Attached files
file | filename |
---|---|
EX-31.1 - CHINA FIRE & SECURITY GROUP, INC. | v177378_ex31-1.htm |
EX-32.1 - CHINA FIRE & SECURITY GROUP, INC. | v177378_ex32-1.htm |
EX-23.1 - CHINA FIRE & SECURITY GROUP, INC. | v177378_ex23-1.htm |
EX-31.2 - CHINA FIRE & SECURITY GROUP, INC. | v177378_ex31-2.htm |
EX-21.1 - CHINA FIRE & SECURITY GROUP, INC. | v177378_ex21-1.htm |
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, 2009
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 þ
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 þ
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 þ No
¨
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 þ
The
aggregate market value of the 9,537,941 shares of voting and non-voting
common equity stock held by non-affiliates of the registrant was $116,076,742 as
of June 30, 2009, 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 $12.17 per share, as reported by The
NASDAQ Stock Market, Inc.
As
of March 15, 2010, there were 27,595,541 shares of common stock of China
Fire & Security Group, Inc. outstanding.
TABLE
OF CONTENTS
Page
|
|||||
PART
I
|
|||||
Item
1
|
Business
|
3
|
|||
Item
1A
|
Risk
Factors
|
11
|
|||
Item
1B
|
Unresolved
Staff Comments
|
20
|
|||
Item
2
|
Properties
|
20
|
|||
Item
3
|
Legal
Proceedings
|
21
|
|||
PART
II
|
|||||
Item
5
|
Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
21
|
|||
Item
6
|
Selected
Financial Data
|
22
|
|||
Item
7
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operation
|
23
|
|||
Item
7A
|
Quantitative
and Qualitative Disclosures About Market Risk
|
34
|
|||
Item
8
|
Financial
Statements and Supplementary Data
|
34
|
|||
Item
9
|
Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure
|
35
|
|||
Item
9A
|
Controls
and Procedures
|
35
|
|||
Item
9B
|
Other
Information
|
37
|
|||
PART
III
|
|||||
Item
10
|
Directors,
Executive Officers and Corporate Governance
|
37
|
|||
Item
11
|
Executive
Compensation
|
41
|
|||
Item
12
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
47
|
|||
Item
13
|
Certain
Relationships and Related Transactions, and Director
Independence
|
48
|
|||
Item
14
|
Principal
Accounting Fees and Services
|
48
|
|||
PART
IV
|
|||||
Item
15
|
Exhibits
and Financial Statement Schedules
|
49
|
-2-
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 for customers of our industrial fire safety
systems. 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, power
and petrochemical industries in China. In 2009, we also secured several
contracts with power generation plants in India. We are further developing our
business in the transportation sector, including subways, highway tunnels, high
speed trains and marine transportation, and telecommunications
sectors.
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 and have successfully developed a
comprehensive line of linear heat detectors.
We are
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 the 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. In 2008 and 2009, we were also twice
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 products have been used by customers in more
than 20 provinces throughout China.
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 with significantly lower cost. 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 breakthrough in the
retrofitting and maintenance services area to win more contract
opportunities from 2010 to 2012, and to capitalize on the industry's
continued consolidation.
|
-3-
|
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 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 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 independent product sales
through 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 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. According to a study published by China’s Building
Mechanical & Electrical Engineering Magazine, China’s total revenues
from industrial fire safety products and services in 2006 was approximately $1
billion and the annual growth rate for the following five years was expected to
be more than 11%.
-4-
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 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, expansion and
renovation of existing facilities in 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:
·
|
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, 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 (LHD) 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 high-tech enterprise, China Fire has ample
manufacturing capacity to support its future business growth in specialized fire
detection and suppression products.
-5-
·
|
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 for achieving sustained
business and financial growth over the last six years.
Our
Products and Services
Our major
customers are in the iron and steel (contributing approximately 75% of
revenues), traditional power generation (contributing approximately 16% of
revenues) and petrochemical (contributing approximately 1% of revenues)
industries. Our revenues are mainly from three sources: Total Solutions, Product
Sales, and Maintenance Services. In 2009, revenues from total solutions
accounted for approximately 77.0% of total revenues and the sale of products
integrated accounted for approximately 19.4% of total revenues, while
maintenance services accounted for approximately 3.6% 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
2009, we designed and installed more than 181 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 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 2009,
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 2009
Name
|
Industry
|
Amount of
Revenues
(in
thousands)
|
Percentage of
Total Solution
Revenues
|
|||||||
Capital
Iron & Steel Group (Caofeidian Project)
|
Metallurgy
|
8,103 | 12.69 | % | ||||||
Jinan
Iron & Steel Group
|
Metallurgy
|
7,222 | 11.55 | % | ||||||
MCC
Capital Engineering & Research
|
Metallurgy
|
3,535 | 5.65 | % | ||||||
Dongbei
Special Steel Group
|
Metallurgy
|
2,974 | 4.76 | % | ||||||
Datang
Power (Tashan Project)
|
Power
|
2,811 | 4.50 | % | ||||||
Total
|
24,645 | 39.42 | % |
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:
-6-
Fire
Detectors. The products include:
-
Linear Heat Fire Detectors
-
Multi-Frequency Infrared Flame Detectors
-
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
-
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.
In 2009,
we developed new products, including fixed point combustible gas detectors,
foam-based fire extinguishing systems and anti-explosive cylinders. 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,
2009. 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 2009
Name
|
Industry
|
Sales in
(in
thousands)
|
Percentage of
Total Product
Sales
|
|||||||
Datang
Power (Guangdong)
|
Power
|
1,021 | 6.56 | % | ||||||
Datang
Power (Jiangsu)
|
Power
|
902 | 5.80 | % | ||||||
Wuxi
Tianyou Special Detection Technology Co., Ltd.
|
Other
|
820 | 5.27 | % | ||||||
China
Power Investment Group (Shanghai)
|
Power
|
724 | 4.66 | % | ||||||
Tianjin
Tianchuan Municipal Enginneering Co., Ltd.
|
Other
|
696 | 4.47 | % | ||||||
Total
|
4,163 | 26.76 | % |
-7-
Our
Intellectual Property
We
develop our own technologies for our products and services. We own 119 patents
and have 24 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
|
45
|
11
|
||||||
Infrared
Flame Detectors
|
2
|
0
|
||||||
Water
Mist Nozzles
|
6
|
0
|
||||||
Remote
System Control Device
|
3
|
0
|
||||||
Fire
Alarm Control Device
|
11
|
3
|
||||||
Foamed-Based
Fire Extinguishing Device
|
4
|
1
|
||||||
Others
|
48
|
9
|
||||||
Total
|
119
|
24
|
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”.
Our
Research and Development Efforts
We
currently have approximately 33 members on our research and development 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 $1,631,435 and
$2,102,976 during the years ended December 31, 2009 and 2008,
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.
-8-
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 two 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 20 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 100 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 .
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.
-9-
Major
Suppliers
The
tables below list our top five suppliers as of December 31,
2009
Major
Suppliers of Materials and Parts for Our Own Products
Item
|
Suppliers
|
Amount
Purchased
in 2009
(in
thousands)
|
Percentage
of Total
Purchase
|
|||||||
Cabinet
|
Hebei
Qingxian Fangzheng Cabinet Co., Ltd.
|
108 | 7.75 | % | ||||||
Cabinet
|
Qingxian
Zhiyingda Electricity Applicants Co., Ltd.
|
103 | 7.37 | % | ||||||
Cable
Materials
|
Nanjing
Xianbang Technology Co., Ltd.
|
93 | 6.64 | % | ||||||
Electron
Component
|
Beijing
Tianlike Commercial Co., Ltd.
|
86 | 6.17 | % | ||||||
Electron
Component
|
Beijing
Huatai Chuangxin Technology Co., Ltd.
|
62 | 4.4 | % | ||||||
Total
|
452 | 32.33 | % |
Major
Suppliers for Third Party Products of Our Fire Safety Systems
Item
|
Suppliers
|
Amount
Purchased
in 2009
(in
thousands)
|
Percentage
of Total
Purchase
|
|||||||
Devulge
valve, nozzle, gas fire extinguisher
|
Tianjin
Tianxiao Safety Equipment Co., Ltd.
|
1,246 | 8.8 | % | ||||||
Monitor,
detector
|
Honeywell
( Shanghai )
|
720 | 5.1 | % | ||||||
Electrical
applicants and environment monitoring system
|
Dinglian
High Technology Co., Ltd. (Beijing )
|
677 | 4.8 | % | ||||||
Galvanized
seamless steel pipe
|
Cangzhou
Junda Steel Pipe Co., Ltd.
|
590 | 4.2 | % | ||||||
Fire-refractory
coating
|
Wuxi
Hongyuan Fire Protection Material Co., Ltd.
|
465 | 3.3 | % | ||||||
Total
|
3,698 | 26.2 | % |
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.
-10-
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, 2009, we employed 425 full-time employees. Approximately 20% of our
employees are management personnel, 8% are R&D staff members and 18% are
sales staff members. Approximately 81% 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.
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. 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.
-11-
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.
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.
-12-
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 two 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. We are
negotiating with another company to enter into a similar agreement. 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 products. 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;
|
|
·
|
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.
-13-
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
Untied 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.
No customer individually accounted for more than 20% of our revenues for the
fiscal year ended December 31, 2009. In aggregate, our five largest customers in
our total solutions and products businesses accounted for approximately 39% and 27%, respectively,
of our revenues from these segments in fiscal 2009. 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.
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. Gangjin Li, our Chief Executive
Officer, Mr. Brian Lin, our Chief Financial Officer, Mr. Weishe Zhang, our Vice
President of Strategic Planning, Mr. Robert Yuan, our Principal Accounting
Officer and Mr. Weigang Li, our Vice President of Sales. 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.
-14-
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
|
|
·
|
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.
-15-
Risks
Related To Our Industry
Our market will
open to foreign companies. China’s commitments under the WTO (World Trade
Organization) 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. 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;
|
-16-
|
·
|
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 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 effect service of process
in the U.S., or to enforce a judgment obtained in the U.S. against us or any of
these persons.
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.
-17-
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.
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 (“SASAC”),
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 (“SAFE”), 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, or SPVs, 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.
-18-
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 percent 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. 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,
|
-19-
|
·
|
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.
Our Common Stock
may be considered to be a “penny stock” and, as such, the market for our Common
Stock may be further limited by certain SEC rules applicable to penny
stocks. To the extent the price of our common stock remains below $5.00
per share, we have net tangible assets of $2,000,000 or less, or if we fall
below certain other thresholds, our common shares will be subject to certain
“penny stock” rules promulgated by the SEC. Those rules impose certain sales
practice requirements on brokers who sell penny stocks to persons other than
established customers and accredited investors (generally institutions with
assets in excess of $5,000,000 or individuals with net worth in excess of
$1,000,000). For transactions covered by the penny stock rules, the broker must
make a special suitability determination for the purchaser and receive the
purchaser’s written consent to the transaction prior to the sale. Furthermore,
the penny stock rules generally require, among other things, that brokers
engaged in secondary trading of penny stocks provide customers with written
disclosure documents, monthly statements of the market value of penny stocks,
disclosure of the bid and asked prices and disclosure of the compensation to the
brokerage firm and disclosure of the sales person working for the brokerage
firm. These rules and regulations adversely affect the ability of brokers to
sell our common shares and limit the liquidity of our securities.
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 61% 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.
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.
-20-
Item
3. Legal Proceedings
In 2008,
we filed five lawsuits against four different companies for the infringement of
our intellectual properties in linear heat detectors. By March 10, 2010, three
of these five lawsuits had been settled in our favor and the other two cases are
still pending. We expect the two pending cases filed in 2008 will be settled in
our favor in the future. In 2008, we were counter-sued by three 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.
In 2009, we filed four lawsuits against
four different companies for the infringement of our intellectual properties in
linear heat detectors and these four cases are still pending. We expect these
four pending cases 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, 2010, these two cases are pending. We expect these two pending cases
to be 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,
2010
|
|
High
|
|
|
Low
|
|
||
First
Quarter (up to March 15)
|
$
|
16.49
|
$
|
10.64
|
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 |
Year ending December 31,
2008
|
|
High
|
|
|
Low
|
|
||
First
Quarter
|
$
|
13.00
|
$
|
3.55
|
||||
Second
Quarter
|
$
|
13.00
|
$
|
6.85
|
||||
Third
Quarter
|
$
|
12.75
|
$
|
7.28
|
||||
Fourth
Quarter
|
$
|
10.63
|
$
|
5.70
|
On March
15, 2010, the last reported sale price of our common stock on The NASDAQ Capital
Market was $15.48 per share.
Shareholders
As of
March 15, 2010, we had outstanding 27,595,541 shares of common stock, held
by approximately 1,500 stockholders of record and beneficially.
-21-
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
|
|||||||||||||||||||
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||
Revenues
|
$ | 81,181,198 | $ | 69,079,119 | $ | 46,753,837 | $ | 32,455,036 | $ | 21,178,476 | ||||||||||
Cost
of revenues
|
34,127,922 | 29,581,246 | 21,090,854 | 16,226,307 | 8,642,234 | |||||||||||||||
Gross
profits
|
47,053,276 | 39,497,873 | 25,662,983 | 16,228,729 | 12,536,242 | |||||||||||||||
Operating
expenses
|
19,468,840 | 15,931,124 | 10,776,553 | 8,250,285 | 5,495,578 | |||||||||||||||
Income
from operations
|
27,584,436 | 23,566,749 | 14,886,430 | 7,978,444 | 7,040,664 | |||||||||||||||
Other
income (expenses)
|
940,704 | 1,184,526 | 1,920,287 | (926,597 | ) | 577,673 | ||||||||||||||
Income
before provision for income taxes and noncontrolling
interest
|
28,525,140 | 24,751,275 | 16,806,717 | 7,051,847 | 7,618,337 | |||||||||||||||
Provision
for income taxes
|
4,165,548 | 47,423 | 5,081 | 82,206 | 202,920 | |||||||||||||||
Less: Net
income (loss) attributable to noncontrolling
interest
|
(55,244 | ) | - | - | - | 143,283 | ||||||||||||||
Net
income attributable to controlling interest
|
24,414,836 | 24,703,852 | 16,801,636 | 6,969,641 | 7,272,134 | |||||||||||||||
Comprehensive
income
|
$ | 24,433,929 | $ | 28,440,879 | $ | 19,304,231 | $ | 7,551,573 | $ | 7,755,724 | ||||||||||
Weighted
average number of shares
|
27,590,523 | 27,568,214 | 26,873,742 | 24,340,196 | 24,000,000 | |||||||||||||||
Earnings
per share
|
$ | 0.88 | $ | 0.90 | $ | 0.63 | $ | 0.29 | $ | 0.30 | ||||||||||
Weighted
average number of shares Diluted
|
28,311,955 | 28,210,620 | 27,721,171 | 24,539,414 | 24,000,000 | |||||||||||||||
Earnings
per share Diluted
|
$ | 0.86 | $ | 0.88 | $ | 0.61 | $ | 0.28 | $ | 0.30 |
-22-
CONSOLIDATED
BALANCE SHEETS
|
Years Ended December 31
|
|||||||||||||||||||
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||
Cash
and cash equivalents
|
$ | 34,976,880 | $ | 26,655,333 | $ | 17,110,449 | $ | 9,426,091 | $ | 2,357,399 | ||||||||||
Accounts
receivables – current, net of allowance
|
30,989,569 | 25,826,343 | 16,525,161 | 13,211,721 | 7,687,260 | |||||||||||||||
Receivables
from related party
|
551,792 | 466,223 | - | - | - | |||||||||||||||
Inventories
|
5,360,520 | 6,538,938 | 4,048,283 | 4,190,830 | 2,410,020 | |||||||||||||||
Total
current assets
|
121,046,728 | 91,449,840 | 62,190,368 | 43,295,272 | 24,630,283 | |||||||||||||||
Plant
and equipment, net
|
8,617,521 | 8,445,254 | 6,568,250 | 3,529,808 | 3,615,374 | |||||||||||||||
Total
assets
|
138,366,191 | 105,408,918 | 71,646,427 | 48,308,828 | 28,844,363 | |||||||||||||||
Total
current liabilities
|
33,966,635 | 26,719,771 | 21,438,311 | 20,649,342 | 28,766,633 | |||||||||||||||
Total
shareholder's equity
|
$ | 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., (the "Company" or "CFSG") 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 consumers 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 the first company in China to utilize high
technology for fire protection and safety of its clients in the iron and
steel companies, power plants, petrochemical plants, as well as, special purpose
construction in China.
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. in exchange for a controlling interest in our common shares. The
transaction was completed on Oct 27, 2006.
China
Fire Protection Group 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 Fire Safety Limited and
Sureland Industrial Fire Equipment Co., Ltd became wholly-owned subsidiaries of
China Fire Protection Group Limited, and China Fire Protection Group Limited is
a wholly-owned subsidiary of Unipro.
