for the year ended December 31, 2009 as compared to approximately $2.1 million for the year ended December 31, 2008, a decrease of approximately $0.5 million or 22.4%. The decrease in R&D expenses was mainly attributable to the variance in expenditures required in different product development cycles.

Operating income was approximately $27.6 million for the year ended December 31, 2009 as compared to approximately $23.6 million for the year ended December 31, 2008, an increase of approximately $4.0 million or 17.0%. The increase in operating income was mainly attributable to the increase in revenues and higher gross margins during this period.

Total other income was approximately $0.9 million for the year ended December 31, 2009 as compared to approximately $1.2 million for the year ended December 31, 2008, a decrease of $0.3 million or 20.6%.

Income before income tax was approximately $28.5 million for the year ended December 31, 2009 as compared to approximately $24.8 million for the year ended December 31, 2008, an increase of $3.8 million or 15.2%. The reason for this increase in income before income tax was mainly due to the increase in revenues offset by the decrease in operating margin during the period. Provision for income tax was approximately $4.2 million for the year ended December 31, 2009 with an effective tax rate of approximately 14.6%, as compared to $47,423 provision for income tax for the year ended 31, December 2008, an increase of $4.2 million. The
 
 
34

 
significant increase in provision for income tax was mainly due to the fact that Sureland Industrial, our major operating subsidiary, began to pay income tax at a rate of 12.5% with 50% tax exemption, after the expiration of its 100% tax exemption period in 2008.

Net income was approximately $24.4 million for the year ended December 31, 2009 as compared to approximately $24.7 million net income for the year ended December 31, 2008, a decrease of $0.3 million or 1.2%. The reason for this slight decrease in net income was mainly due to the significant increase in the provision of income tax, offset by the increase in income before income tax during the period.

Currency translation adjustments resulting from RMB appreciation amounted to $19,093 and $3,737,027 for the years ended December 31, 2009 and 2008, respectively.

The comprehensive income, which adds the currency adjustment to the net income, was approximately $24.4 million for the year ended December 31, 2009 as compared to approximately $28.4 million comprehensive income for the year ended December 31, 2008, a decrease of $4.0 million or 14.1%.
 
Liquidity and Capital Resources

As of December 31, 2010, we had working capital of $106.5 million, including cash and cash equivalents of $28.1 million. The following table sets forth a summary of our cash flow for the periods indicated:

Statements of Cash Flow
 
   
Year Ended December 31
 
   
2010
   
2009
   
2008
 
                   
Net cash provided by (used in) operating activities
 
$
(2,190,269
)  
$
5,467,756
   
$
13,361,704
 
Net cash provided by (used in) investing activities
   
(1,582,860
   
948,283
     
(1,945,199
)
Net cash provided by (used in) financing activities
   
(3,695,888
)    
1,897,613
     
(3,097,855
Effect of foreign currency translation on cash and cash equivalents
   
643,826
     
7,895
     
1,226,234
 
Net cash flow
 
$
(6,825,191
)  
$
8,321,547
     
9,544,884
 

Operating Activities

Comparison of the Years Ended December 31, 2010 and 2009

Net cash used by operating activities was approximately $2.2 million for the year ended December 31, 2010 as compared to approximately $5.5 million provided for the same period in 2009. The decrease in net cash provided by operating activities was mainly due to the slower cash payments collected from our customers during the weakness experienced in the iron and steel industry in 2010. Net cash provided by operating activities in the year ended December 31, 2010 was mainly due to net income of $15.4 million, a $4.7 million increase in accrued liabilities and $1.4 million increase in billings in excess of costs and estimated earnings, offset by a $9.7 million increase in notes receivable, 10.2 million increase in accounts receivable, an $2.8 million increase in costs and estimated earnings in excess of billing, a $6.5 million decrease in prepayment and deferred expenses.
 
The increase of $2.8 million in costs and estimated earnings in excess of billings in 2010 was mainly due to the increase in aggregate value of projects where we have recognized revenues more than we have billed our customers for these projects, while the decrease in billings in excess of costs and estimated earnings was mainly due to the decrease in aggregate value of projects where we have billed our customers less than we have recognized revenues for these projects.

As of December 31, 2010, approximately 7.2% of accounts receivable related to revenue recognized for maintenance service contracts and were due from clients in China’s iron and steel industry. Most of these clients are leading, large-size State-Owned Enterprises (“SOEs”), and include Anshan Iron and Steel, Wuhan Iron and Steel and Capital Iron and Steel. Since China’s government is the majority shareholder of these companies, the creditworthiness of these companies is generally perceived to be much higher than that of private companies in the market. Moreover, we have not observed nor do we expect to observe any bankruptcies amongst these leading SOEs in the foreseeable future. Therefore, we believe that the accounts receivable for maintenance service contracts are highly
 
 
35

 
collectible. Also, given that accounts receivable from such SOEs are overall highly collectible, it is customary in the interest of maintaining client relationships and securing recurring maintenance contracts not to aggressively enforce the collection of receivables.