On
February 9, 2007, Unipro changed its name to China Fire & Security Group,
Inc. (CFSG) 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.
-23-
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 and of
design and installation of industrial fire safety systems that utilizes 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 recently begun contract manufacturing products
for the export market and it has begun to provide a fire safety system for a
Chinese company operating abroad.
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
developing 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.
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 only manufacturer in China which has successfully developed a
comprehensive line of linear heat detectors.
As of
December 31, 2009, Sureland operated more than 20 sales and liaison offices in
China.
Sureland
has 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. 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.
Revenue
recognition
Revenue
is recognized when it is probable that the economic benefits will flow to the
Company as follows:
1.
|
Revenue from system contracting
projects are recognized using the percentage-of-completion method of
accounting and, therefore, take into account the costs, estimated earnings
and revenue to date on contracts not yet completed. Revenue recognized is
that percentage of the total contract price that cost expended to date
bears to anticipated final total cost, based on current estimates of costs
to complete. Contract costs include all direct material and labor costs
and those indirect costs related to contract performance, such as indirect
labor, supplies, tools, repairs, and depreciation costs. Selling, general,
and administrative costs are charged to expense as incurred. At the time a
loss on a contract becomes known, the entire amount of the estimated
ultimate loss is recognized in the consolidated financial statements.
Claims for additional contract costs are recognized upon a signed change
order from the customer.
|
2.
|
Revenue from product sales is
recognized when the goods are delivered and title has passed. Product
sales revenue represents the invoiced value of goods, net of the
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 percent 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 when such services are
provided.
|
4.
|
Provision is made for foreseeable
losses as soon as they are anticipated by
management.
|
-24-
5.
|
Where contract costs incurred to
date plus recognized profits less recognized losses exceed progress
billings, the surplus is treated as an amount due from contract consumers.
Where progress billings exceed contract costs incurred to date plus
recognized profits less recognized losses, the surplus is treated as an
amount due to contract
customers.
|
Foreign currency
translation
The
reporting currency of the Company is the US dollar. The Company uses their local
currency, Renminbi (RMB) 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 statement of changes in equity. 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, although there is no assurance that the Company
will not enter into such activities 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 and the allowance of doubtful accounts. Management evaluates all of its
estimates and judgments on an on-going basis.
Accounts
receivable
Accounts
receivable represents the products sales, maintenance services and system
contracting projects with its customers that were on credit. 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.
Inventories
Inventories
are stated at the lower of cost or market, using the weighted average method.
Inventories consist of raw materials, work in progress, finished goods and
consumables. Raw materials consist primarily of materials used in production.
Finished goods consist primarily of equipment used in product sales and project
contracts. The cost of finished goods included 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 annually for possible obsolete goods or 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.
-25-
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 percent residual value.
Recently issued accounting
pronouncements
In
January 2009, ASC 325-40, “Amendments to the Impairment Guidance of ASC
325-40,“Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets”. ASC 325-40 changes the
impairment model included within ASC 325-40 to be more consistent with the
impairment model of ASC-320. ASC 325-40 achieves this by amending the impairment
model in ASC 325-40 to remove its exclusive reliance on “market participant”
estimates of future cash flows used in determining fair value. Changing the cash
flows used to analyze other-than-temporary impairment from the “market
participant” view to a holder’s estimate of whether there has been a “probable”
adverse change in estimated cash flows allows companies to apply reasonable
judgment in assessing whether other-than-temporary impairment has occurred. The
adoption of ASC 325-40 did not have a material impact on our consolidated
financial statements because all of the investments in debt securities are
classified as trading securities.
In April
2009, the ASC 820-10, “Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly” ASC 820-10 amends ASC820 and provides
additional guidance for estimating fair value in accordance with ASC820 when the
volume and level of activity for the asset or liability have significantly
decreased and also includes guidance on identifying circumstances that indicate
a transaction is not orderly for fair value measurements. This accounting
standard shall be applied prospectively with retrospective application not
permitted. The adoption of ASC 820-10 did not have a material impact on our
consolidated financial statements.
In April
2009, the FASB issued ASC 320-10 and ASC 958-302. ASC 320-10, “Accounting for
Certain Investments in Debt and Equity Securities,” ASC 958-302, “Accounting for
Certain Investments Held by Not-for-Profit Organizations,” and, ASC 325-40
“Recognition of Interest Income and Impairment on Purchased Beneficial Interests
and Beneficial Interests That Continue to Be Held by a Transferor in Securitized
Financial Assets,” to make the other-than-temporary impairments guidance more
operational and to improve the presentation of other-than-temporary impairments
in the financial statements. This FSP will replace the existing requirement that
the entity’s management assert it has both the intent and ability to hold an
impaired debt security until recovery with a requirement that management assert
it does not have the intent to sell the security, and it is more likely than not
it will not have to sell the security before recovery of its cost basis. This
ASC provides increased disclosure about the credit and noncredit components of
impaired debt securities that are not expected to be sold and also requires
increased and more frequent disclosures regarding expected cash flows, credit
losses, and an aging of securities with unrealized losses. Although this FSP
does not result in a change in the carrying amount of debt securities, it does
require that the portion of an other-than-temporary impairment not related to a
credit loss for a held-to-maturity security be recognized in a new category of
other comprehensive income and be amortized over the remaining life of the debt
security as an increase in the carrying value of the security. The adoption of
ASC 320-10 and ASC 958-302 did not have a material impact on our consolidated
financial statements.
In April
2009, the FASB issued ASC 825-10 and ASC 270-10-05. This ASC amends ASC 825-10,
“Disclosures about Fair Value of Financial Instruments,” to require disclosures
about fair value of financial instruments not measured on the balance sheet at
fair value in interim financial statements as well as in annual financial
statements. Prior to this ASC, fair values for these assets and liabilities were
only disclosed annually. This ASC applies to all financial instruments within
the scope of ASC 825-10 and requires all entities to disclose the method(s) and
significant assumptions used to estimate the fair value of financial
instruments. The adoption of ASC 825-10 and ASC 270-10-05 did not
have a material impact on our consolidated financial statements.
In June
2009, the FASB issued Statement of Financial Accounting Standards No. ASC 860,
Accounting for Transfers of Financial Assets — an amendment of ASC 860,
which requires entities to provide more information regarding sales of
securitized financial assets and similar transactions, particularly if the
entity has continuing exposure to the risks related to transferred financial
assets. ASC 860 eliminates the concept of a “qualifying special-purpose entity,”
changes the requirements for derecognizing financial assets and
requires additional disclosures. ASC 860 is effective for fiscal years
beginning after November 15, 2009. We have not completed the
assessment of the impact ASC 860 will have on our financial condition,
results of operations or cash flows.
In June
2009, the FASB issued Statement of Financial Accounting Standards No. ASC
810-10, Amendments to FASB Interpretation No. 46(R), which modifies how a
company determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. ASC
810-10 clarifies that the determination of whether a company is required to
consolidate an entity is based on, among other things, an entity’s purpose
and design and a company’s ability to direct the activities of the entity that
most significantly impact the entity’s economic performance. ASC 810-10
requires an ongoing reassessment of whether a company is the primary beneficiary
of a variable interest entity. ASC 810-10 also requires additional
disclosures about a company’s involvement in variable interest entities and any
significant changes in risk exposure due to that involvement. ASC 810-10 is
effective for fiscal years beginning after November 15, 2009. We have
not completed the assessment of the impact ASC 810-10 will have on our
financial condition, results of operations or cash flows.
In August 2009, the FASB issued an
Accounting Standards Update (“ASU”) regarding measuring liabilities at
fair value. This ASU provides additional guidance clarifying the measurement of liabilities at
fair value in circumstances in which a quoted price in an active market for the
identical liability is not available; under those circumstances, a reporting
entity is required to measure fair value using one or more of valuation techniques, as defined. This
ASU is effective for the first reporting period, including interim periods,
beginning after the issuance of this ASU. We are currently evaluating the impact of this
ASU on our consolidated financial
statements.
In October 2009, the FASB issued an ASU
regarding accounting for own-share lending arrangements in contemplation of
convertible debt issuance or other financing. This ASU requires that
at the date of issuance of the shares in a share-lending arrangement
entered into in contemplation of a convertible
debt offering or other financing, the shares issued shall be measured at fair
value and be recognized as an issuance cost, with an offset to additional
paid-in capital. Further, loaned shares are excluded from basic and diluted earnings per share unless
default of the share-lending arrangement occurs, at which time the loaned shares
would be included in the basic and diluted earnings-per-share
calculation. This ASU is effective for fiscal years beginning on or
after December 15, 2009, and interim periods
within those fiscal years for arrangements outstanding as of the beginning of
those fiscal years. We are
currently evaluating the
impact of this ASU on our consolidated financial
statements.
In
November 2009, the FASB issued an ASU regarding accounting for stock dividends,
including distributions to shareholders with components of stock and cash. This
ASU clarifies that the stock portion of a distribution to shareholders that
contains components of cash and stock and allows shareholders to select their
preferred form of the distribution (with a limit on the amount of cash that will
be distributed in total) should be considered a stock dividend and included in
EPS calculations as a share issuance. The adoption of this guidance did not have
a material impact on our consolidated financial statements
-26-
In
December 2009, FASB issued ASU No. 2009-16, Accounting for Transfers of
Financial Assets. This Accounting Standards Update amends the FASB Accounting
Standards Codification for the issuance of FASB Statement No. 166, Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No. 140.The amendments in
this Accounting Standards Update improve financial reporting by eliminating the
exceptions for qualifying special-purpose entities from the consolidation
guidance and the exception that permitted sale accounting for certain mortgage
securitizations when a transferor has not surrendered control over the
transferred financial assets. In addition, the amendments require enhanced
disclosures about the risks that a transferor continues to be exposed to because
of its continuing involvement in transferred financial assets. Comparability and
consistency in accounting for transferred financial assets will also be improved
through clarifications of the requirements for isolation and limitations on
portions of financial assets that are eligible for sale accounting. We do not expect the adoption of this ASU to have a material impact on
our consolidated financial
statements.
In
December, 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167, Amendments to FASB Interpretation
No. 46(R). The amendments in this Accounting Standards Update replace the
quantitative-based risks and rewards calculation for determining which reporting
entity, if any, has a controlling financial interest in a variable interest
entity with an approach focused on identifying which reporting entity has the
power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance and (1) the obligation to
absorb losses of the entity or (2) the right to receive benefits from the
entity. An approach that is expected to be primarily qualitative will be more
effective for identifying which reporting entity has a controlling financial
interest in a variable interest entity. The amendments in this Update also
require additional disclosures about a reporting entity’s involvement in
variable interest entities, which will enhance the information provided to users
of financial statements. We are
currently evaluating the
impact of this ASU, however, we do not expect the adoption of this ASU to
have a material impact on our consolidated financial
statements.
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. We do not expect the adoption of this ASU to have a
material impact on our 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. We do not expect the adoption of this ASU to have a
material impact on our 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, and
settlements (that is, on a gross basis rather than as one net number). This
update provides amendments to Subtopic 820-10 that clarify 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. We
are currently evaluating
the impact of this ASU, however, we do not expect the adoption of this ASU to
have a material impact
on our consolidated financial
statements.
Results
of Operations
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 percent. This increase was
primarily due to the increase in our revenues from our 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.
-27-
Revenues
from our total solution system contracting projects increased by 9.5 percent 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 the 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 our 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 the revenues from product sales was mainly due to the
increase in value of product sales contracts executed in power generation
industry. The revenues from maintenance service increased by 28.0 percent 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 that
we executed as the result of the expansion of our customer base during the
period.
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 $18.9 million of revenues, representing
23.2 percent of total revenues for the year ended December 31,
2009.
For the Year Ended December 31,
|
||||||||||||||||||||||||
2009
|
2008
|
Y/Y Change
|
||||||||||||||||||||||
Amount ($)
|
% 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 our cost of
revenues was mainly driven by the increase in our revenue as well as the
increase in our subcontractor cost while we executed our 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 $7.6 million
or 18.7 percent. Gross margin for the year ended December 31, 2009 was 58.0
percent, which is slightly higher than the gross margin of 57.2 percent for the
year ended December 31, 2008. The increase in our gross margin was mainly due to
the increase in the gross margin of our system contracting projects, offset by a
decrease in the gross margin of our product sales and maintenance services
during the period.
Gross
margin of our system contracting was 57.2 percent for the year ended December
31, 2009, compared to 54.8 percent for the year ended December 31, 2008. This
increase in the gross margin of system contracting projects was due to the
successful execution of total solution contacts in the iron and steel industry
that contributed higher gross margins during the fiscal year. Total solution
projects from the iron and steel industry contributed higher gross margins than
the projects from other industries due to a higher percentage of our
self-manufactured proprietary products being utilized in the iron and steel
projects, partially offset by the increase in our subcontractor cost. The gross
margin of product sales was 64.4 percent for the year ended December 31, 2009,
compared to 73.5 percent for the year ended December 31, 2008. The decrease in
the gross margin of product sales was mainly attributable to a lower percentage
of self-manufactured proprietary products sold through our product sales
contracts during the period, contributing to lower gross
margin. Gross margin of our maintenance services was 40.0 percent for
the year ended December 31, 2009, compared to 47.1 percent for the year ended
December 31, 2008. This decrease in the gross margin of our
maintenance services was primarily due to the increase in our labor cost while
we executed the maintenance contracts during the period.
For the Year Ended December 31,
|
||||||||||||||||||||||||
2009
|
2008
|
Y/Y Change
|
||||||||||||||||||||||
Amount ($)
|
% 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 | % |
-28-
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 percent. The increase in
operating expenses was mainly due to the increase in our 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 percent. The significant increase
in our selling expenses was mainly attributable to the increase in our marketing
activities and our 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 percent. The increase in
general administrative expenses was mainly attributable to the increase in
employees’ salary 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
percent. 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 $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 percent. The
decrease in our 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 percent. The increase in our
operating income was mainly attributable to the increase in our 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 percent.
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 percent. 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 percent, as compared to $47,423
provision for income tax for the year ended 31, December 2008, an increase of
$4.2 million. The significant increase in our 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 percent with 50% tax exemption, after
the expiration of its 100% tax exemption period in 2008.
Our 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 percent. 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 process 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 $4.0 million or 14.1 percent.
-29-
Comparison
of the Years Ended December 31, 2008 and 2007:
|
|
For the Year Ended December 31,
|
|
|||||||||||||||||||||
|
|
2008
|
|
|
2007
|
|
|
Y/Y Change
|
|
|||||||||||||||
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount ($)
|
|
|
%
|
|
||||||
Revenue
|
||||||||||||||||||||||||
System
contracting projects
|
57,101,984
|
82.7
|
%
|
34,581,376
|
74.0
|
%
|
22,520,608
|
65.1
|
%
|
|||||||||||||||
Products
|
9,673,922
|
14.0
|
%
|
10,592,683
|
22.7
|
%
|
(918,761
|
) |
-8.7
|
%
|
||||||||||||||
Maintenance
Services
|
2,303,213
|
3.3
|
%
|
1,579,778
|
3.4
|
%
|
723,435
|
45.8
|
%
|
|||||||||||||||
Total
Revenue
|
69,079,119
|
100.0
|
%
|
46,753,837
|
100.0
|
%
|
22,325,282
|
47.8
|
%
|
Total
revenues were approximately $69.1 million for the year ended December 31, 2008
as compared to approximately $46.8 million for the year ended December 31, 2007,
an increase of approximately $22.3 million or 47.8 percent. This increase was
primarily due to the increase in our revenues from our total solution system
contracting projects and maintenance services, offset by the decrease in
revenues from product sales during the period. The Company recognized revenues
from 319 total solution, product sales and maintenance contracts for the year
ended December 31, 2008 as compared to 277 contracts for the year ended December
31, 2007.
Revenues
from our total solution system contracting projects increased by 65.1 percent to
$57.1 million derived from 161 contracts for the year ended December 31, 2008,
compared to $34.6 million derived from 127 contracts for the year ended December
31, 2007. This increase in the 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 like the Canfeidian Project of Capital Iron and Steel Group during the
period. Revenues from our product sales were $9.7 million with 115
contracts executed for the year ended December 31, 2008, compared to $10.6
million with 111 contracts executed for the year ended December 31, 2007.
The decrease in the revenues from product sales was mainly due to the
decrease in the average contract value of product sales contracts. The revenues
from maintenance service increased by 45.8 percent to $2.3 million derived from
43 contracts for the year ended December 31, 2008, compared to $1.6 million
derived from 39 contracts for the year ended December 31, 2007. The increase in
revenues from maintenance service was mainly attributable to the increase
in the number of maintenance service contracts that we executed as the result of
the expansion of our customer base during the period.
In
particular, the three largest customers were Capital Iron and Steel Group,
Anshan Iron and Steel Group and Datang Tashan Power Plant, which collectively
contributed approximately $23.2 million of revenues, representing 40.6 percent
of total revenues for the year ended December 31, 2008.
|
|
For the Year Ended December 31,
|
|
|||||||||||||||||||||
|
|
2008
|
|
|
2007
|
|
|
Y/Y Change
|
|
|||||||||||||||
|
|
Amount ($)
|
|
|
% of
Revenue
|
|
|
Amount ($)
|
|
|
% of
Revenue
|
|
|
Amount ($)
|
|
|
%
|
|
||||||
Cost
of Revenues
|
||||||||||||||||||||||||
System
contracting projects
|
25,805,086
|
45.2
|
%
|
16,158,844
|
46.7
|
%
|
9,646,242
|
59.7
|
%
|
|||||||||||||||
Products
|
2,558,844
|
26.5
|
%
|
4,329,067
|
40.9
|
%
|
(1,770,223
|
) |
-40.9
|
%
|
||||||||||||||
Maintenance
Services
|
1,217,316
|
52.9
|
%
|
602,943
|
38.2
|
%
|
614,373
|
101.9
|
%
|
|||||||||||||||
Total
Cost of Revenues
|
29,581,246
|
42.8
|
%
|
21,090,854
|
45.1
|
%
|
8,490,392
|
40.3
|
%
|
|||||||||||||||
Gross
Profit
|
||||||||||||||||||||||||
System
contracting projects
|
31,296,898
|
54.8
|
%
|
18,422,532
|
53.3
|
%
|
12,874,366
|
69.9
|
%
|
|||||||||||||||
Products
|
7,115,078
|
73.5
|
%
|
6,263,616
|
59.1
|
%
|
851,462
|
13.6
|
%
|
|||||||||||||||
Maintenance
Services
|
1,085,897
|
47.1
|
%
|
976,835
|
61.8
|
%
|
109,062
|
11.2
|
%
|
|||||||||||||||
Total
Gross Profit
|
39,497,873
|
57.2
|
%
|
25,662,983
|
54.9
|
%
|
13,834,890
|
53.9
|
%
|
Cost of
Revenues for the year ended December 31, 2008 was approximately $29.6 million,
as compared to $21.1 million for the year ended December 31, 2007, representing
an increase of approximately $8.5 million or 40.3%. Gross profit for the year
ended December 31, 2008 was approximately $39.5 million, as compared to $25.7
million for the year ended December 31, 2007, an increase of approximately $13.8
million or 53.9 percent. Gross margin for the year ended December 31, 2008 was
57.2 percent, which is higher than the gross margin of 54.9 percent for the year
ended December 31, 2007. The increase in our gross margin was mainly due to the
increase in the gross margin of our system contracting projects and product
sales during the period.
-30-
Gross
margin of our total solution system contracting projects was 54.8 percent for
the year ended December 31, 2008, compared to 53.3 percent for the year ended
December 31, 2007. This slight increase in the gross margin of system
contracting projects was due to the execution of total solution contacts that
contributed higher gross margins, offset by the increase in the cost of raw
materials during the period. The gross margin of product sales was 73.5 percent
for the year ended December 31, 2008, compared to 59.1 percent for the year
ended December 31, 2007. The increase in the gross margin of product sales was
mainly attributable to a higher percentage of our in-house manufactured
proprietary products sold in product sales contracts, which contributed higher
gross margins than our outsourced products manufactured by third
parties.
|
For the Year Ended December 31,
|
|||||||||||||||||||||||
|
2008
|
2007
|
Y/Y Change
|
|||||||||||||||||||||
|
Amount ($)
|
% of
Total
Revenue
|
Amount ($)
|
% of
Total
Revenue
|
Amount ($)
|
%
|
||||||||||||||||||
Operating
Expenses
|
||||||||||||||||||||||||
Selling
Expense
|
6,434,887
|
9.3
|
%
|
3,907,067
|
8.4
|
%
|
2,527,820
|
64.7
|
%
|
|||||||||||||||
General
Administrative
|
6,680,992
|
9.7
|
%
|
5,661,356
|
12.1
|
%
|
1,019,636
|
18.0
|
%
|
|||||||||||||||
Depreciation
and Amortization
|
712,269
|
1.0
|
%
|
535,751
|
1.1
|
%
|
176,518
|
32.9
|
%
|
|||||||||||||||
R&D
|
2,102,976
|
3.0
|
%
|
672,379
|
1.4
|
%
|
1,430,597
|
212.8
|
%
|
|||||||||||||||
Total
Operating Expenses
|
15,931,124
|
23.1
|
%
|
10,776,553
|
23.0
|
%
|
5,154,571
|
47.8
|
%
|
Operating
expenses were approximately $15.9 million for the year ended December 31, 2008
as compared to approximately $10.8 million for the year ended December 31, 2007,
an increase of approximately $5.2 million or 47.8 percent. The increase in
operating expenses was mainly due to the increase in our selling expense and
R&D expenditure during the period.
Selling
expenses were approximately $6.4 million for the year ended December 31, 2008 as
compared to approximately $3.9 million for the year ended December 31, 2007, an
increase of approximately $2.5 million or 64.7 percent. The significant increase
in our selling expenses was mainly attributable to the increase in our
sales-related activities and our efforts to expand our business into new
industries including nuclear power and transportations. General administrative
expenses were approximately $6.7 million for the year ended December 31, 2008,
as compared to approximately $5.7 million for the year ended December 31, 2007,
an increase of approximately $1.0 million or 18.0 percent. The increase in
general administrative expenses were mainly attributable to the increase in
staff and greater bad debt allowance. Depreciation and amortization expenses
were approximately $0.7 million for the year ended December 31, 2008 as compared
to approximately $0.5 million for the year ended December 31, 2007, an increase
of approximately $176,518 or 32.9 percent. The 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 $2.1 million
for the year ended December 31, 2008 as compared to approximately $0.7 million
for the year ended December 31, 2007, an increase of approximately $1.4 million
or 212.8 percent. The significant percentage increase in our R&D expenses
was mainly attributable to our efforts in new product development including an
anti-explosive gas bottles and alternant foam storage and mix devices and the
improvement of our existing product offerings including linear heat directors
and water mist systems.
Operating
income was approximately $23.6 million for the year ended December 31, 2008 as
compared to approximately $14.9 million for the year ended December 31, 2007, an
increase of $8.7 million or 58.3 percent. The increase in our operating income
was mainly attributable to the increase in our revenues and higher gross margins
during this period.
Total
other income was approximately $1.2 million for the year ended December 31, 2008
as compared to approximately $1.9 million for the year ended December 31, 2007,
a decrease of $0.7 million or 38.3 percent. If excluding the one-time gain of
$1.2 million for the change in fair value of derivatives in the year 2007, our
total other income actually increased by $0.5 million. This increase was mainly
attributable to the increase in the VAT refund to Beijing Hua An and the
increase in our interest income, offset by our one-time donation of 500,000 RMB
($72,150) in charitable aid for Wenchuan’s “5.19” earthquake.
-31-
Our net
income was approximately $24.7 million for the year ended December 31, 2008 as
compared to approximately $16.8 million net income for the year ended December
31, 2007, an increase of $7.9 million or 47.0 percent. Excluding the one-time
gain of $1.2 million for the change in fair value of derivatives in the year
2007, our non-GAAP net income increased by $9.1 million or 58.4 percent for the
year ended December 31, 2008. The reason for this increase in the net income was
mainly due to the increase in our revenues and improvement in our gross margins
during the period.
Currency
translation adjustments resulting from RMB appreciation process amounted to
$3,737,027 and $2,502,595 as of the year ended December 31, 2008 and 2007,
respectively.
The
comprehensive income, which adds the currency adjustment to the net income, were
approximately $28.4 million for the year ended December 31, 2008 as compared to
approximately $19.3 million comprehensive income for the year ended December 31,
2007, an increase of $9.1 million or 47.3 percent.
Liquidity
and Capital Resources
As of
December 31, 2009, we had working capital of $87.1 million, including cash and
cash equivalents of $35.0 million. The following table sets forth a summary of
our cash flow for the periods indicated:
Statements
of Cash Flow
Year Ended December 31
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
Net
cash provided by operating activities
|
$ | 5,467,756 | $ | 13,361,704 | $ | 9,773, 114 | ||||||
Net
cash provided by (used in) investing activities
|
948,283 | (1,945,199 | ) | (3,929,978 | ) | |||||||
Net
cash provided by (used in) financing activities
|
1,897,613 | (3,097,855 | ) | 1,051,952 | ||||||||
Effect
of foreign currency translation on cash and cash
equivalents
|
7,895 | 1,226,234 | 789,270 | |||||||||
Net
cash flow
|
$ | 8,321,547 | $ | 9,544,884 | 7,684,358 |
Operating
Activities
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 net cash
provided by operating activities 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, a $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.
-32-
Comparison
of the Years Ended December 31, 2008 and 2007
Net cash
provided by operating activities was approximately $13.4 million for the year
ended December 31, 2008 as compared to approximately $9.8 million net cash
provided by operating activities for the year ended December 31, 2007. Net cash
provided by operating activities in the year ended December 31, 2008 was mainly
due to net income of $24.7 million and a $1.7 million increase in accrued
liabilities, offset by a $10.6 million increase in accounts receivable, a $2.2
million increase in inventories, a $3.8 million increase in costs and estimated
earnings in excess of billing. The increase in accrued liabilities, accounts
receivable, inventories 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 $3.8 million in costs and estimated earnings in excess of billings
in 2008 was mainly due to the increase in aggregate value of projects where we
have recognized revenues more than we have billed the 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, 2009 and 2008
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 that we
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 proceed
of $1.6 million received from the restructuring on Tianxiao Fire Safety
Equipment Co. Ltd. and the proceed 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.
Comparison
of the Years Ended December 31, 2008 and 2007
Net cash
used in investing activities in the year ended December 31, 2008 was $1.9
million as compared to net cash used in investing activities of $3.9 million in
the year ended December 31, 2007. The cash used in investing activities in the
year ended December 31, 2008 was mainly attributable to capital expenditure in
the purchase of new equipments and the improvement of office and manufacturing
facilities.
Financing
Activities
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.
As a
result of the total cash activities, net cash increased $8.3 million from
December 31, 2008 to December 31, 2009. We believe that our currently
available working capital of $87.1 million including cash and cash equivalents
of $35.0 million should be adequate to sustain our current operations and our
anticipated expansion.
Comparison
of the Years Ended December 31, 2008 and 2007
Net cash
used in financing activities in the year ended December 31, 2008 totaled $3.1
million as compared to $1.1 million provided by financing activities in the year
ended December 31, 2007. The cash used in financing activities in the year ended
December 31, 2008 was mainly attributable to the increase in restricted cash
during the period.
-33-
As a
result of the total cash activities, net cash increased $9.5 million from
December 31, 2007 to December 31, 2008.
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, 2009.
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.
Our 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. Our 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 primarily operated in the PRC, and its value is effectively
denominated in Renminbi. The fluctuation of foreign exchange rate between U.S.
dollars and Renminbi could affect the value of our common stock. Our revenues
and expenses are primarily denominated in Renminbi, and 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,
representing only 0.2 percent of total revenue in 2009. Thus, we believe that
our exposure to foreign exchange risks to the Indian Rupee should generally be
limited.
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 devaluate the assets and liabilities denominated in U.S.
dollar, while devaluation of Renminbi again U.S. dollars will appreciate the
assets and liabilities denominated in U.S. dollar. In China, 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 at all.
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:
|
-34-
QUARTERLY
DATA
(UNAUDITED)
Years Ended December 31
|
|||||||||||||||||||||
2008
|
First Quarter
|
Second Quarter
|
Third Quarter
|
Fourth Quarter
|
Full Year
|
||||||||||||||||
Revenues
|
14,696,626 | 16,653,724 | 16,743,267 | 20,985,502 | 69,079,119 | ||||||||||||||||
Gross
profits
|
8,044,395 | 10,184,293 | 9,864,431 | 11,404,754 | 39,497,873 | ||||||||||||||||
Net
income
|
4,740,780 | 6,676,100 | 6,457,964 | 6,829,008 | 24,703,852 | ||||||||||||||||
Earnings
per share
|
$ | 0.17 | $ | 0.24 | $ | 0.23 | $ | 0.26 | $ | 0.90 | |||||||||||
Earnings
per share Diluted
|
$ | 0.17 | $ | 0.24 | $ | 0.23 | $ | 0.24 | $ | 0.88 | |||||||||||
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
|
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 |
Item
9. Changes In and Disagreements With Accountants On Accounting and
Financial Disclosure
Not
applicable.
Item
9A. Controls And Procedures
(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, 2009.
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 Principal Accounting 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, 2009.
(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, 2009.
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,
|
-35-
|
·
|
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, 2009. 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, 2009, our internal
control over financial reporting was effective. Frazer Frost, LLP
(Successor Entity of Moore Stephens Wurth Frazer and Torbet, 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, 2009.
(c)
Changes in Internal Controls over Financial Reporting
During
the fourth fiscal quarter ended December 31, 2009, 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
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, 2009, 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, 2009, 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, 2010 expressed an unqualified
opinion.
/s/
Frazer Frost, LLP (Successor Entity of Moore Stephens Wurth Frazer and Torbet,
LLP, see Form 8-K filed on January 7, 2010)
Brea,
California
March 16,
2010
-36-
Item
9B. Other Information
None.
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.
Name
|
Age
|
Position
|
||
Gangjin Li
|
48
|
Chairman
of the Board and Chief Executive Officer
|
||
Brian Lin
|
45
|
Director
and Chief Financial Officer
|
||
Weishe
Zhang
|
45
|
Director
and Vice President of Strategic Planning
|
||
Weigang
Li
|
42
|
Genernal
Manager of Sureland Industrial
|
||
Xiaoyuan
Yuan
|
35
|
Principal
Accounting Officer
|
||
Xianghua
Li
|
65
|
Independent
Director
|
||
Xuewen
Xiao
|
41
|
Independent
Director
|
||
Guoyou
Zhang
|
58
|
Independent
Director
|
||
Albert
McLelland
|
51
|
Independent
Director
|
-37-
Mr. Gangjin Li, Chief
Executive Officer, Chairman of the Board, 48. Since December 2009, Mr. Li
resumed his former role as our Chief Executive Officer. Mr. Li
has served as our Chairman of the Board since October 2006. Mr. Li is the
founder of Sureland, and served as Chairman of the Board and the General Manager
of Sureland Industrial from 1995 until January 2009. Mr. Li is an executive
director of China Fire Protection Association (CFPA), and vice-chairman of
“Electrical Fire Prevention Committee of CFPA”. Mr. Li holds a bachelor’s
degree from Wuhan University of Science and Technology and a Master degree in
management science from Beijing University. We believe Mr. Li’s
qualifications to serve on our board include his extensive knowledge of the
Company as founder, Chairman, and CEO and his understanding and in-depth
experience in dealing in the markets served.
Mr. Brian Lin, Chief Financial
Officer, Director, 45. Since December 2009, Mr. Lin serves 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 US 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. Weishe Zhang, Vice
President, Director, 45. 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.
Mr. Weigang Li, Vice President
of Sales of China Fire, General Manager of Sureland Industrial, 42. 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. Xiaoyuan (Robert) Yuan,
Principal Accounting Officer, 35, 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, 65,
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.
-38-
Mr. Xuewen Xiao, Director, 41,
Mr. Xuewen Xiao has served as an independent Director since September 2008. Mr.
Xiao has been the president of Chongqing Iron & Steel Design & Research
Institute and the chairman of CISDI Engineering Co, Ltd, a state-owned
company since March 2003. Mr. Xiao graduated from Tsinghua University with
a Master of Science degree in Mechanical Engineering in 1994. We
believe Mr. Xiao’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. Guoyou Zhang,
Director, 58, 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, 51, 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.
Family
Relationships
Mr.
Weigang Li is the brother of Mr. Gangjin Li, Chairman of the Board and Chief
Executive Officer.
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”. Mr. Gangjing Li serves
as both our Chief Executive Officer and the Chairman of the Board. We believe
that combining the role of Chairman and CEO is appropriate for our operations
because Mr. Li is most familiar with our business strategy and our
industry. We also believe that the combined role of Chairman and CEO greater
facilitates the flow of information between the board and management and helps
promote effective corporate governance. 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 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.
-39-
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. Xuewen Xiao, 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. Xuewen Xiao, Mr. Guoyou Zhang, and Mr. Xianghua Li,
with Xuewen Xiao as the chairman.
The Board
had 9 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.
-40-
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 ten percent (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).
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.
Brian Lin, 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.
-41-
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 2009 was $88 million in
revenue and $30.2 million in pre-tax income, representing 28% and 22% growth
respectively compared to the results in fiscal year 2008. The actual financial
results in 2009 were $81.0 million in revenue and $28.5 million in pre-tax
income, which missed the financial guidance. Consequently, the bonuses to Mr.
Brian Lin and Mr. Xiaoyuan Yuan were not paid in fiscal year 2009.
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 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 2009 with respect the executive
officers named in the Compensation Table on page 45.