During the past year, we did not change or extend our standard contract payment terms. Primarily, fundamental weaknesses in the iron and steel industry resulted in the delay of customers’ payments related to the revenue recognized for maintenance service contracts beyond one-year. These delays also are a side effect of the industry practice to not aggressively enforce collection of SOE receivables in the interest of maintaining client relationships. These late payments were the result of our goodwill to maintain client relationships rather than the result of payment extensions.

According to our standard contract terms, the prerequisite that must be met in order to have the legal right to bill our customers for the amounts recognized as unbilled costs and earnings is the customer’s acceptance of the completion of different stages throughout the implementation of the whole project. This is accomplished through the customer’s inspection process upon completion of certain stages of a project’s implementation including (but not limited to): the completion of a project’s design, the delivery of certain equipment to a project’s location, the completion of a certain stage of a project’s construction, the completion of a system adjustment and final acceptance by the customer and the fire safety department. For a standard system contracting project, there are multiple stages of construction, customer inspection and billing. These processes are on-going throughout the term of the contract, which can be for an extended period of time. In our operating history, we have never been unable to bill our customers or receive payments for the amounts recognized as unbilled costs and earnings as a result of the customer’s inspection process upon achieving a certain stage. Therefore, the collectability of the amounts recognized as unbilled costs and earnings is reasonably assured.

The main reason for the recent delays or prolonged customer inspection processes is the weakness in the iron and steel industry. These delays or prolonged inspection processes can slow the customers’ payments to their suppliers including our company. The recent delays in our customer’s inspection process did not relate to any performance issues raised by our customers. We have not experienced any inability to bill and/or non-payment for a receivable and/or customer’s claim because of a contract dispute. In recent quarters, we have not made any material changes in the standard contract payment provisions as compared to prior periods. In the future, we will disclose any material contract changes to our standard contractual terms and also provide investors with an explanation of such changes, along with an explanation of any material impact such changes are having or may have on our operating results and liquidity.

There are a number of factors and/or circumstances that could adversely impact our ability to collect the receivables from and/or bill the Costs and estimated earnings in excess billings (“CIEB”) to the SOEs. First, a significant decline in the overall demand for iron and steel products in China could adversely impact our ability to collect the receivables from and/or bill the CIEB to the SOEs. The iron and steel industry is one of the core industries in China’s economy. Thus, the Chinese government has a vested interest in maintaining the health of this sector and consequently maintains shareholdings in key players in the industry. However, if there was a significant decrease in the overall demand for iron and steel products in China, the Chinese government could be forced to close certain companies, even SOEs, whose iron and steel production capacities are outdated. Second prolonged monetary losses amongst SOEs could adversely impact our ability to collect the receivables from and/or bill the CIEB to the SOEs. If the iron and steel SOEs sustained long-term losses with no prospects for improvement, there exists the possibility that the Chinese government could force these SOEs to be acquired or even shutdown. Even though the possibility exists, we have never observed these circumstances nor do we expect them to occur in the foreseeable future.

As the Chinese government is only a shareholder in these SOEs, we do not have any direct recourse against the Chinese government and there is not any requirement for the Chinese government to settle and/or act on the payment of the receivables.

However, there are a few mechanisms available to us to collect the receivables from the SOEs, including the following:

1) In order to improve the collection of our accounts receivable, during the third quarter we formed a special accounts receivable collection team to enhance communication with our clients. Not only do we assign accounts receivable quotas to each individual sales person, we also hold a weekly accounts receivable team call to ensure full execution and effectiveness of our accounts receivable collection process.

2) If the enhanced collection effort does not lead to a successful collection of receivables, we can have our counsel send an opinion letter to our delinquent clients to express our serious concern over the collection of the outstanding receivables and highlighting the importance we attach to the collection of receivables.

 
36

 
3) If the two mechanisms discussed above do not produce positive results in the collection of our receivables, the last mechanism available to us is to initiate a legal proceeding in a Chinese court against any clients unwilling to pay us. However, it is difficult to predict how long a lawsuit can take or its final adjudication. In the history of the Company’s operation, we have never initiated a legal proceeding against our SOE clients over payment matters.

Account Receivable Aging Analysis, as of December 31, 2010
     
 
1-180 days
181-360 days
361-720 days
720-1080 days
over 1080 days
Total
Balance
25,991,333
6,547,924
11,195,429
5,031,048
4,073,614
52,839,348
 
As of December31, 2010, the Company believes that there was 14.7 percentage of accounts receivable would be collected in more than one year, based on our historical collection pattern
 
CIEB is the net difference between the aggregate values of recognized revenue versus the aggregate value of invoices billed.  This account reflects the timing difference between the date that we recognize revenue and the date that we bill to our customers. Revenue recognized from total solution projects is based on the percentage of project’s completion, which most properly reflects the progress of total solution service we render to our clients, while the billing to our customers was based on the contract’s payment schedule of our clients.
 