In 2009,
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$800
million
|
The
Compensation Committee collected the executive compensation information of the
following companies (“Comparison Group”) during the course of discussing and
finalizing the compensation for our executives.
Fiscal
Year 2008
|
|||||||||||||
Salary
($)
|
Option
($)
|
Total
($)
|
|||||||||||
1
|
China
Security & Surveillance (CSR)
|
||||||||||||
CEO
|
322,108 | 1,327,715 | 1,649,823 | ||||||||||
CFO
|
191,992 | 962,087 | 1,154,079 | ||||||||||
2
|
China
Information Security Technology, Inc. (CPBY)
|
||||||||||||
CEO
|
82,732 | - | 82,732 | ||||||||||
CFO
|
60,360 | - | 60,360 | ||||||||||
3
|
COGO
Group, Inc. (COGO)
|
||||||||||||
CEO
|
74,940 | 322,719 | 397,659 | ||||||||||
CFO
|
100,000 | 388,940 | 488,940 | ||||||||||
4
|
Harbin
Electric, Inc. (HRBN)
|
||||||||||||
CEO
|
26,470 | 45,784 | 72,254 | ||||||||||
CFO
|
15,882 | 31,856 | 47,738 | ||||||||||
5
|
Shengdatech,
Inc. (SDTH)
|
||||||||||||
CEO
|
300,000 | - | 300,000 | ||||||||||
CFO
|
120,000 | - | 120,000 | ||||||||||
6
|
Wonder
Auto Technology, Inc. (WATG)
|
||||||||||||
CEO
|
90,000 | 117,281 | 207,281 | ||||||||||
CFO
|
60,000 | 78,188 | 138,188 | ||||||||||
Highest
|
Lowest
|
||||||||||||
CEO
|
1,649,823 | 72,254 | |||||||||||
CFO
|
1,154,079 | 47,738 |
-42-
The
Compensation Committee conducted a comparison of the proposed executive
compensation structure and practices to those of the Comparison Group, including
base salary, target bonus and equity grants. The market analysis developed was
used to determine pay targets for 2009.
In 2009,
the proposed compensation for Mr. Brian Lin is as follows:
Cash
Compensation: $120,000 where the Base Salary is $84,000 (70%) and the Bonus is
$36,000 (30%). The Bonus will be paid in full if the company’s actually
financial results meet or beat the financial guidance approved by the board of
directors and released to the public. Otherwise, no Bonus will be paid to Mr.
Brian Lin.
Equity
Compensation: On January 2nd, 2009, the Company issued 300,000 stock
options to Brian Lin, with exercise price at $6.81 which was the closing price
of the Company stock on December 31, 2008. By the end of the year 2009,
56,250 shares of options were vested.
In 2009,
the proposed compensation for Mr. Xiaoyuan Yuan is as follows:
Cash
Compensation: $60,000 where the Base Salary is $48,000 (80%) and the Bonus is
$12,000 (20%). The Bonus will be paid in full if the company’s actually
financial results meet or beat the financial guidance approved by the board of
directors and released to the public. Otherwise, no Bonus will be paid to Mr.
Xiaoyuan Yuan.
Equity
Compensation: Per stock option agreement dated July 1, 2007, 5,000 shares
of options with exercise price at $6.70 were vested to Mr. Xiaoyuan Yuan
during the year of 2009. There is no additional equity based compensation for
Xiaoyuan Yuan in 2009..
Based on
its review in 2009, the Compensation Committee concluded that the structure of
CFSG’s proposed compensation program is reasonably consistent with industry
practices. The target parameters for the compensation of Mr. Gangjin
Lin, our current CEO, Mr. Brian Lin, our current CFO, who served as our CEO for
the majority of 2009 and Mr. Xiaoyuan Yuan, our current Principal Accounting
Officer were determined based on the range of compensation for the above
Comparison Group. The actual compensation for Mr. Gangjin Li in fiscal year
2009 was $96,107, which fell within the targeted parameters of $72,254 and
$1,649,823 for CEOs. The actual compensation for Mr. Brian Lin in fiscal year
2009 was $399,854, which fell within the targeted parameters of $47,738 and
$1,154,079 for CFOs. The actual compensation for Mr. Xiaoyuan Yuan in fiscal
year 2009 was $62,300, which is below the targeted parameters of $47,738
and $1,154,079 for CFOs. With only one month left in the year 2009 since Mr.
Gangjin Li assumed his former role as the CEO of the Company, the Compensation
Committee decided not to make any changes in 2009 and to provide a new
compensation package for Mr. Gangjin Li from year 2010.
The
Compensation Committee reviewed and approved the compensation paid to the named
executives of the company as listed in the Compensation Table. Recommendations
for annual increases in compensation to named executives other than our CEO are
recommended by our CEO. These recommendations are presented to the Compensation
Committee and are subject to their approval. The annual increase in compensation
of the CEO was both recommended and approved by our Compensation Committee Pay
increases for non-named employee will be at the discretion of the employee’s
supervisor and subject to senior management approval.
-43-
Stock-Based
Compensation Plans
In 2008,
our board of directors and shareholders adopted our 2008 Omnibus Long-term
Incentive Plan. The Plan is intended to enhance the Company’s and its
Affiliates’ (as defined herein) ability to attract and retain highly qualified
officers, directors, key employees and other persons, and to motivate such
officers, directors, key employees and other persons to serve the Company and
its Affiliates and to expend maximum effort to improve the business results and
earnings of the Company, by providing to such persons an opportunity to acquire
or increase a direct proprietary interest in the operations and future success
of the Company. To this end, the Plan provides for the grant of stock options,
stock appreciation rights, restricted stock, restricted stock units,
unrestricted stock and cash awards. At the time of adoption, 2,000,000 common
shares were reserved for issuance under the plan. The plan has a term of ten
years but may be terminated earlier by our board of directors.
On
January 2, 2009, pursuant to the Company's 2008 Omnibus Long-term Incentive
Plan, the Company's Board of Directors authorized the issuance of options to
purchase 1,000,000 shares for its employees with options to purchase a total of
800,000 shares issued to executive officers. The options will vest
evenly each quarter over the following four years, starting from the first
quarter of 2009.
Based on
the compensation reported by the Company for 2008 and 2009, the Committee
determined that the overall compensation for the management team and some key
employees of the Company are below the market or at the low end of the market,
compared to public companies of similar size in China. The Committee deems it in
the best interests of the Company and its shareholders to bring the level of
compensation for its management and key employees to that of the market and to
issue shares of restricted stock to supplement cash compensation for its
management and key employees in order to provide incentives to and retain
qualified employees. The Committee recommended that shares of the restricted
stock be issued pursuant to the terms and conditions of the Company’s 2008
Omnibus Long Term Incentive Stock Option Plan for its officers and key
employees, to supplement the cash compensation of these officers and key
employees for the next four years. The committee further recommend to issue one
million shares of the restricted stock which will vest from the date of
issuance, in four equal installments, with one installment due every twelve
months.
On
December 1, 2009, pursuant to the Company's 2008 Omnibus Long-term Incentive
Plan, the Company's Board of Directors authorized the issuance of 1,000,000
shares of restricted stocks to its employees, with 285,000 shares of restricted
stocks issued to the executive officers. The restricted stocks will
vest evenly at the end of each year over the following four years, starting from
November 30, 2010.
Compensation
Policies and Practices as Related to Risk Management
Risk
Considerations in our Compensation Program
The
Compensation Committee has discussed the concept of risk as it relates to our
compensation programs. In particular, the Compensation Committee assessed
whether any such programs encourage excessive or inappropriate risk taking. The
Compensation Committee considered the allocation of compensation among base
salary, bonus and equity-base compensation, our approach to establishing
company-wide and individual financial, operational and other performance
targets, with payouts at multiple levels of performance and minimum levels of
achievement, and evaluation of key performance metrics, each of which assists in
mitigating excessive risk-taking that could harm our value. The assessment
resulted in a determination that our current compensation programs, practices or
policies facilitate the appropriate balance between prudent business risk and
resulting compensation that does not encourage excessive risk-taking or create
potential risks that are reasonably likely to have a material adverse effect on
the Company.
-44-
Compensation
Table
Name & Principal
Position
|
Year
|
Salary
|
Bonus
|
Option*
Awards
|
Restricted
Stocks |
Total
|
|||||||||||||||
Gangjin
Li**, Chairman and CEO
|
2009
|
$ | 65,800 | $ | $ | 30,307 | $ | 96,107 | |||||||||||||
2008
|
65,800 | — | 8,400 | — | 74,200 | ||||||||||||||||
2007
|
65,800 | — | 62,550 | — | 128,350 | ||||||||||||||||
Brian
Lin***, CFO
|
2009
|
$ | 84,000 | $ | 289,500 | $ | 26,354 | $ | 399,854 | ||||||||||||
2008
|
84,000 | 36,000 | 4,200 | — | 124,200 | ||||||||||||||||
2007
|
120,000 | — | 31,275 | — | 151,275 | ||||||||||||||||
Xiaoyuan
Yuan, Principal Accounting Officer
|
2009
|
$ | 48,000 | $ | 14,300 | $ | 62,300 | ||||||||||||||
2008
|
36,800 | — | 14,300 | — | 51,100 |
* The
assumptions made in valuing the option were disclosed in the financial
statements Note 14.
** Since
December 2009, Mr. Gangjin Li resumed his former role as our CEO.
*** Since
December 2009, Mr. Brian Lin resigned as Chief Executive Officer and was
appointed as our CFO.
Grants
of Plan-Based Awards
The
following table provides information relating to our grants of plan-based awards
in the fiscal year ended December 31, 2009.
Name
|
Restricted
stocks/Options
|
Grant date
|
Total share
number of future
payouts
|
Base/exercise
price of
restricted
stock/option
awards ($/Sh)
|
Grant date fair
value of
restricted
stock/option
awards ($)
|
||||||||||
Gangjin
Li
|
Restricted
stocks
|
Dec.
1st, 2009
|
115,000 | 12.65 | 1,454,750 | ||||||||||
Brian
Lin
|
Options
|
Jan.
2nd, 2009
|
300,000 | 6.81 | 1,105,200 | ||||||||||
Restricted
stocks
|
Dec.
1st, 2009
|
100,000 | 12.65 | 1,265,000 |
Outstanding
Equity Awards at Fiscal Year-End Table
The
following table provides information concerning unexercised options and
restricted stock that has not vested, and equity incentive plan awards for our
named executive officers outstanding as of December 31, 2009.
|
|
Equity Awards
|
|||||||||||||||||
Name
|
Option/Restricted
Stock |
Number of Securities
Underlying
Unexercised Options
(#)
Exercisable/Restricted
Stocks
|
Number of Securities
Underlying Unexercised
Options (#)
Unexercisable/Restricted
Stocks (#)
|
Equity
Incentive
Plan Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options (#)
|
Option
Exercise
Price
($)/Stock
Base
Price ($)
|
Option
Expiration
Date
|
|||||||||||||
Gangjin
Li
|
Option
|
300,000 | - | - | 1.25 |
Jun.
30, 2016
|
|||||||||||||
Restricted
Stock
|
- | 115,000 | 115,000 | 12.65 | |||||||||||||||
Brian
Lin
|
Option
|
150,000 | - | - | 1.25 |
Jun.
30, 2016
|
|||||||||||||
|
Option
|
56,250 | 243,750 | 243,750 | 6.81 |
Jan.
1, 2014
|
|||||||||||||
|
Restricted
Stock
|
- | 100,000 | 100,000 | 12.65 |
|
|||||||||||||
Xiaoyuan
Yuan
|
Option
|
12,500 | 7,500 | 7,500 | 6.70 |
June
30,
2012
|
-45-
Option
Exercises and Stock Vested
No
options were exercised and no shares of stock were vested in 2009
Pension
Benefits
The
Company does not have any pension plans for its officers.
Nonqualified
Deferred Compensation
There was
no nonqualified deferred compensation for the officers in 2009.
Potential Payment Upon Termination or
Change in Control
The
Company currently does not have payment arrangements for its officers upon
termination or change in control.
Director
Compensation
The
following table provides information concerning compensation paid by us to our
directors during the fiscal year ended December 31, 2009.
DIRECTOR
COMPENSATION
Name
|
Fees
Earned
or Paid
in Cash
($)
|
Stock
Awards
($)
|
Option
Awards
($)
|
Non-Equity
Incentive Plan
Compensation
($)
|
Nonqualified
Deferred
Compensation
Earnings
|
All Other
Compensation
($)
|
Total
($)
|
|||||||||||||||||||||
Guoyou
Zhang
|
21,114 | 21,114 | ||||||||||||||||||||||||||
Xuewen
Xiao
|
21,114 | 21,114 | ||||||||||||||||||||||||||
Xianghua
Li
|
17,595 | 17,595 | ||||||||||||||||||||||||||
Albert
McLelland
|
55,000 | 55,000 |
Compensation
Committee Report
The
Compensation Committee has reviewed and discussed the Compensation Analysis and
Discussion with the management of the Company. Based on the review and the
discussions, the Compensation Committee recommended to Board of Directors that
the Compensation Analysis and Discussions be included in the
Company’s annual report on Form 10-K. The members of the Compensation
Committee are:
Mr.
Guoyou Zhang, Chairman
Mr.
Xianghua Li
Mr.
Xuewen Xiao
-46-
Item
12. Security Ownership Of Certain Beneficial Owners And Management And Related
Shareholders Matters
The
following table sets forth certain information regarding the beneficial
ownership of our Common Stock, including 27,595,541 shares of
Common Stock and 1,082,250 stock options that are exercisable within 60 days
from March 13, 2010:
|
·
|
each person who is known by us to
be the beneficial owner of more than five percent (5%) of our issued
and outstanding shares of Common
Stock;
|
|
·
|
each of our directors, executive
officers and nominees to become directors;
and
|
|
·
|
all directors and executive
officers as a group.
|
Title of
Class
|
Name and Address of Beneficial Owner*
|
Amount and
Nature of
Beneficial Owner |
Percent of Class
|
|||||||
Common
|
Li
Brothers Holding Inc.
|
12,768,000 |
(1)
|
44.52 | % | |||||
Common
|
Vyle
Investment Inc.
|
2,622,000 |
(2)
|
9.14 | % | |||||
Common
|
China
Honor Investment Limited
|
2,667,600 |
(3)
|
9.30 | % | |||||
Common
|
Gangjin
Li
|
9,351,600 |
(4)
|
32.61 | % | |||||
Common
|
Brian
Lin
|
1,030,350 |
(5)
|
3.59 | % | |||||
Common
|
Weishe
Zhang
|
618,150 |
(6)
|
2.16 | % | |||||
Common
|
Weigang
Li
|
6,530,875 |
(7)
|
22.77 | % | |||||
Common
|
Xiaoyuan
Yuan
|
13,750 |
(8)
|
0.05 | % | |||||
Common
|
Albert
Mclelland
|
0
|
0.00 | % | ||||||
Common
|
Xuewen
Xiao
|
0 | 0.00 | % | ||||||
Common
|
Xianghua
Li
|
0
|
0.00 | % | ||||||
Common
|
Guoyou
Zhang
|
2,000 |
(9)
|
0.01 | % | |||||
Common
|
Directors
and executive officers as a group (9 persons)
|
17,546,725 |
(10)
|
61.19 | % |
*
|
The address for the officers and
directors is B-2508 TYG Center, C2 Dongsanhuanbeilu, Chaoyang District,
Beijing 100027, People’s Republic of China and Telephone (86-10) 8441
7400.
|
(1)
|
Li Brothers Holding Inc. is a BVI
company. Mr. Gangjin Li is the sole director of Li Brothers Holding
Inc. with 100% of voting power and owns 50% of economic interest. Mr.
Weigang Li, the brother of Mr. Gangjin Li and Vice President of China Fire
& Security Group, Inc., owns 50% of economic interest of Li Brothers
Holding Inc.
|
(2)
|
Vyle Investment Inc. is a BVI
company. Mr. Brian Lin is a director of Vyle Investment Inc. with
100% of voting power and 30% ownership. Mr. Weishe Zhang holds 20%
ownership.
|
(3)
|
China Honor Investment Limited is
a BVI company of which Mr. Gangjin Li has 100%
ownership.
|
(4)
|
Represents the number of shares
of Common Stock plus options to purchase 300,000 shares of Common Stock
that is exercisable within 60 days from March 13,
2010.
|
(5)
|
Represents the number of shares
of Common Stock plus options to purchase 243,750 shares of Common Stock
that is exercisable within 60 days from March 13,
2010.
|
(6)
|
Represents the number of shares
of Common Stock plus options to purchase 93,750 shares of Common Stock
that is exercisable within 60 days from March 13,
2010.
|
-47-
(7)
|
Represents the number of options
to purchase 146,875 shares of Common Stock that is exercisable within 60
days from March 13, 2010.
|
(8)
|
Represents the number of options
to purchase 13,750 shares of Common Stock that is exercisable within 60
days from March 13, 2010.
|
(10)
|
Represents the number of options
to purchase 2,000 shares of Common Stock that is exercisable within 60
days from March 13,
2010.
|
(11)
|
Represents the number of options
to purchase 798,125 shares of Common Stock that is exercisable within 60
days from March 13, 2010.
|
Item
13. Certain Relationships And Related Transactions and Director
Independence
The
Company has accounts receivable from Hubei Shou An Changjiang Fire Protection
Co., Ltd. (“Hubei Shou An”), in which the Company has a 19% ownership interest.
The receivable due from Hubei Shou An was $155,433 and $114,388 as of December
31, 2009 and December 31, 2008, respectively, resulted from product sales. This
amount is expected to be repaid by December 31, 2010 in cash.
The
Company also has another receivable from Hubei Shou An. The balance of the
additional receivable due from Hubei Shou An was $396,359 and $351,835 as of
December 31, 2009 and December 31, 2008, respectively. This balance
was for operating capital in Hubei Shou and is expected to be repaid by December
31, 2010 in cash.
The
Company has accounts payable to Tianjin Tianxiao Fire Safety Equipment Co.,
Ltd., in which the Company has 16.7% ownership interest. The accounts payable to
Tianjin Tianxiao Fire Safety Equipment Co., Ltd. was $272,994 and $0 as of
December 31, 2009 and 2008, respectively, and resulted from product purchase of
$1,245,792 and processing fees of $220,050 for the six months ended December 31,
2009 after the restructuring of 83.3% ownership in Tianxiao
Equipment.
Item
14. Principal Accounting Fees And Services
We were notified that, effective
January 1, 2010, certain partners of its previous independent accounting firm,
Moore Stephens Wurth Frazer and Torbet, LLP (“MSWFT”), and certain partners of
Frost, PLLC (“Frost”) formed Frazer Frost, LLP (“Frazer Frost”), a new
partnership. Pursuant to the terms of a combination agreement by and among
MSWFT, Frazer Frost and Frost (the “Combination Agreement”), each of MSWFT and
Frost contributed all of their assets and certain of their liabilities to Frazer
Frost, resulting in Frazer Frost assuming MSWFT’s engagement letter with us. On
January 7, 2010, the Audit Committee of our Board of Directors approved the
engagement of Frazer Frost as MSWFT’s successor to continue as our independent
accounting firm.
Frazer
Frost, LLP (Successor entity of Moore Stephens Wurth Frazer and Torbet, LLP) has
audited our financial statements annually since the 2004 fiscal year. All of the
services described below were approved by our board and audit committee prior to
performance. The board has determined that the payments made to its independent
accountant for these services are compatible with maintaining such auditor's
independence.
Audit
Fees
The
aggregate fees for professional services rendered by Frazer Frost, LLP,
(Successor entity of Moore Stephens Wurth Frazer and Torbet, LLP), in connection
with its audit of our internal control over financial reporting, audit of our
annual consolidated financial statements in our Form 10-K or 10-KSB and the
review of our quarterly consolidated financial statements included in our Forms
10-Q or 10-QSB for the fiscal years ended December 31, 2009, 2008 and
2007 totaled approximately $320,000, $245,000 and
$245,000, respectively.
-48-
Audit-Related
Fees
No fees
were paid or accrued by us for assurance and related services rendered by Frazer
Frost, LLP, (Successor entity of Moore Stephens Wurth Frazer and Torbet, LLP),
in connection with its audit and review of our financial statements for the
fiscal years ended December 31, 2009, 2008 and 2007.
Tax
Fees
$10,000,
$10,000 and $5,000 were paid or accrued by us for professional
services rendered by Frazer Frost, LLP, (Successor entity of Moore Stephens
Wurth Frazer and Torbet, LLP), for tax compliance, tax advice and tax planning
for the fiscal years December 31, 2009, 2008 and 2007,
respectively.
All
Other Fees
No fees
were paid or accrued by us for other services rendered by Frazer Frost, LLP,
(Successor entity of Moore Stephens Wurth Frazer and Torbet, LLP), for the
fiscal years ended December 31, 2009, 2008 and 2007.
PART
IV
Item
15. Exhibits and Financial Statement Schedules
(a)(1) The Following financial
statements are included in this Annual Report on Form 10-K commencing on the
page numbers specified below
Report
of Independent Registered Public Accounting Firm
|
F-1
|
|
Consolidated
Balance Sheets at December 31, 2009 and 2008
|
F-2
|
|
Consolidated
Statements of Income and Other Comprehensive Income for the Years Ended
December 31, 2009, 2008 and 2007
|
F-3
|
|
Consolidated
Statements of Changes in Equity
|
F-4
|
|
Consolidated
Statements of Cash Flows for the Years Ended December 31, 2009, 2008 and
2007
|
F-5
|
|
Notes
to Consolidated Financial Statements
|
F-6
|
(2)
Financial Statement Schedules
None
(3)
Exhibits
The
exhibits listed on the Exhibit Index (following the Financial Statements of this
report) are included, or incorporated by reference, in this annual
report.
-49-
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant certifies that it has duly caused this Annual Report on
Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized, in Beijing.
CHINA
FIRE & SECURITY GROUP, INC.
|
||
Dated:
March 16, 2010
|
||
By:
|
/s/ Gangjin Li
|
|
Gangjin
Li
|
||
Chief
Executive Officer
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this Annual Report
on Form 10-K has been signed by the following persons in the capacities
indicated as of March 16, 2010.
Signature
|
Title
|
|
/s/ Gangjin Li
|
Chairman
of the Board and Chief Executive Officer
|
|
Gangjin
Li
|
||
/s/ Brian Lin
|
Director
and Chief Financial Officer
|
|
Brian
Lin
|
||
/s/ Weishe Zhang
|
Director
and Vice President
|
|
Weishe
Zhang
|
||
/s/
Guoyou Zhang
|
Director
|
|
Guoyou
Zhang
|
||
/s/
Xuewen Xiao
|
Director
|
|
Xuewen
Xiao
|
||
/s/
Xianghua Li
|
Director
|
|
Xianghua
Li
|
||
/s/ Albert McLelland
|
Director
|
|
Albert
McLelland
|
-50-
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Stockholders of
China
Fire & Security Group, Inc.
We have
audited the accompanying consolidated balance sheets of China Fire &
Security Group, Inc. and subsidiaries as of December 31, 2009 and 2008, and the
related consolidated statements of income and other comprehensive income,
changes in equity, and cash flows for each of the years in the three-year period
ended December 31, 2009. China Fire & Security Group, Inc.’s management is
responsible for these consolidated financial statements. Our responsibility is
to express an opinion on these consolidated financial statements based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of China Fire & Security
Group, Inc. and subsidiaries as of December 31, 2009 and 2008, and the results
of its operations and its cash flows for each of the years in the three-year
period ended December 31, 2009 in conformity with accounting principles
generally accepted in the United States of America.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), China Fire & Security Group, Inc. and
subsidiaries’ internal control over financial reporting as of December 31, 2009,
based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated March 16, 2010 expressed an
unqualified opinion.
/s/
Frazer Frost, LLP (Successor Entity of Moore Stephens Wurth Frazer and Torbet,
LLP, see Form 8-K filed on January 7, 2010)
Brea,
California
March 16,
2010
F-1
CONSOLIDATED
BALANCE SHEETS
AS OF
DECEMBER 31, 2009 AND 2008
December 31,
|
December 31,
|
|||||||
2009
|
2008
|
|||||||
ASSETS
|
||||||||
CURRENT
ASSETS:
|
||||||||
Cash
and cash equivalents
|
$ | 34,976,880 | $ | 26,655,333 | ||||
Restricted
cash
|
1,837,134 | 5,377,933 | ||||||
Notes
receivable
|
4,274,268 | 3,670,259 | ||||||
Accounts
receivable, net of allowance for doubtful accounts of $6,539,787 and
$4,370,362 as of December 31, 2009 and 2008, respectively
|
30,989,569 | 25,826,343 | ||||||
Receivables
from related party
|
551,792 | 466,223 | ||||||
Other
receivables
|
368,679 | 419,419 | ||||||
Refundable
bidding and system contracting project deposits
|
1,774,330 | 1,112,840 | ||||||
Inventories
|
5,360,520 | 6,538,938 | ||||||
Costs
and estimated earnings in excess of billings
|
36,562,573 | 17,821,708 | ||||||
Employee
advances
|
953,625 | 743,868 | ||||||
Prepayments
and deferred expenses
|
3,397,358 | 2,816,976 | ||||||
Total
current assets
|
121,046,728 | 91,449,840 | ||||||
PLANT
AND EQUIPMENT, net
|
8,617,521 | 8,445,254 | ||||||
OTHER
ASSETS:
|
||||||||
Restricted
cash - non current
|
3,602,906 | 1,872,828 | ||||||
Accounts
receivable - retentions
|
3,463,998 | 1,107,450 | ||||||
Deferred
expenses - non current
|
116,045 | - | ||||||
Advances
on building and equipment purchases
|
- | 249,859 | ||||||
Investment
in joint ventures
|
477,837 | 1,167,238 | ||||||
Intangible
assets, net
|
1,041,156 | 1,116,449 | ||||||
Total
other assets
|
8,701,942 | 5,513,824 | ||||||
Total
assets
|
$ | 138,366,191 | $ | 105,408,918 | ||||
LIABILITIES AND EQUITY
|
||||||||
CURRENT
LIABILITIES:
|
||||||||
Accounts
payable
|
$ | 6,903,961 | $ | 6,664,090 | ||||
Accounts
payable to related party
|
272,994 | - | ||||||
Customer
deposits
|
2,182,790 | 6,102,026 | ||||||
Billings
in excess of costs and estimated earnings
|
1,429,999 | 4,237,528 | ||||||
Other
payables
|
333,121 | 837,973 | ||||||
Accrued
liabilities
|
13,841,300 | 6,785,409 | ||||||
Taxes
payable
|
9,002,470 | 2,092,745 | ||||||
Total
current liabilities
|
33,966,635 | 26,719,771 | ||||||
COMMITMENTS
AND CONTINGENCIES
|
||||||||
EQUITY:
|
||||||||
Common
stock, $0.001 par value, 65,000,000 shares authorized, 27,595,541 and
27,586,593 shares issued and outstanding as of December 31, 2009 and 2008,
respectively
|
27,595 | 27,586 | ||||||
Additional
paid-in-capital
|
20,601,138 | 19,357,409 | ||||||
Statutory
reserves
|
7,147,795 | 7,148,827 | ||||||
Retained
earnings
|
69,266,049 | 44,850,181 | ||||||
Accumulated
other comprehensive income
|
7,324,237 | 7,305,144 | ||||||
Total
shareholders' equity
|
104,366,814 | 78,689,147 | ||||||
Noncontrolling
interest
|
32,742 | - | ||||||
Total
equity
|
104,399,556 | 78,689,147 | ||||||
Total
liabilities and equity
|
$ | 138,366,191 | $ | 105,408,918 |
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of these consolidated financial
statements.
F-2
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR THE
YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
2009
|
2008
|
2007
|
||||||||||
REVENUES
|
||||||||||||
System
contracting projects
|
$ | 62,514,475 | $ | 57,101,984 | $ | 34,581,376 | ||||||
Products
|
15,718,815 | 9,673,922 | 10,592,683 | |||||||||
Maintenance
services
|
2,947,908 | 2,303,213 | 1,579,778 | |||||||||
Total
revenues
|
81,181,198 | 69,079,119 | 46,753,837 | |||||||||
COST
OF REVENUES
|
||||||||||||
System
contracting projects
|
26,769,508 | 25,805,086 | 16,158,844 | |||||||||
Products
|
5,589,310 | 2,558,844 | 4,329,067 | |||||||||
Maintenance
services
|
1,769,104 | 1,217,316 | 602,943 | |||||||||
Total
cost of revenues
|
34,127,922 | 29,581,246 | 21,090,854 | |||||||||
GROSS
PROFIT
|
47,053,276 | 39,497,873 | 25,662,983 | |||||||||
OPERATING
EXPENSES
|
||||||||||||
Selling
and marketing
|
8,908,697 | 6,434,887 | 3,907,067 | |||||||||
General
and administrative
|
8,154,801 | 6,680,992 | 5,661,356 | |||||||||
Depreciation
and amortization
|
773,907 | 712,269 | 535,751 | |||||||||
Research
and development
|
1,631,435 | 2,102,976 | 672,379 | |||||||||
Total
operating expenses
|
19,468,840 | 15,931,124 | 10,776,553 | |||||||||
INCOME
FROM OPERATIONS
|
27,584,436 | 23,566,749 | 14,886,430 | |||||||||
OTHER
INCOME (EXPENSES)
|
||||||||||||
Other
income
|
678,530 | 929,919 | 581,192 | |||||||||
Other
expenses
|
(6,907 | ) | (127,620 | ) | (14,932 | ) | ||||||
Interest
income
|
269,081 | 382,227 | 148,236 | |||||||||
Change
in fair value of derivative instruments
|
- | - | 1,205,791 | |||||||||
Total
other income (expenses)
|
940,704 | 1,184,526 | 1,920,287 | |||||||||
INCOME
BEFORE PROVISION FOR INCOME TAXES AND NONCONTROLING
INTEREST
|
28,525,140 | 24,751,275 | 16,806,717 | |||||||||
PROVISION
FOR INCOME TAXES
|
4,165,548 | 47,423 | 5,081 | |||||||||
NET
INCOME BEFORE NONCONTROLLING INTEREST
|
24,359,592 | 24,703,852 | 16,801,636 | |||||||||
Less:
Net loss attributable to noncontrolling interest
|
(55,244 | ) | - | - | ||||||||
NET
INCOME ATTRIBUTABLE TO CONTROLLING INTEREST
|
24,414,836 | 24,703,852 | 16,801,636 | |||||||||
OTHER
COMPREHENSIVE INCOME
|
||||||||||||
Foreign
currency translation adjustment
|
19,093 | 3,737,027 | 2,502,595 | |||||||||
COMPREHENSIVE
INCOME
|
$ | 24,433,929 | $ | 28,440,879 | $ | 19,304,231 | ||||||
BASIC
EARNINGS PER SHARE
|
||||||||||||
Weighted
average number of shares
|
27,590,523 | 27,568,214 | 26,873,742 | |||||||||
Earnings
per share
|
$ | 0.88 | $ | 0.90 | $ | 0.63 | ||||||
DILUTED
EARNINGS PER SHARE
|
||||||||||||
Weighted
average number of shares
|
28,311,955 | 28,210,620 | 27,721,171 | |||||||||
Earnings
per share
|
$ | 0.86 | $ | 0.88 | $ | 0.61 |
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of these consolidated financial
statements.
F-3
CONSOLIDATED
STATEMENTS OF CHANGES IN EQUITY
China Fire & Security
Group, Inc. Shareholders' Equity
|
||||||||||||||||||||||||||||||||
Retained Earnings
|
Accumulated other
|
|||||||||||||||||||||||||||||||
Common Stock
|
Additional
|
Statutory
|
comprehensive
|
Noncontrolling
|
||||||||||||||||||||||||||||
Shares
|
Par value
|
paid-in-capital
|
reserves
|
Unrestricted
|
income
|
interest
|
Totals
|
|||||||||||||||||||||||||
BALANCE,
December 31, 2006
|
26,461,678 | $ | 26,462 | $ | 13,393,171 | $ | 4,030,627 | $ | 6,462,893 | $ | 1,065,522 | $ | - | $ | 24,978,675 | |||||||||||||||||
Net
income
|
16,801,636 | 16,801,636 | ||||||||||||||||||||||||||||||
Warrants
reclassified from liabilities
|
1,475,020 | 1,475,020 | ||||||||||||||||||||||||||||||
Issuance
of common stock
|
984,680 | 983 | 4,164,214 | 4,165,197 | ||||||||||||||||||||||||||||
Warrants
exercised
|
110,535 | 111 | (111 | ) | - | |||||||||||||||||||||||||||
Warrants
issued for services
|
94,274 | 94,274 | ||||||||||||||||||||||||||||||
Options
issued to employees
|
190,719 | 190,719 | ||||||||||||||||||||||||||||||
Adjustment
on registered capital
|
(605,000 | ) | 605,000 | - | ||||||||||||||||||||||||||||
Adjustment
on statutory reserves
|
1,641,434 | (1,641,434 | ) | - | ||||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
2,502,595 | 2,502,595 | ||||||||||||||||||||||||||||||
BALANCE,
December 31, 2007
|
27,556,893 | $ | 27,556 | $ | 19,317,287 | $ | 5,067,061 | $ | 22,228,095 | $ | 3,568,117 | $ | - | $ | 50,208,116 | |||||||||||||||||
Net
income
|
24,703,852 | 24,703,852 | ||||||||||||||||||||||||||||||
Warrants
exercised
|
29,700 | 30 | (30 | ) | - | |||||||||||||||||||||||||||
Options
issued to employees
|
40,152 | 40,152 | ||||||||||||||||||||||||||||||
Adjustment
on statutory reserves
|
2,081,766 | (2,081,766 | ) | - | ||||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
3,737,027 | 3,737,027 | ||||||||||||||||||||||||||||||
BALANCE,
December 31, 2008
|
27,586,593 | $ | 27,586 | $ | 19,357,409 | $ | 7,148,827 | $ | 44,850,181 | $ | 7,305,144 | $ | - | $ | 78,689,147 | |||||||||||||||||
Capital
received from noncontrolling interest
|
88,003 | 88,003 | ||||||||||||||||||||||||||||||
Net
income (loss)
|
24,414,836 | (55,244 | ) | 24,359,592 | ||||||||||||||||||||||||||||
Warrants
exercised
|
6,682 | 7 | (7 | ) | - | |||||||||||||||||||||||||||
Options
exercised
|
2,266 | 2 | (2 | ) | - | |||||||||||||||||||||||||||
Options
issued to employees
|
980,196 | 980,196 | ||||||||||||||||||||||||||||||
Stock
based compensation for services
|
263,542 | 263,542 | ||||||||||||||||||||||||||||||
Deconsolidation
of statutory reserves held in Tianjin Tianxiao Fire Safety
Equipment Co., Ltd.
|
(1,032 | ) | 1,032 | - | ||||||||||||||||||||||||||||
Foreign
currency translation adjustment
|
19,093 | (17 | ) | 19,076 | ||||||||||||||||||||||||||||
- | ||||||||||||||||||||||||||||||||
BALANCE,
December 31, 2009
|
27,595,541 | $ | 27,595 | $ | 20,601,138 | $ | 7,147,795 | $ | 69,266,049 | $ | 7,324,237 | $ | 32,742 | $ | 104,399,556 |
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of these consolidated financial
statements.