As of December 31, 2010, the balance of CIEB was $40.7 million. There was a material portion of CIEB was not yet billed in the early of March, 2011. The reason for the increase in CIEB in recent quarters is mainly due to the clients’ prolonged inspection and approval period for the project completion in their administrative process, as China’s iron and steel industry experienced industry-wide weakness during recent quarters. However, we believe that this industry-wide weakness is short-term. The ratio of CIEB relative to our total current will revert back to historical level when the iron and steel industry recovers.
 
Comparison of the Years Ended December 31, 2009 and 2008
 
Net cash provided by operating activities was approximately $5.5 million for the year ended December 31, 2009 as compared to approximately $13.4 million for the same period in 2008. The decrease in net cash provided by operating activities was mainly due to the slower cash payments collected from our customers during the global financial crisis experienced in 2009. Net cash provided by operating activities in the year ended December 31, 2009 was mainly due to net income of $24.4 million, a $6.7 million increase in accrued liabilities and a $6.9 million increase in taxes payable, offset by a $9.9 million increase in accounts receivable, an $18.7 million increase in costs and estimated earnings in excess of billing, a $3.9 million decrease in customer deposits and a $2.8 million decrease in billings in excess of costs and estimated earnings. The increase in accrued liabilities, accounts receivable and cost and estimated earnings in excess of billing was mainly attributable to the growth of our business during the fiscal year.
 
The increase of $18.7 million in costs and estimated earnings in excess of billings in 2009 was mainly due to the increase in aggregate value of projects where we have recognized revenues more than we have billed our customers for these projects, while the decrease in billings in excess of costs and estimated earnings was mainly due to the decrease in aggregate value of projects where we have billed our customers less than we have recognized revenues for these projects.
 
Investing Activities

Comparison of the Years Ended December 31, 2010 and 2009

Net cash used by investing activities in the year ended December 31, 2010 was $1.6 million as compared to net cash provided in investing activities of $0.9 million in the year ended December 31, 2009. The cash used by investing activities in the year ended December 31, 2010 was mainly attributable to capital expenditure in the purchase of new equipment and the improvement of office and manufacturing facilities.

Comparison of the Years Ended December 31, 2009 and 2008

 
37

 
Net cash provided by investing activities in the year ended December 31, 2009 was $0.9 million as compared to net cash used in investing activities of $1.9 million in the year ended December 31, 2008. The cash provided by investing activities in the year ended December 31, 2009 was mainly attributable to proceeds received from the sales of our investments, offset by capital expenditure in the purchase of new equipments and the improvement of office and manufacturing facilities.

Net cash provided by investing activities in 2009 was mainly attributable to the proceeds of $1.6 million received from the restructuring of Tianxiao Fire Safety Equipment Co. Ltd. and the proceeds of $1.0 million received from the sales of our investment in King Galaxy Investments Ltd., offset by the capital expenditure of $1.3 million to purchase building and equipment in 2009.

Financing Activities

Comparison of the Years Ended December 31, 2010 and 2009

Net cash used by financing activities in the year ended December 31, 2010 totaled $3.7 million as compared to $1.9 million provided by financing activities in the year ended December 31, 2009. The cash used by financing activities in the year ended December 31, 2010 was mainly attributable to the increase in restricted cash during the period.

Comparison of the Years Ended December 31, 2009 and 2008

Net cash provided by financing activities in the year ended December 31, 2009 totaled $1.9 million as compared to $3.1 million used by financing activities in the year ended December 31, 2008. The cash provided by financing activities in the year ended December 31, 2009 was mainly attributable to the decrease in restricted cash during the period.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors.

Contractual Obligations

We do not have contractual obligations as of December 31, 2010.

Item 7A. Quantitative And Qualitative Disclosures About Market Risk

Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, exchange rates, commodity prices, equity prices and other market changes. Cash and cash equivalents are held for working capital purposes and consist primarily of bank deposits. We do not enter into investments for trading or speculative purposes.

Interest Rate Risk

We currently do not have any long-term debt. Exposure to interest rate risk primarily relates to the interest income generated by excess cash invested in demand deposits. We have not used derivative financial instruments in our investment portfolio in order to reduce interest rate risk. Interest earning instruments carry a degree of interest rate risk and our future interest income may change, depending on market interest rate movement.

Foreign Currency Risk

Our business is operated in the PRC and India, and its value is effectively denominated in Renminbi and Indian Rupees. The fluctuation of foreign exchange rate between U.S. dollars and Renminbi and U.S. Dollars and Indian Rupees could affect the value of our Common Stock. Our revenues and expenses are primarily denominated in Renminbi and Indian Rupees, so our exposure to foreign exchange risks to Renminbi should generally be limited. In 2009, we began to develop our business in India; revenues and expenses of our operations there are denominated in India’s Rupee. However the revenue contribution from our operations in India is immaterial to our overall business in 2010. Thus, we believe that our exposure to foreign exchange risks to the Indian Rupee should generally be limited.

 
38

 
We do not have material monetary assets and liabilities denominated in U.S. dollars, although to the extent that we do in the future, the fluctuation of foreign exchange rate would affect the value of these monetary assets and liabilities denominated in U.S. dollars. Generally, appreciation of the Renminbi against U.S. dollars will devalue the assets and liabilities denominated in U.S. dollar, while devaluation of Renminbi and the Indian Rupee against the U.S. dollar will appreciate the assets and liabilities denominated in U.S. dollars. In China and India, very limited hedging transactions are available to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure.

Item 8. Financial Statements And Supplementary Data

(a)
Financial statements required by Item 8 are set forth at the pages indicated in item 15(a) below.
(b)
Supplementary Data:

QUARTERLY DATA
(UNAUDITED)

 
Years Ended December 31
 
2009
First Quarter
 
Second Quarter
 
Third Quarter
 
Fourth Quarter
 
Full Year
 
Revenues
   
16,712,211
     
22,731,868
     
24,816,429
     
16,920,690
     
81,181,198
 
Gross profits
   
10,296,759
     
14,500,571
     
13,999,311
     
8,256,635
     
47,053,276
 
Net income Attributable to Controlling Interest
   
5,645,603
     
8,336,222
     
7,553,941
     
2,879,070
     
24,414,836
 
Earnings per share
 
$
0.20
   
$
0.30
   
$
0.27
   
$
0.11
   
$
0.88
 
Earnings per share Diluted
 
$
0.20
   
$
0.29
   
$
0.27
   
$
0.10
   
$
0.86
 
                                         
2010
First Quarter
 
Second Quarter
 
Third Quarter
 
Fourth Quarter
 
Full Year
 
Revenues
   
20,943,726
     
22,833,431
     
24,817,588
     
11,381,937
     
79,976,682
 
Gross profits
   
            11,632,156
     
                   12,395,052
     
12,541,575
     
4,709,659
     
41,278,442
 
Net income Attributable to Controlling Interest
   
              5,247,225
     
                    6,333,660
     
5,934,770
     
              (2,077,720
   
15,437,935
 
Earnings per share
  $ 0.19       0.23    
0.22
    (0.08 )  
0.56
 
Earnings per share Diluted
  $ 0.19        0.22     $
0.20
    (0.07 )   $   0.52  
 
Item 9.  Changes In and Disagreements With Accountants On Accounting and Financial Disclosure
 
Not applicable.

Item 9A. Controls And Procedures

 
39

 
(a)    Management’s annual report on disclosure control and procedures.

As required by Exchange Act Rule 13a-15(b), our management has carried out an evaluation, under the supervision of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2010.

Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of December 31, 2010.

(b)          Management’s annual report on internal control over financial reporting.

As required by Exchange Act Rule 13a-15(c), our management has carried out an evaluation, under the supervision of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our internal control over financial reporting as of December 31, 2010.

Management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process that is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:

 
Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company,

 
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the board of directors of the Company, and

 
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

Management performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on our assessment, we determined that, as of December 31, 2010, our internal control over financial reporting was effective.  Frazer Frost, LLP, an independent registered public accounting firm, has audited the financial statements included in this annual report and, as part of the audit, has issued a report, included herein, on the effectiveness of our internal control over financial reporting as of December 31, 2010.

(c) Changes in Internal Controls over Financial Reporting

During the fourth fiscal quarter ended December 31, 2010, there was no change in our internal controls over financial reporting that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.
 
(d) Independent Registered Public Accounting Firm’s Attestation Report
 
 
40

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of
China Fire & Security Group, Inc.

 
We have audited China Fire & Security Group, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). China Fire & Security Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying “Management’s Annual Report on Internal Control over Financial Reporting.”  Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
 
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, China Fire & Security Group, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets and the related consolidated statements of income and other comprehensive income, changes in equity, and cash flows of China Fire & Security Group, Inc. and subsidiaries, and our report dated March 16, 2011 expressed an unqualified opinion.
 
 
/s/ Frazer Frost, LLP
 
Brea, California
March 16, 2011


Item 9B. Other Information

None.
 