F-4
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
FOR THE
YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
2009
|
2008
|
2007
|
||||||||||
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
||||||||||||
Net
income attributable to controlling interest
|
$ | 24,414,836 | $ | 24,703,852 | $ | 16,801,636 | ||||||
Net
loss attributable to noncontrolling interest
|
(55,244 | ) | - | - | ||||||||
Consolidated
net income
|
24,359,592 | 24,703,852 | 16,801,636 | |||||||||
Adjustments
to reconcile net income to cash provided by operating
activities:
|
||||||||||||
Depreciation
|
766,473 | 728,080 | 555,604 | |||||||||
Amortization
|
75,284 | 75,041 | 54,257 | |||||||||
Provision
for doubtful accounts
|
2,172,588 | 1,683,336 | 1,111,051 | |||||||||
(Gain)
Loss on disposal of equipment
|
(7,602 | ) | (35,689 | ) | 17,715 | |||||||
Options
issued to employees
|
980,196 | 40,152 | 190,719 | |||||||||
Stock
based compensation for services
|
263,542 | - | 94,274 | |||||||||
Change
in fair value of derivative instruments
|
- | - | (1,205,791 | ) | ||||||||
Provision
for estimated warranty claims
|
582,595 | 518,940 | - | |||||||||
Change
in operating assets and liabilities
|
||||||||||||
Notes
receivable
|
(603,639 | ) | (120,143 | ) | (2,256,606 | ) | ||||||
Accounts
receivable
|
(9,875,285 | ) | (10,571,077 | ) | (3,206,458 | ) | ||||||
Receivables
from related party
|
(85,517 | ) | (458,119 | ) | - | |||||||
Other
receivables
|
50,740 | (159,199 | ) | 229,221 | ||||||||
Refundable
bidding and system contracting project deposits
|
(689,560 | ) | (559,757 | ) | (46,736 | ) | ||||||
Inventories
|
(63,808 | ) | (2,168,821 | ) | 416,317 | |||||||
Costs
and estimated earnings in excess of billings
|
(18,729,367 | ) | (3,771,899 | ) | (3,286,191 | ) | ||||||
Employee
advances
|
(227,973 | ) | 663,369 | 419,589 | ||||||||
Prepayments
and deferred expenses
|
(676,908 | ) | (412,888 | ) | 334,603 | |||||||
Accounts
payable
|
666,007 | (98,219 | ) | (117,311 | ) | |||||||
Accounts
payable to related party
|
272,994 | - | - | |||||||||
Customer
deposits
|
(3,907,650 | ) | 994,154 | 1,781,869 | ||||||||
Billings
in excess of costs and estimated earnings
|
(2,805,806 | ) | (969,403 | ) | (4,418,793 | ) | ||||||
Other
payables
|
(485,243 | ) | 645,855 | (287,672 | ) | |||||||
Accrued
liabilities
|
6,503,713 | 1,722,071 | 2,168,961 | |||||||||
Taxes
payable
|
6,932,390 | 912,068 | 422,856 | |||||||||
Net
cash provided by operating activities
|
5,467,756 | 13,361,704 | 9,773,114 | |||||||||
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
||||||||||||
Purchase
of plant and equipment
|
(1,272,393 | ) | (2,015,051 | ) | (3,419,056 | ) | ||||||
Advances
on building and equipment purchase
|
- | - | (351,809 | ) | ||||||||
Proceeds
from sale of equipment
|
26,859 | 69,852 | 20,820 | |||||||||
Purchase
of intangible assets
|
- | - | (613,582 | ) | ||||||||
Payments
for investment in Hubei Sureland Changjiang Fire Safety Technology Co.,
Ltd.
|
- | - | (150,104 | ) | ||||||||
Proceeds
from investment sold (payments for investment) in King Galaxy Investments
Limited
|
1,000,000 | - | (1,000,000 | ) | ||||||||
Deconsolidation
of cash held in Tianjin Tianxiao Fire Safety Equipment Co.,
Ltd.
|
(241,344 | ) | - | - | ||||||||
Proceeds
from restructuring in Tianjin Tianxiao Fire Safety Equipment Co.,
Ltd.
|
1,551,134 | - | - | |||||||||
Proceeds
from sale of investment in Tianjin Fire Security Equipment Co.,
Ltd.
|
- | - | 514,856 | |||||||||
Proceeds
from restructuring in Beijing Zhong Xiao Fire Safety Tecnhology Co.
Ltd.
|
- | - | 1,068,897 | |||||||||
Payments
for long term deferred assets
|
(115,973 | ) | - | - | ||||||||
Net
cash provided by (used in) investing activities
|
948,283 | (1,945,199 | ) | (3,929,978 | ) | |||||||
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
||||||||||||
Change
in restricted cash
|
1,809,610 | (3,097,855 | ) | (2,011,480 | ) | |||||||
Payments
to Beijing Zhong Xiao Fire Safety Technology Co., Ltd.
|
- | - | (2,466,395 | ) | ||||||||
Proceeds
from Beijing Zhong Xiao Fire Safety Technology Co., Ltd.
|
- | - | 1,364,630 | |||||||||
Proceeds
from issuance of common stock
|
- | - | 4,165,197 | |||||||||
Capital
contributed by noncontrolling interest shareholder
|
88,003 | - | - | |||||||||
Net
cash provided by (used in) financing activities
|
1,897,613 | (3,097,855 | ) | 1,051,952 | ||||||||
EFFECT
OF EXCHANGE RATE CHANGES ON CASH
|
7,895 | 1,226,234 | 789,270 | |||||||||
INCREASE
IN CASH
|
8,321,547 | 9,544,884 | 7,684,358 | |||||||||
CASH
and CASH EQUIVALENTS, beginning of year
|
26,655,333 | 17,110,449 | 9,426,091 | |||||||||
CASH
and CASH EQUIVALENTS, end of year
|
$ | 34,976,880 | $ | 26,655,333 | $ | 17,110,449 | ||||||
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION
|
||||||||||||
Income
taxes paid
|
$ | 1,300,439 | $ | 29,048 | $ | 46,390 | ||||||
Interest
paid
|
$ | - | $ | - | $ | - | ||||||
NON-CASH
TRANSACTIONS INVESTING AND FINANCING ACTIVITIES:
|
||||||||||||
Reclassification
of warrant liability to paid-in capital upon modification of warrants
agreement
|
$ | - | $ | - | $ | 1,475,020 | ||||||
Reclassification
of advances on building and equipment purchase to plant and equipment upon
receipt of purchase
|
$ | 249,859 | $ | 139,638 | $ | - |
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of these consolidated financial
statements.
F-5
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
1 - Background
Principal Activities and
Reorganization
China Fire & Security Group
Inc. (the “Company” or “CFSG”), is a Florida corporation. The
Company, through its subsidiaries, is engaged in the design, development,
manufacture and sale of fire protection products and services for industrial
customers in People’s Republic of China (“China”) and India.
Current
Development
Formation
of Beijing
Shian Kexin Technology Co., Ltd (“Shian Kexin”)
Shian
Kexin was incorporated in May 2009 in Beijing, China with registered capital
amounted to $732,500 (RMB5,000,000). Shian Kexin is 100% owned by Sureland
Industrial Fire Safety Limited (“Sureland Industrial”) and engages in technology
developing, transferring and consulting, computer software development and
selling of fire safe product and equipment.
Formation of Shenyang
Hongshida Electronics Co., Ltd (“Shenyang Hongshida”)
Shenyang
Hongshida was incorporated in Shenyang, Liaoning Province, China with registered
capital amounted to $1,465,000 (RMB10,000,000). Pursuant to Shengyang
Hongshida’s by-laws dated on June 1, 2009, the registered capital is required to be injected over the
subsequent two years. Shenyang Hongshida is 80% owned by Beijing Hua An
Times Fire Safety Technology Co., Ltd. with 20% noncontrolling interest owned by
an unrelated party. Shenyang Hongshida engages in production and selling of fire
equipment, electronic products, instrumentation, computer parts and providing
technical advisory services. Shenyang Hongshida will focus on the low-end and
middle-end market of fire product. As of December 31, 2009, the registered
capital received was $439,500 (RMB3,000,000) and the remaining registered
capital of $1,026,900 (RMB 7,000,000) is required to be contributed by the two
owners by June 1, 2011. The Company is in pre-operating stage.
Sales of 5% interest in King
Galaxy Investments Limited (“King Galaxy”)
During
September 2009, the Company sold its 5% interest in King Galaxy Investment
Limited at cost to Mr. Wei Jing, who is the controlling shareholder of King
Galaxy Investment Limited for cash consideration of $1.0 million. The proceeds
of $1.0 million have been fully received by the Company as of December 31,
2009. King Galaxy through its wholly owned subsidiary, China Alliance
Security Holdings Company Limited, owns 100% of Wan Sent (China) Technology Co.,
Ltd.
See
report of independent registered public accounting firm
F-6
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Restructuring of 83.3%
ownership in Tianjin Tianxiao Fire Safety Equipment Co., Ltd. (“Tianxiao
Equipment”)
On July
3, 2009, Sureland Industrial signed an agreement to transfer 83.3% ownership in
Tianxiao Equipment to Tianjin Fire Protection Equipment Co., Ltd. for the
consideration price approximately equal to the net assets of Tianxiao Equipment
as of June 30, 2009, which was approximately $1.6 million (RMB 10.6 million).
Thus, a loss of $913 was recognized in this transaction. The proceeds of $1.6
million have been fully received by the Company as of December 31,
2009.
After the
restructuring of Tianxiao Equipment, Sureland Industrial held 16.7% ownership in
Tianxiao Equipment as a minority interest holder. The investment is
recorded under the cost accounting method. Sureland Industrial is
continuing to purchase fire safety and protection products through Tiaoxiao
Equipment, which does not require the classification of the deconsolidation of
Tianxiao Equipment as a discontinued operation in accordance to FASB Accounting
Standards Codification (“ASC”) 205-20-55.
Note
2 - Summary of significant accounting policies
The reporting
entity
The
consolidated financial statements of China Fire & Security Group Inc. and
Subsidiaries reflect the activities of the parent and the following
subsidiaries:
Subsidiaries
|
Incorporated in
|
Ownership
Percentage
|
||||
China
Fire Protection Group Inc. (“CFPG”)
|
British
Virgin Islands
|
100 | % | |||
Sureland
Industrial Fire Safety Limited (“Sureland Industrial”)
|
People’s Republic of China
|
100 | % | |||
Sureland
Industrial Fire Equipment Co. Ltd. (“Sureland Equipment”)
|
People’s
Republic of China
|
100 | % | |||
Beijing
Hua An Times Fire Safety Technology Co., Ltd. (“Beijing Hua
An”)
|
People’s
Republic of China
|
100 | % | |||
Beijing
Shian Kexin Technology Co., Ltd
|
People’s
Republic of China
|
100 | % | |||
Shenyang
Hongshida Electronics Co., Ltd
|
People’s
Republic of China
|
80 | % |
Basis of
presentation
The
accompanying consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America.
All material intercompany transactions and balances have been eliminated in
consolidation.
See
report of independent registered public accounting firm
F-7
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
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.
The
Company’s certain 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, determining the fair value of stock based compensation and the allowance
of doubtful accounts and warranty expenses. Management evaluates all of its
estimates and judgments on an on-going basis.
Revenue
recognition
Revenue
is recognized when it is probable that the economic benefits will flow to the
Company as follows:
|
1.
|
Revenue
from system contracting projects are recognized using the
percentage-of-completion method of accounting and, therefore, take into
account the costs, estimated earnings and revenue to date on contracts not
yet completed. Revenue recognized is that percentage of the total contract
price that cost expended to date bears to anticipated final total cost,
based on current estimates of costs to complete. Contract costs include
all direct material and labor costs and those indirect costs related to
contract performance, such as indirect labor, supplies, tools, repairs,
and depreciation costs. Selling, general, and administrative costs are
charged to expense as incurred. At the time a loss on a contract becomes
known, the entire amount of the estimated ultimate loss is recognized in
the consolidated financial statements. Claims for additional contract
costs are recognized upon a signed change order from the
customer.
|
|
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 People’s
Republic of China (“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.
See
report of independent registered public accounting firm
F-8
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Enterprise Wide
Disclosure
Almost
all the Company’s products (fire detecting products, fire alarm control device,
and water mist/sprinkler systems) are sold via system contracting projects or as
part of the integrated products sales. The composition of these three types of
products varies significantly from project to project, both in quantity and in
dollar amounts. Although the Company could provide a breakdown of sales
contribution for the Company’s own products for each project, it is almost
impossible to provide revenues for each of the products when the revenue from
each project is recognized based on percentage of completion. More
importantly, the revenues from the Company’s own products do not accurately
reflect the Company’s overall financial performance. The Company is a system
contracting projects provider rather than product vendors who sell their own
products directly or through channels. Therefore, it is not practical
to separately disclose the revenues from external customers for each of the
products.
The
Company’s chief operating decision-makers (i.e. chief executive officer and his
direct reports) review financial information presented on a consolidated basis,
accompanied by disaggregated information about revenues by business lines for
purposes of allocating resources and evaluating financial performance. There are
no segment managers who are held accountable for operations, operating results
and plans for levels or components below the consolidated unit level. Based on
qualitative and quantitative criteria established by ASC 280-10, “Disclosures
about Segments of an Enterprise and Related Information”, the Company considers
itself to be operating within one reportable segment.
Shipping and
handling
Costs
related to shipping and handling are included in cost of revenue pursuant to ASC
605-45 “Accounting for Shipping and Handling Fees and Costs.”
Foreign currency
translation
The
reporting currency of the Company is the US dollar. The Company uses their local
currency, Renminbi (RMB) 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 statements of changes in
equity.
See
report of independent registered public accounting firm
F-9
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Asset and
liability accounts at December 31, 2009 were translated at 6.82 RMB to $1.00 and
46.89 INR to $1.00 as compared to 6.82 RMB to $1.00 at December 31,
2008. Equity accounts were stated at their historical
rate. The average translation rates of RMB applied to income
statements accounts for the years ended December 31, 2009, 2008 and 2007 were
6.82 RMB, 6.94 RMB and 7.59 RMB, respectively. The average translation rates of
INR applied to income statements accounts for the year ended December 31, 2009
were 48.85 INR. 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
entered any currency trading or hedging transactions, although there is no
assurance that the Company will not enter into such transactions in the
future.
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. Depreciation expense amounted to
$766,473, $728,080 and $555,604 for the years ended December 31, 2009, 2008 and
2007, respectively.
Estimated
useful lives of the assets are as follows:
Useful
Life
|
|
Buildings
and improvements
|
40
years
|
Transportation
equipment
|
5
years
|
Machinery
|
10
years
|
Office
equipment
|
5
years
|
Furniture
|
5
years
|
Construction
in progress represents the costs incurred in connection with the construction of
buildings or additions to the Company’s plant facilities. No depreciation is
provided for construction in progress until such time as the assets are
completed and placed into service. Interest incurred during construction is
capitalized into construction in progress. All other interest is expensed as
incurred.
The cost
and related accumulated depreciation of assets sold or otherwise retired are
eliminated from the accounts and any gain or loss is included in the
consolidated statements of income. Maintenance, repairs and minor renewals are
charged directly to expense as incurred. Major additions and betterments to
buildings and equipment are capitalized.