41

 

PART III

Item 10. Directors, Executive Officers and Corporate Governance

Executive Officers and Directors

We have provided below certain information about our executive officers and directors. Our directors serve for a term of one year or until their successors are duly elected. Our executive officers serve at the pleasure of our board of directors and have no fixed term of office. Our executive officers and directors as of March 15, 2011 are listed below. The ages shown are as of March 15, 2011.

Name
 
Age
 
Position
Weigang Li
 
43
 
Chairman of the Board
Brian Lin
 
46
 
Director and Chief Executive Officer
Tongzhou Qin
 
41
 
Chief Financial Officer
Weishe Zhang
 
46
 
Director and Vice President of Strategic Planning
Xiaoyuan Yuan
 
36
 
Principal Accounting Officer
Xianghua Li
 
66
 
Independent Director
Yinqing Li
 
58
 
Independent Director
Guoyou Zhang
 
59
 
Independent Director
Albert McLelland
 
52
 
Independent Director

Mr. Weigang Li , Chairman of the Board, Vice President of Sales of China Fire, General Manager of Sureland Industrial, 43. Mr. Li has served as our VP of Sales since February 2009. Mr. Li co-founded Sureland Industrial in 1995 and held various positions, including deputy director, director and deputy General Manager of Sales. Mr. Li has been influential in winning a number of large, notable contracts since the Company’s inception. Mr. Li has over 15 years of hands on experience in project sales and sales force management in the China fire protection industry. He is currently completing a business diploma in an advanced program for young Chinese entrepreneurs at Tsinghua University. Mr. Li is the brother of Mr. Gangjin Li, the Chairman of the Board.
 
Mr. Brian Lin , Chief Executive Officer, Director, 46. Since March 2010, Mr. Lin serves as our Chief Executive Officer. From December 2009 through March 2010, Mr. Lin served as our Chief Financial Officer. Mr. Lin has served as a director since October 2006 and served as our Chief Executive Officer from October 2006 to December 2009. Mr. Lin has over 17 years of management and technical experience both in the United States and China. Mr. Lin is an early stage investor and co-founder of the Company and has been providing strategic guidance since its inception. Prior to joining the Company full time in January 2006, Mr. Lin served as CEO of Beijing Linkhead Technologies from 2001 to 2005. Mr. Lin received his Master’s Degree in Electrical Engineering from University of Toronto, Canada in 1989.  We believe Mr. Lin’s qualifications to serve on our board include his extensive knowledge of the Company as a long-term executive, which gives him detailed understanding of the complexities of our operations.

Mr. Tongzhou Qin , Chief Financial Officer, Deputy General Manager of Sureland Industrial, 41. Mr. Qin joined the Company in March 2010 as the Deputy General Manager of Sureland Industrial, one of the Company’s indirect subsidiaries, responsible for finance, internal audit, human resources and administration. Mr. Qin has over 18 years of accounting, finance and general management experience. Prior to joining the Company, he was the senior manager at Ernst & Young Huaming Certified Public Accounting Firm in Beijing from March 2001 to February 2010, where he led the audit team and advised clients on internal controls, corporate governance and other public listing rules. Mr. Qin is a Certified Public Accountant, Certified Public Valuer and Certified Tax Agent in the PRC. Mr. Qin obtained his Bachelors degree in Investment Economy Management from China’s Central University of Finance and Economy in 1992.

Mr. Weishe Zhang , Vice President, Director, 46. Since December 2009, Mr. Zhang has served as Vice President of strategic planning and management of marketing, technology and product development.  Mr. Zhang has served as a director since February 2009 and served as Chief Technology Officer from February 2009 to December 2009. From 2002 to February 2009, Mr. Zhang held various positions in the field of product research and development, including Director of System Integration, Director of Product Research and Development Center and Chief Engineer in Sureland Industrial (a wholly owned subsidiary of China Fire). With over 15 years of experience in the China fire protection industry, Mr. Zhang is the inventor of dozens of international and domestic product and technology patents.   Mr. Zhang received a Master’s Degree in Engineering from Beijing University of Aeronautics & Astronautics in 1989.  We believe Mr. Zhang’s qualifications to serve on our board include his extensive knowledge of the Company and his extensive knowledge and experience of the markets in which we conduct business.  Furthermore, Mr. Zhang is a professional in the technology that we utilize and provides technical support to the board, which support is particularly important when evaluating new ventures proposed to the board.
 
 
42

 
 
Mr. Xiaoyuan (Robert) Yuan , Principal Accounting Officer, 36. Mr. Xiaoyuan (Robert) Yuan joined the Company as Chief Accounting Officer in July 2007 and has served as the Principal Accounting Officer since August 2008. From October 2006 to July 2007, Mr. Yuan worked for CCG Elite Investor Relations, a global investor relations company, as an account executive representing a number of public companies listed in the U.S. From 2003 to 2005, Mr. Yuan held various positions in the fields of industry research, strategic planning and M&A for Lenovo Group Co. Ltd. (HKSE: 0992.HK), the largest PC manufacturer in China. Mr. Yuan graduated from Texas Christian University with his Ph.D. degree in Physics and an MBA with a concentration in finance in 2003.

Mr. Xianghua Li , Director, 66. Mr. Xianghua Li has served as an independent Director since September 2008. Mr. Li was the vice chairman of China Fire Protection Association since October 2003. Mr. Li received his diploma from the Military School of Mechanical Technology.  We believe Mr. Li’s qualifications to serve on our board include his extensive knowledge of the Company and his extensive knowledge and experience of the markets in which we conduct business.

Mr. Yinqing Li , Director, 58. Mr. Yinqing Li is the president of the Institute of Building Fire Research, China Academy of Building Research. Mr. Li also holds several concurrent positions including Secretary-general of the Fire-proof and Comprehensive Technique Institute of the Architectural Society of China, the executive director of the China Fire Protection Association, and the director of the National Fire Standardization Technical Committee. Mr. Li has more than 30 years of experience in the fire protection industry including experience with technology innovation, industry standardization and new product development. Mr. Li has also hosted several fire protection design workshops for the mega-buildings in Beijing including the Beijing Capital Airport Terminal 3, the National Stadium and the National centre for the Performing Arts. Mr. Li received his Bachelor’s Degree from Tsinghua University in 1977.

Mr. Guoyou Zhang,   Director, 59. Mr. Zhang has served as an independent Director since April 2007. Mr. Zhang is currently the Vice President of Beijing University and the director of the Institute of International Business Management, Beijing University. Professor Zhang has extensive experience in teaching economics and business management and has written and/or edited many published articles and books over the past 20 years. Mr. Zhang has been teaching in Beijing University since 1976. He received his Ph.D. degree in Economics from Beijing University in 1991.  We believe Mr. Zhang’s qualifications to serve on our board include his extensive knowledge of the Company and his in-depth knowledge of our market and general management.

Mr. Albert McLelland , Director, 52. Mr. McLelland has served  as an independent Director since September 2008. Since 2003, Mr. McLelland has been the Senior Managing Director of AmPac Strategic Capital LLC (AmPac) Prior to founding AmPac, Mr. McLelland was responsible for the day-to-day operations of the cross-border transactions initiative of PricewaterhouseCoopers’ (PwC) Financial Advisory Services. Albert possesses extensive investment and merchant banking experience. He has built two Asian based financial service firms and also ran corporate finance at CEF Taiwan Limited. Mr. McLelland began his investment banking career at Shearson Lehman. Mr. McLelland is also teaching “Venturing in China” at the Caruth Institute for Entrepreneurship at the Cox School of Business at Southern Methodist University. Since 2009, Mr. Mclleland has been an Independent Director and Chairman of the Audit Committee for Yanglin Soybean, Inc. (“YSYB.OB”) and China Housing and Land Development, Inc. (“CHLN”). Mr. McLelland holds an MBA degree from the University of Chicago and a Master of International Affairs from Columbia.  He did his undergraduate studies at the University of South Florida and also studied Mandarin at the National Normal University in Taiwan.  We believe Mr. McLelland’s qualifications to serve on our board include his extensive knowledge of the Company, his experience serving on boards of other companies and the unique perspective he brings to various issues considered by the board, particularly related to finance, accounting and general management.

Board Composition and Committees
 
Our Board has seven (7) members, of which four (4) are independent directors. We have an Audit Committee, a Compensation Committee and a Nominating and Corporate Governance Committee. The Audit Committee has been established as a separately designated standing committee in accordance with section 3(a)(58)(A) of the Exchange Act. The Audit Committee has at least one member, Mr. Albert McLelland, who meets the definition of a “financial expert” under SEC rules and whom the Board has determined to be “independent”.   We do not have a lead independent director, but have independent board members that bring experience, oversight and expertise from outside the Company and our industry.
 
Audit Committee . The Audit Committee currently comprises Mr. Albert Mclelland, Mr. Xianghua Li and Mr. Guoyou Zhang, with Mr. Albert Mclelland as the chairman, each of whom are “independent” as that term is defined by SEC rules and under the
 
 
43

NASDAQ listing standards. The Audit Committee is directly responsible for the appointment, retention, compensation and oversight of the work of any registered public accounting firm employed by the Company (including resolution of disagreements between management and the accounting firm regarding financial reporting) for the purpose of preparing or issuing an audit report or related work or performing other audit, review or other services. The Audit Committee has the ultimate authority and responsibility to evaluate and, where appropriate, replace the registered public accounting firm. The Audit Committee has the authority to review and approve transactions between the Company and its directors, officers and affiliates.
 