See
report of independent registered public accounting firm
F-10
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Long-term
assets of the Company are reviewed at least annually, more often if
circumstances dictate, to determine whether their carrying value has become
impaired. The Company considers assets to be impaired if the carrying value
exceeds the future projected cash flows from related operations. The Company
evaluates the periods of depreciation and amortization to determine whether
subsequent events and circumstances warrant revised estimates of useful lives.
As of December 31, 2009, the Company expects these assets to be fully
recoverable.
Plant and
equipment consists of the following:
|
December 31,
2009
|
December 31,
2008
|
||||||
Buildings
and improvements
|
$ | 6,439,015 | $ | 6,417,304 | ||||
Transportation
equipment
|
3,307,236 | 2,747,038 | ||||||
Machinery
|
900,781 | 1,249,470 | ||||||
Office
equipment
|
1,348,261 | 1,262,426 | ||||||
Furniture
|
165,736 | 90,882 | ||||||
Total
depreciable assets
|
12,161,029 | 11,767,120 | ||||||
Less
accumulated depreciation
|
(3,875,487 | ) | (3,321,866 | ) | ||||
Construction
in progress
|
331,979 | - | ||||||
Plant
and equipment, net
|
$ | 8,617,521 | $ | 8,445,254 |
Concentration of
risk
Cash
includes cash on hand and demand deposits in accounts maintained with state
owned banks within the People’s Republic of China, Hong Kong and India. The
Company maintains balances at financial institutions which, from time to time,
may exceed Hong Kong Deposit Protection Board insured limits for the banks
located in Hong Kong. Balances at financial institutions or state owned banks
within the PRC are not covered by insurance. The balances maintained
in India are deposited in the branch of DBS Bank (Singapore) Limited, which are
fully insured by the Government of Singapore till December 31, 2010. As of
December 31, 2009 and December 31, 2008, the Company had deposits (including
restricted cash balances) totaling to $33,603,047 and $30,765,488, respectively,
that are not covered by insurance. The Company has not experienced any losses in
such accounts and believes it is not exposed to any risks on its cash in bank
accounts.
The
Company's operations are mainly carried out in the PRC while the revenue
recognized from operations in India is immaterial to the Company’s financial
statement. Accordingly, the Company's business, financial condition and results
of operations may be influenced by the political, economic and legal
environments in the PRC, and by the general state of the PRC's economy. The
Company's operations in the PRC are subject to specific considerations and
significant risks not typically associated with companies in the North America
and Western Europe. These include risks associated with, among others, the
political, economic and legal environments and foreign currency exchange. The
Company's results may be adversely affected by changes in governmental policies
with respect to laws and regulations, anti-inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation, among other
things.
See
report of independent registered public accounting firm
F-11
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
The
Company has one major customer who represents approximately 10% of the Company’s
sales for the year ended December 31, 2009. Accounts receivable from this
customer was $97,000 as of December 31, 2009. The Company has one major customer
who represents approximately 25% of the Company’s sales for the years ended
December 31, 2008. Accounts receivable from this customer was $0 as of December
31, 2008.
Cash and cash
equivalents
The
Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents. Cash and cash
equivalents also include unrestricted time deposits.
Restricted
cash
Restricted
cash represents cash required to be deposited in a separate bank account subject
to withdrawal restrictions by its system contracting projects and product sales
customers to guarantee its contracts will be performed. The deposit cannot be
drawn or transferred by the Company until the restriction period has
expired.
Restricted
cash consists of the following:
|
December 31,
2009
|
December 31,
2008
|
||||||
Products
sales
|
$ | 3,728,599 | $ | 1,608,056 | ||||
System
contracting projects
|
1,711,441 | 5,642,705 | ||||||
Total
restricted cash
|
5,440,040 | 7,250,761 | ||||||
Restricted
cash - non current
|
(3,602,906 | ) | (1,872,828 | ) | ||||
Restricted
cash - current
|
$ | 1,837,134 | $ | 5,377, 933 |
Inventories
Inventories
are stated at the lower of cost or market, using the weighted average
method.
See
report of independent registered public accounting firm
F-12
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Inventories
consist of the following as of:
|
December 31,
2009
|
December 31,
2008
|
||||||
Raw
materials
|
$ | 144,829 | $ | 896,797 | ||||
Finished
goods
|
4,574,075 | 4,597,407 | ||||||
Work
in progress
|
641,616 | 1,044,734 | ||||||
Total
|
$ | 5,360,520 | $ | 6,538,938 |
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 inventories periodically to determine if any reserves are
necessary for potential obsolescence. As of December 31, 2009 and 2008, the
Company determined no reserves are necessary.
Accounts
receivable
Accounts
receivable represents amounts due from customers for products sales, maintenance
services and system contracting projects. Overdue balances are reviewed
regularly by senior management. Reserves are recorded when collection of amounts
due are in doubt. Delinquent account balances are written-off after
management has determined that the likelihood of collection is not probable,
known bad debts are written off against allowance for doubtful accounts when
identified.
Accounts
receivable consists of the following:
|
December 31,
2009
|
December 31,
2008
|
||||||
System
contracting projects
|
$ | 23,814,248 | $ | 19,167,096 | ||||
Maintenance
services
|
3,190,843 | 3,193,166 | ||||||
Products
sales
|
13,988,263 | 8,943,893 | ||||||
Total
accounts receivable
|
40,993,354 | 31,304,155 | ||||||
Allowance
for bad debts
|
(6,539,787 | ) | (4,370,362 | ) | ||||
Accounts
receivable, net
|
34,453,567 | 26,933,793 | ||||||
Accounts
receivable - non-current retentions
|
(3,463,998 | ) | (1,107,450 | ) | ||||
Accounts
receivable - current
|
$ | 30,989,569 | $ | 25,826,343 |
See
report of independent registered public accounting firm
F-13
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
The
activity in the allowance for doubtful accounts for trade accounts receivable
for the years ended December 31, 2009 and 2008 is as follows:
|
December 31,
2009
|
December 31,
2008
|
||||||
Beginning
allowance for doubtful accounts
|
$ | 4,370,362 | $ | 2,483,359 | ||||
Additional
charged to bad debt expense
|
2,172,588 | 1,683,336 | ||||||
Write-off
charged against the allowance
|
- | - | ||||||
Foreign
currency translation adjustment
|
(3,163 | ) | 203,667 | |||||
Ending
allowance for doubtful accounts
|
$ | 6,539,787 | $ | 4,370,362 |
Retentions
held by customers of system contracting projects included in the Company’s
accounts receivable are as follows:
|
December 31,
2009
|
December 31,
2008
|
||||||
Current
|
$ | 3,463,998 | $ | 3,685,136 | ||||
Non-current
|
2,967,248 | 1,107,450 | ||||||
Total
retentions
|
$ | 6,431,246 | $ | 4,792,586 |
These
balances represent portions of billings made by the Company but held for payment
by the customer pending satisfactory completion of the project. Retention
payments are generally collected within one year of the completion of the
project.
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.
Costs and
estimated earnings in excess of billings consist of the following:
|
December 31,
2009
|
December 31,
2008
|
||||||
Contract
costs incurred plus recognized profits less recognized losses to
date
|
$ | 116,754,059 | $ | 68,149,817 | ||||
Less:
progress billings
|
(80,191,486 | ) | (50,328,109 | ) | ||||
Costs
and estimated earnings in excess of billings
|
$ | 36,562,573 | $ | 17,821,708 |
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.
See
report of independent registered public accounting firm
F-14
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Billings
in excess of costs and estimated earnings consists of the
following:
|
December 31,
2009
|
December 31,
2008
|
||||||
Progress
billings
|
$ | 14,679,369 | $ | 31,456,807 | ||||
Less:
contracts costs incurred plus recognized profits less recognized
losses to date
|
(16,109,368 | ) | (27,219,279 | ) | ||||
Billings
in excess of costs and estimated earnings
|
$ | 1,429,999 | $ | 4,237,528 |
Research and
development
Research
and development expenses include salaries, consultant fees, supplies and
materials, as well as costs related to other overhead such as depreciation,
facilities, utilities and other departmental expenses. The costs the Company
incur with respect to internally developed technology and engineering services
are included in research and development expenses as incurred as they do not
directly relate to any particular licensee, license agreement or licenses
fee.
Warranty
Generally,
the Company’s products are not covered by specific warranty terms. However, it
is the Company’s policy to replace parts if they become defective within one
year after deployment at no additional charge. The Company maintains
a provision for potential warranty costs on these products for one
year. This provision represents management’s assessment of the
Company’s history of warranty costs while incorporating estimates by the quality
review staff of the potential product failure rates. The Company
records a warranty obligation in selling expense at the time revenue is
recognized. As of December 31, 2009, 2008 and 2007 the Company
recorded $582,953, $518,940 and $0, respectively, as reserve for estimated
warranty claims.
Fair value of financial
instruments
ASC
825-10-50, Disclosures about Fair Value of Financial Instruments, defines
financial instruments and requires fair value disclosures for those instruments.
ASC 820-10, Fair Value Measurements, adopted January 1, 2008, defines fair
value, establishes a three-level valuation hierarchy for disclosures of fair
value measurement and enhances disclosures requirements for fair value measures.
The carrying amounts reported in the balance sheets for receivables and payables
qualify as financial instruments and are a reasonable estimate of fair value
because of the short period of time between the origination of such instruments
and their expected realization and their current market rate of interest. The
three levels are defined as follow:
See
report of independent registered public accounting firm
F-15
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
|
·
|
Level
1 inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities in active
markets.
|
|
·
|
Level
2 inputs to the valuation methodology include quoted prices for similar
assets and liabilities in active markets, and inputs that are observable
for the assets or liability, either directly or indirectly, for
substantially the full term of the financial
instruments.
|
|
·
|
Level
3 inputs to the valuation methodology are unobservable and significant to
the fair value.
|
The
investment in joint ventures is also a financial instrument. The
Company invested $167,237 (RMB 1,140,000) in Hubei Shou An Changjiang Fire
Protection Co., Ltd for 19% ownership, and invested $310,600 in Tianxiao Fire
Safety Equipment Co., Ltd. for 16.7% ownership. Total investment as of December
31, 2009 amounted to $477,837, there is no quoted or observable market price for
the fair value of similar long term investments in joint
ventures. The Company then used the level 3 inputs for its valuation
methodology. The determination of the fair value was based on the cost of the
capital contribution to the joint ventures.
The
Company did not identify any assets and liabilities that are required to be
presented on the balance sheet at fair value in accordance with ASC
820-10.
Intangible
assets
Land use
rights - All land in the People’s Republic of China is owned by the government.
However, the government grants the user “land use rights”. The Company acquired
land use rights in 2001 and the land use rights expire in 2051. The costs of
these rights are being amortized over fifty years using the straight-line
method.
Technology
rights - In May 2007, the Company acquired two technology rights to manufacture
fire protection products and the costs of these rights are being amortized over
ten years using the straight-line method.
Intangible
assets consist of the following:
|
December 31,
2009
|
December 31,
2008
|
||||||
Land
use rights
|
$ | 770,789 | $ | 770,789 | ||||
Technology
rights
|
608,745 | 608,745 | ||||||
Accumulated
amortization
|
(338,378 | ) | (263,085 | ) | ||||
Balance
|
$ | 1,041,156 | $ | 1,116,449 |
Amortization
expense amounted to $75,284, $75,041 and $54,257 for the years ended December
31, 2009, 2008 and 2007, respectively.
See
report of independent registered public accounting firm
F-16
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Intangible
assets of the Company are reviewed annually, more often when circumstances
require, to determining whether their carrying value has become impaired. The
Company considers assets to be impaired if the carrying value exceeds the future
projected cash flows from related operations. The Company also evaluates the
periods of amortization to determine whether subsequent events and circumstances
warrant revised estimates of useful lives. As of December 31, 2009, the Company
expects these assets to be fully recoverable.
Income
taxes
The
Company reports income taxes pursuant to ASC 740, “Accounting for Income Taxes”
ASC 740-10, “Accounting for Uncertainty in Income Taxes” (formerly “FIN 48”).
ASC 740 requires the recognition of deferred income tax liabilities and assets
for the expected future tax consequences of temporary differences between income
tax basis and financial reporting basis of assets and liabilities. Provision for
income taxes consist of taxes currently due plus deferred taxes. Deferred tax
assets amounted to $84,126 and
$0 as of December
31, 2009 and December 31, 2008, respectively, are classified as prepayment and
deferred expenses in the accompanying consolidated balance sheets.
Under ASC
740-10, a tax position is recognized as a benefit only if it is “more likely
than not” that the tax position would be sustained in a tax examination, with a
tax examination being presumed to occur. The amount recognized is the largest
amount of tax benefit that is greater than 50% likely of being realized on
examination. For tax positions not meeting the “more likely than not” test, no
tax benefit is recorded. ASC 740-10 also provides guidance on de-recognition,
classification, interest and penalties, accounting in interim periods,
disclosures, and transition.
The
Company’s operations are subject to income and transaction taxes in the United
States, the PRC and the India jurisdictions. Significant estimates and judgments
are required in determining the Company’s worldwide provision for income taxes.
Some of these estimates are based on interpretations of existing tax laws or
regulations. The ultimate amount of tax liability may be uncertain as a
result.
The
Company does not anticipate any events which could cause change to these
uncertainties.
The
charge for taxation is based on the results for the year as adjusted for items,
which are non-assessable or disallowed. It is calculated using tax rates that
have been enacted or substantively enacted by the balance sheet
date.
Deferred
tax is accounted for using the balance sheet liability method in respect of
temporary differences arising from differences between the carrying amount of
assets and liabilities in the financial statements and the corresponding tax
basis used in the computation of assessable tax profit.
See
report of independent registered public accounting firm
F-17
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
In
principal, deferred tax liabilities are recognized for all taxable temporary
differences, and deferred tax assets are recognized to the extent that it is
probable that taxable profit will be available against which deductible
temporary differences can be utilized. Deferred tax is calculated using tax
rates that are expected to apply to the period when the asset is realized or the
liability is settled. Deferred tax is charged or credited in the income
statement, except when it is related to items credited or charged directly to
equity, in which case the deferred tax is also dealt with in equity. Deferred
tax assets and liabilities are offset when they relate to income taxes levied by
the same taxation authority and the Company intends to settle its current tax
assets and liabilities on a net basis.
Value Added
Tax
Enterprises
or individuals who sell products, engage in repair and maintenance or import and
export goods in the PRC are subject to a value added tax in accordance with
Chinese laws. The value added tax standard rate is 17% of the gross sales price.
A credit is available whereby VAT paid on the purchases of semi-finished
products or raw materials used in the contract and production of the Company’s
finished products can be used to offset the VAT due on sales of the finished
product. All of our PRC subsidiaries’ VAT is subject to 17% rate
except Beijing Hua An. To support the development of the software
industry, the Chinese government has instituted policies to rebate VAT charged
for software certified by the government up to 14%. As a result, Beijing Hua An,
is paying its VAT at an effective rate of 3% for their intercompany software
sales.
VAT on
sales and VAT on purchases amounted to $9,745,786 and $4,935,357 for the year
ended December 31, 2009, VAT on sales
and VAT on purchases amounted to $6,941,766 and $5,183,036 for the year ended
December 31, 2008 and $6,279,253 and $4,485,292 for the year ended December 31,
2007. Sales and purchases are recorded net of VAT collected and paid as the
Company acts as an agent for the government. VAT taxes are not impacted by the
income tax holiday.
Stock-based
compensation
The
Company adopted ASC 718, “Accounting for Stock-Based Compensation” at the
beginning of 2006, which defines a fair-value-based method of accounting for
stock-based employee compensation and transactions in which an entity issues its
equity instruments to acquire goods and services from non-employees. Stock
compensation granted to non-employees has been determined in accordance with ASC
718 and the ASC 505-50, "Accounting for Equity Instruments that are issued to
Other than Employees for Acquiring, or in Conjunction with Selling Goods or
Services", as the fair value of the consideration received or the fair value of
equity instruments issued, whichever is more reliably measured.
See
report of independent registered public accounting firm
F-18
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Recently issued accounting
pronouncements
In
January 2009, ASC 325-40, “Amendments to the Impairment Guidance of ASC
325-40,“Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets”. ASC 325-40 changes the
impairment model included within ASC 325-40 to be more consistent with the
impairment model of ASC-320. ASC 325-40 achieves this by amending the impairment
model in ASC 325-40 to remove its exclusive reliance on “market participant”
estimates of future cash flows used in determining fair value. Changing the cash
flows used to analyze other-than-temporary impairment from the “market
participant” view to a holder’s estimate of whether there has been a “probable”
adverse change in estimated cash flows allows companies to apply reasonable
judgment in assessing whether other-than-temporary impairment has occurred. The
adoption of ASC 325-40 did not have a material impact on the Company’s
consolidated financial statements because all of the investments in debt
securities are classified as trading securities.