Compensation Committee. The Compensation Committee is responsible for the administration of all salary, bonus and incentive compensation plans for our officers and key employees. The members of the Compensation Committee are Mr. Guoyou Zhang, Mr. Xianghua Li and Mr. Yinqing Li, with Mr. Guoyou Zhang as the chairman. All of the members of the Compensation Committee are “independent” directors
 
Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee is responsible for preparing the list of candidates to fill the expiring terms of directors on our Board of Directors. The committee submits the list of candidates to the Board of Directors who determines which candidates will be nominated to serve on the Board of Directors. The nominees are then submitted for election at the annual meeting of stockholders. The committee also submits to the entire Board of Directors a list of candidates to fill any interim vacancies on the Board of Directors resulting from the departure of a member of the Board of Directors for any reason prior to the expiration of his term. In recommending candidates for the Board of Directors, the committee keeps in mind the functions of this body.
 
The committee considers various criteria, including the ability of the individual to meet SEC and NASDAQ “independence” requirements, general business experience, general financial experience, knowledge of the company’s industry (including past industry experience), education, and demonstrated character and judgment. The committee will consider director candidates recommended by a stockholder if the stockholder mails timely notice to the secretary of the Company at its principal offices, which notice includes (i) the name, age and business address of such nominee, (ii) the principal occupation of such nominee, (iii) a brief statement as to such nominee’s qualifications, (iv) a statement that such nominee consents to his or her nomination and will serve as a director if elected, (v) whether such nominee meets the definition of an “independent” director under the SEC rules and under NASDAQ listing standards and (vi) the name, address, class and number of shares of company stock held by the nominating stockholder.
 
The Company has no definitive policy on diversity.  With the exception of two directors who are not Chinese citizens, the Company is managed by executives of Chinese citizenship and actively staffs the Company at all levels with employees that are citizens of China.  While each member of the board of directors has diversified education background, different industry experiences including government agencies, universities, state-owned enterprises, consulting services, multinational companies, and private owned companies,  the board believes that there exists no need for a diversity policy for employees or directors because the Company is diversified when compared to American-based enterprises.
 
Any person nominated by a stockholder for election to the Board of Directors will be evaluated based on the same criteria as all other nominees. The committee also oversees our adherence to our corporate governance standards. The members of the committee are Mr. Yinqing Li, Mr. Guoyou Zhang, and Mr. Xianghua Li, with Yinqing Li as the chairman.
 
The Board had 10 meetings during the last fiscal year.  All members attended at least 75% of the meetings.

The Board’s Role in Risk Oversight.  The Board has an active role in overseeing our risk management.  The Board’s role in the Company’s risk oversight process includes receiving regular reports from members of senior management on areas of material risk to the Company, including operational, financial, legal, regulatory, and strategic risks. The full Board receives these reports from the appropriate senior manager within the organization to enable it to understand the Company’s risk identification, risk management and risk mitigation strategies. Upon receiving such reports, the Board provides such guidance as it deems necessary.

Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Exchange Act requires our executive officers, directors and beneficial owners of more than 10% to report their beneficial ownership of equity interests in the company to the SEC. Their initial reports are required to be filed using the SEC’s Form 3, and they are required to report subsequent purchases, sales, and other changes using the SEC’s Form 4, which must be filed within two business days of most transactions. Officers, directors, and persons owning more than 10% of our capital shares are required by SEC regulations to furnish us with copies of all of reports they file pursuant to Section 16(a).
 
 
44

 
Code of Ethics
 
We have adopted a Code of Ethics (as defined in Item 406 of Regulation S-K) that applies to our principal executive, financial and accounting officers. China Fire & Security Group, Inc. will provide a copy of its code of ethics, without charge, to any person that requests it. Requests should be addressed in writing to Mr. Tongzhou Qin, Chief Financial Officer, B-2502 TYG Center, C2 Dongsanhuanbeilu, Chaoyang District, Beijing 100027, People’s Republic of China.

Item 11. Executive Compensation

Compensation Discussion and Analysis

The Company’s executive compensation program is designed to pay key management personnel competitive remuneration based on the authority, responsibility and accountability of the position held by the individual. In addition, the Company considers the competitive environment relative to compensation paid to senior management with comparable job scopes in companies in related industries and of the same approximate size.

Our senior officers receive compensation in the form of salaries, annual bonuses, stock options and restricted stock. We have entered into service agreements with each of our senior officers. None of these service agreements provide benefits to our senior officers upon termination.

An understanding of our executive compensation program begins with an understanding of the objectives the program is intended to serve. These include:
 
 
Offering competitive compensation . We seek to offer a compensation package that is attractive and competitive with the compensation practices of the peer companies with which we compete for talent.
 
Rewarding performance . Our compensation program is intended to closely align executive compensation with performance by tying a significant portion of compensation to the achievement of financial and other Company goals and the executive’s contributions to the accomplishment of those goals.
 
Aligning the interests of our executives with those of our shareholders . A significant portion of the total compensation paid to our key Executive Officers is in the form of equity-based compensation. This serves to further align the interests of our executives with those of our shareholders.

Elements of Our Executive Compensation Programs

Our Compensation mainly consists of two parts, Cash Compensation and Equity Incentive Compensation. The Cash Compensation consists of Base Salary and Bonus. The Equity Incentive Compensation aligns executives’ and shareholders’ interests by providing executives an ownership stake in the Company.

Base Salary : Base salaries for our named executives are set based on their professional qualifications and experiences, education background, scope of their responsibilities, taking into account competitive market compensation levels paid by other similar-sized companies for similar positions and reasonableness and fairness when compared to other similar positions of responsibility within the Company. Base salaries are reviewed annually by the Compensation Committee and may be adjusted annually as needed.

Bonus : To achieve our goal of pay-for-performance, bonuses will be paid to our named executives when company financial goals are achieved. The bonus is typically a percentage of the Base Salary and is part of the cash compensation of our named executives. The Compensation Committee has determined that when the Company actual financial results are better than the guidance provided by the Company, the bonuses will be paid in full. Otherwise, no bonuses will be paid to our named executives.  The financial guidance was determined based on the condition of the industry and industry trends in the fire protection market and the historical financial performance of the Company. The financial guidance approved by the board of directors in fiscal year 2010 was $103.9 million in revenue and $34.8 million in pre-tax income, representing 28% and 22% growth respectively compared to the results in fiscal year 2009. The actual financial results in 2010 were $80.8 million in revenue and $18.7 million in pre-tax income, which missed the financial guidance. Consequently, the bonuses to Mr. Brian Lin and Mr. Tongzhou Qin were not paid in fiscal year 2010.

Equity Incentive Compensation : A key element of our pay-for-performance philosophy is our reliance on performance-based equity awards through the Company’s stock option plan. This program aligns executives’ and shareholders’ interests by providing executives
 
 
45

 
an ownership stake in the Company. Our Compensation Committee has the authority to award equity incentive compensation, i.e. stock options, to our executive officers in such amounts and on such terms as the Compensation Committee determines in its sole discretion. The Compensation Committee reviews each executive’s individual performance and his or her contribution to our strategic goals and determines the amount of stock options or the restricted shares to be awarded towards the end of the fiscal year. The exercise price for stock options was the closing market price on the date of the grant.

The following is a discussion of our executive compensation program and the compensation decisions made for fiscal year 2010 with respect the executive officers named in the Compensation Table on page 48.
 
In 2010, the Compensation Committee, which is responsible for approving and overseeing executive compensation, accepted recommendations from senior management and reviewed such recommendations with market data to determine the compensation to be paid to the Company’s executive officers.  Important determining factors included the Company’s financial performance, the level of compensation paid to similarly situated executives in comparably-sized public companies and the contributions made by each of the executive officers to the success of the Company.

How Executive Compensation is Determined

The Compensation Committee of the company seeks to offer our executives compensation packages that are attractive and competitive with compensation practices of the peer companies with which we might compete for talent. The Compensation Committee has determined that a peer company would have the following characteristics:
 
 
majority of the business is providing solutions and systems to industrial customers in China

 
listed on a major exchange in the United States with market capitalization between US$200 million to US$800 million

The Compensation Committee collected the executive compensation information of the following companies (the “Comparison Group”) during the course of discussing and finalizing the compensation for our executives.
     
Year 2009
     
Salary
 
Stock
 
Option
 
All Other
Compensation
 
Bonus
 
Total
1
 
China Security & Surveillance (CSR)
 
   
CEO
$290,058
                 
$290,058
   
CFO
$315,904
 
 
 
 
 
 
 
 
 
$315,904
                           
2
 
China Information Security Technolgy, Inc. (CPBY)
                     
   
CEO
58,644
 
$119,000
             
$177,644
   
CFO
$12,500
 
119,000  
 
-
 
 
 
 
 
$131,500 
                           
3
 
COGO Group, Inc. (COGO)
                     
   
CEO
$74,904
 
$320,600
     
$2,251
     
$397,755
   
CFO
$100,000
 
$307,242
 
 
 
$1,548
 
 
 
$408,790
                           
4
 
Harbin Electric, Inc. (HRBN)
                     
   
CEO
$26,470
     
$11,946
         
$38,416
   
CFO
$15,882
 
 
 
$7,962
 
 
 
 
 
$23,844
                           
5
 
Shengdatech, Inc. (SDTH)
                     
   
CEO
$195,000
     
-
     
$105,000
 
$300,000
   
CFO
$92,500
 
 
 
-
 
 
 
$49,850
 
$142,350