In April
2009, the ASC 820-10, “Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly” ASC 820-10 amends ASC820 and provides
additional guidance for estimating fair value in accordance with ASC820 when the
volume and level of activity for the asset or liability have significantly
decreased and also includes guidance on identifying circumstances that indicate
a transaction is not orderly for fair value measurements. This accounting
standard shall be applied prospectively with retrospective application not
permitted. The adoption of ASC 820-10 did not have a material impact on the
Company’s consolidated financial statements.
In April
2009, the FASB issued ASC 320-10 and ASC 958-302. ASC 320-10, “Accounting for
Certain Investments in Debt and Equity Securities,” ASC 958-302, “Accounting for
Certain Investments Held by Not-for-Profit Organizations,” and, ASC 325-40
“Recognition of Interest Income and Impairment on Purchased Beneficial Interests
and Beneficial Interests That Continue to Be Held by a Transferor in Securitized
Financial Assets,” to make the other-than-temporary impairments guidance more
operational and to improve the presentation of other-than-temporary impairments
in the financial statements. This FSP will replace the existing requirement that
the entity’s management assert it has both the intent and ability to hold an
impaired debt security until recovery with a requirement that management assert
it does not have the intent to sell the security, and it is more likely than not
it will not have to sell the security before recovery of its cost basis. This
ASC provides increased disclosure about the credit and noncredit components of
impaired debt securities that are not expected to be sold and also requires
increased and more frequent disclosures regarding expected cash flows, credit
losses, and an aging of securities with unrealized losses. Although this FSP
does not result in a change in the carrying amount of debt securities, it does
require that the portion of an other-than-temporary impairment not related to a
credit loss for a held-to-maturity security be recognized in a new category of
other comprehensive income and be amortized over the remaining life of the debt
security as an increase in the carrying value of the security. The adoption of
ASC 320-10 and ASC 958-302 did not have a material impact on the Company’s
consolidated financial statements.
See
report of independent registered public accounting firm
F-19
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
In April
2009, the FASB issued ASC 825-10 and ASC 270-10-05. This ASC amends ASC 825-10,
“Disclosures about Fair Value of Financial Instruments,” to require disclosures
about fair value of financial instruments not measured on the balance sheet at
fair value in interim financial statements as well as in annual financial
statements. Prior to this ASC, fair values for these assets and liabilities were
only disclosed annually. This ASC applies to all financial instruments within
the scope of ASC 825-10 and requires all entities to disclose the method(s) and
significant assumptions used to estimate the fair value of financial
instruments. The adoption of ASC 825-10 and ASC 270-10-05 did not
have a material impact on the Company’s consolidated financial
statements.
In June
2009, the FASB issued Statement of Financial Accounting Standards No. ASC 860,
Accounting for Transfers of Financial Assets — an amendment of ASC 860,
which requires entities to provide more information regarding sales of
securitized financial assets and similar transactions, particularly if the
entity has continuing exposure to the risks related to transferred financial
assets. ASC 860 eliminates the concept of a “qualifying special-purpose entity,”
changes the requirements for derecognizing financial assets and
requires additional disclosures. ASC 860 is effective for fiscal years
beginning after November 15, 2009. The Company has not completed the assessment
of the impact ASC 860 will have on the Company’s financial condition,
results of operations or cash flows.
In June
2009, the FASB issued Statement of Financial Accounting Standards No. ASC
810-10, Amendments to FASB Interpretation No. 46(R), which modifies how a
company determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. ASC
810-10 clarifies that the determination of whether a company is required to
consolidate an entity is based on, among other things, an entity’s purpose
and design and a company’s ability to direct the activities of the entity that
most significantly impact the entity’s economic performance. ASC 810-10
requires an ongoing reassessment of whether a company is the primary beneficiary
of a variable interest entity. ASC 810-10 also requires additional
disclosures about a company’s involvement in variable interest entities and any
significant changes in risk exposure due to that involvement. ASC 810-10 is
effective for fiscal years beginning after November 15, 2009. The Company has
not completed the assessment of the impact ASC 810-10 will have on the
Company’s financial condition, results of operations or cash flows.
In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not available; under
those circumstances, a reporting entity is required to measure fair value using
one or more of valuation techniques, as defined. This ASU is effective for the
first reporting period, including interim periods, beginning after the issuance
of this ASU. The Company is currently evaluating the impact of this ASU on its
consolidated financial statements.
See
report of independent registered public accounting firm
F-20
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing. This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation. This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning of those
fiscal years. The Company is currently evaluating the impact of this ASU on its
consolidated financial statements.
In
November 2009, the FASB issued an ASU regarding accounting for stock dividends,
including distributions to shareholders with components of stock and cash. This
ASU clarifies that the stock portion of a distribution to shareholders that
contains components of cash and stock and allows shareholders to select their
preferred form of the distribution (with a limit on the amount of cash that will
be distributed in total) should be considered a stock dividend and included in
EPS calculations as a share issuance. The adoption of this guidance did not have
a material impact on the Company’s consolidated financial
statements
In
December 2009, FASB issued ASU No. 2009-16, Accounting for Transfers of
Financial Assets. This Accounting Standards Update amends the FASB Accounting
Standards Codification for the issuance of FASB Statement No. 166, Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No. 140.The amendments in
this Accounting Standards Update improve financial reporting by eliminating the
exceptions for qualifying special-purpose entities from the consolidation
guidance and the exception that permitted sale accounting for certain mortgage
securitizations when a transferor has not surrendered control over the
transferred financial assets. In addition, the amendments require enhanced
disclosures about the risks that a transferor continues to be exposed to because
of its continuing involvement in transferred financial assets. Comparability and
consistency in accounting for transferred financial assets will also be improved
through clarifications of the requirements for isolation and limitations on
portions of financial assets that are eligible for sale accounting. The Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.
See
report of independent registered public accounting firm
F-21
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
In
December, 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167, Amendments to FASB Interpretation
No. 46(R). The amendments in this Accounting Standards Update replace the
quantitative-based risks and rewards calculation for determining which reporting
entity, if any, has a controlling financial interest in a variable interest
entity with an approach focused on identifying which reporting entity has the
power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance and (1) the obligation to
absorb losses of the entity or (2) the right to receive benefits from the
entity. An approach that is expected to be primarily qualitative will be more
effective for identifying which reporting entity has a controlling financial
interest in a variable interest entity. The amendments in this Update also
require additional disclosures about a reporting entity’s involvement in
variable interest entities, which will enhance the information provided to users
of financial statements. The Company is currently evaluating the impact of this
ASU, however, the Company does not expect the adoption of this ASU to have a
material impact on its consolidated financial statements.
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. The Company does not expect the adoption of this ASU to
have a material impact on its 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. The Company does not expect the adoption of
this ASU to have a material impact on the Company’s consolidated financial
statements.
See
report of independent registered public accounting firm
F-22
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
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, and
settlements (that is, on a gross basis rather than as one net number). This
update provides amendments to Subtopic 820-10 that clarify 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. The
Company is currently evaluating the impact of this ASU, however, the Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.
Reclassifications
Certain
prior period amounts have been reclassified to conform to the current period
presentation. These reclassifications have no effect on net income or cash
flows.
Note
3 - Earnings per share
The
Company reports earnings per share in accordance with the provisions of ASC
260-10, “Earnings per Share.” ASC260-10 requires presentation of basic and
diluted earnings per share in conjunction with the disclosure of the methodology
used in computing such earnings per share. Basic earnings per share
are computed by dividing income available to common stockholders by the weighted
average common shares outstanding during the period. Diluted earnings per share
takes into account the potential dilution that could occur if securities or
other contracts to issue common stock were exercised and converted into common
stock.
See
report of independent registered public accounting firm
F-23
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
The
following is a reconciliation of the basic and diluted earnings per share
computation for the years ended December 31:
2009
|
2008
|
2007
|
||||||||||
Net
income for earnings per share
|
$ | 24,414,836 | $ | 24,703,852 | $ | 16,801,636 | ||||||
Weighted
average shares used in basic computation
|
27,590,523 | 27,568,214 | 26,873,742 | |||||||||
Diluted
effect of stock options and warrants
|
721,432 | 642,406 | 847,429 | |||||||||
Weighted
average shares used in diluted computation
|
28,311,955 | 28,210,620 | 27,721,171 | |||||||||
Earnings
per share:
|
||||||||||||
Basic
|
$ | 0.88 | $ | 0.90 | $ | 0.63 | ||||||
Diluted
|
$ | 0.86 | $ | 0.88 | $ | 0.61 |
As of
December 31, 2009, 2008, and 2007, all outstanding stock options and warrants
were included in the calculation of diluted earnings per share.
Note
4 - Related party transactions
The
Company has accounts receivable from Hubei Shou An Changjiang Fire Protection
Co., Ltd. (“Hubei Shou An”), in which the Company has a 19% ownership interest.
The receivable due from Hubei Shou An was $155,433 and $114,388 as of December
31, 2009 and December 31, 2008, respectively, resulted from product sales. This
amount was expected to be repaid by December 31, 2010 in cash.
The
Company has other receivable from Hubei Shou An. The receivable due from Hubei
Shou An was $396,359 and $351,835 as of December 31, 2009 and December 31, 2008,
respectively. This balance was for operating capital in Hubei Shou An
and expected to be repaid by December 31, 2010 in cash.
The
Company has accounts payable to Tianjin Tianxiao Fire Safety Equipment Co.,
Ltd., in which the Company has 16.7% ownership interest. The accounts payable to
Tianjin Tianxiao Fire Safety Equipment Co., Ltd. was $272,994 and $0 as of
December 31, 2009 and 2008, respectively, resulted from product purchase of
$1,245,792 and processing fees of 220,050 for the six months ended December 31,
2009 after the restructuring of 83.3% ownership in Tianxiao
Equipment.
Note
5 - Notes receivable
Notes
receivable represents trade accounts receivable due from various customers where
the customers’ bank has guaranteed the payment of the receivable. This amount is
non-interest bearing and is normally paid within three to nine months. The
Company has the ability to submit their request for payment to the customer’s
bank earlier than the scheduled payment date. However, the Company will incur an
interest charge and a processing fee when they submit the payment request early.
The Company‘s notes receivable totaled $4,274,268 and $3,670,259
as of December 31, 2009 and 2008, respectively.
See
report of independent registered public accounting firm
F-24
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
6 - Prepayments and deferred expenses
Prepayments
and deferred expenses are monies deposited with or advanced to subcontractors to
perform services on System Contracting Projects. Some subcontractors require a
certain amount of money to be deposited as a guarantee payment in order for them
to start performing the services. Prepayments and deferred expenses
also include monies deposited or advanced to vendors on future inventory
purchases to ensure timely delivery. The total outstanding amount was $3,397,358
and $2,816,976 as of December 31, 2009 and 2008,
respectively.
Note
7 - Investment in joint ventures
During
the second quarter of 2007, the Company invested $167,237 (RMB1,
140,000) for a 19% interest in Hubei Shou An Changjiang Fire Protection Co.,
Ltd., located in China Hubei, PRC. The investment is recorded under
the cost accounting method.
As of
December 31, 2009, the Company held an investment of $310,600 (RMB2, 117,246)
for a 16.7% interest in Tianjin Tianxiao Fire Safety Equipment Co., Ltd. as a
non-controlling interest holder. The investment is recorded under the cost
accounting method at fair value at the deconsolidation date on July 3,
2009.
Note
8 - Customer deposits
Customer
deposits represent amounts advanced by customers on products orders and
maintenance services deposits and system contracting projects deposits. The
product or service normally is shipped or performed within nine months after
receipt of the advance payment and the related sale is recognized in accordance
with the Company’s revenue recognition policy. Customer deposits also
represent amounts advanced by customers on system contracting projects deposits.
The advance payment will apply to the invoices when the Company billed our
customer based on the progression of the projects. As of December 31, 2009 and
2008 customer deposits amounted to $2,182,790, and $6,102,026,
respectively.
Note
9 - Accrued liabilities
Accrued
liabilities represent subcontractors’ expenses incurred as of balance sheet date
for system contracting projects. Accrued liabilities also represent accrued
estimation of warranty expenses. As of December 31, 2009 and 2008,
accrued liabilities amounted to $13,841,300 and $6,785,409
respectively.
See
report of independent registered public accounting firm
F-25
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
10 - Income taxes
Local PRC Income
Tax
Prior to
January 1, 2008, under the Income Tax Laws of PRC, the Company’s subsidiaries
are generally subject to an income tax at an effective rate of 33% on income
reported in the statutory financial statements after appropriate tax
adjustments, unless the enterprise is located in a specially designated region
where it allows enterprises a three-year income tax exemption and a 50% income
tax reduction for the following three years or the enterprise is a manufacturing
related joint venture with a foreign enterprise or a wholly owned subsidiary of
a foreign enterprise, where it allows enterprises a two-year income tax
exemption and a 50% income tax reduction for the following three
years.
The
Company’s subsidiaries were paying the following tax rate for the year ended
December 31, 2007:
Subsidiaries
|
Income tax exemption
|
Effective
income tax rate
|
||||||
Sureland
Industrial
|
33 | % | - | % | ||||
Sureland
Equipment
|
33 | % | - | % | ||||
Beijing
Hua An
|
33 | % | - | % | ||||
Tianxiao
Equipment
|
- | % | 33 | % |
Beginning
from January 1, 2008, the new Enterprise Income Tax (“EIT”) law replaced the
existing income tax laws for Domestic Enterprises (“DES”) and Foreign Invested
Enterprises (“FIEs”).
The key
changes are:
a.
|
The
new standard EIT rate of 25% will replace the 33% rate currently
applicable to both DES and FIEs, except for High Tech companies who pays a
reduced rate of 15%;
|
b.
|
Companies
established before March 16, 2007 will continue to enjoy tax holiday
treatment approved by local government for a grace period of the next 5
years or until the tax holiday term is completed, whichever is
sooner.
|
India Project Office Income
Tax
The
Company’s operation in India is managed on the project basis and projects are
under the name of CFPG or Sureland Industrial as a foreign enterprise. Under the
India Income Tax Act, the Company’s projects are generally subject to an income
tax at an effective rate of 40% on income reported in the statutory financial
statements after appropriate tax adjustments.
See
report of independent registered public accounting firm
F-26
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
The
Company’s subsidiaries were paying the following tax rate for the year ended
December 31, 2008:
Subsidiaries
|
Income tax
exemption
|
Effective
income tax
rate
|
||||||
Sureland
Industrial
|
25.0 | % | - | % | ||||
Sureland
Equipment
|
12.5 | % | 12.5 | % | ||||
Beijing
Hua An
|
25.0 | % | - | % | ||||
Tianxiao
Equipment
|
- | % | 25.0 | % |
The
Company’s subsidiaries were paying the following tax rate for the year
ended December 31, 2009:
Subsidiaries
|
Income tax
exemption
|
Effective
income tax
rate
|
||||||
Sureland
Industrial
|
12.5 | % | 12.5 | % | ||||
Sureland
Equipment
|
12.5 | % | 12.5 | % | ||||
Beijing
Hua An
|
17.5 | % | 7.5 | % | ||||
Tianxiao
Equipment (six months ended June 30, 2009)
|
- | % | 25.0 | % | ||||
Shian
Kexin
|
- | % | 25.0 | % | ||||
India
Project Office
|
- | % | 40.0 | % | ||||
Shanyang
Hongshida
|
- | % | 25.0 | % |
The
provision (credit) for income taxes amounted to $4,165,548, $47,423 and $5,081
for the years ended December 31, 2009, 2008 and 2007, respectively.
The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the years ended December 31:
2009
|
2008
|
2007
|
||||||||||
U.S.
Statutory rates
|
34.0 | % | 34.0 | % | 34.0 | % | ||||||
Foreign
income not recognized in USA
|
(34.0 | ) | (34.0 | ) | (34.0 | ) | ||||||
China
income taxes
|
25.0 | 25.0 | 33.0 | |||||||||
China
income tax exemption
|
(15.5 | ) | (24.8 | ) | (33.0 | ) | ||||||
Other
item (1)
|
5.1 | 0.2 | 0.0 | |||||||||
Total
provision for income taxes
|
14.6 | % | 0.2 | % | 0.0 | % |
(1) The
5.1%, 0.2% and 0.0% represents expenses incurred by CFSG and CFPG that are not
deductible in PRC for the years ended December 31, 2009, 2008 and
2007.
See
report of independent registered public accounting firm
F-27
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
The
estimated tax savings for the years ended December 31, 2009, 2008 and 2007
amounted to $4,412,017, $6,382,286 and $5,441,008, respectively. The net effect
on basic and diluted earnings per share if the income tax had been applied would
decrease basic and diluted earnings per share for the years ended December 31,
2009, 2008 and 2007 by $0.14, $0.23 and $0.20,
respectively.
China
Fire & Security Group, Inc. was incorporated in the United States and has
incurred net operating losses of $0 for income tax purposes for the years ended
December 31, 2009. The estimated net operating loss carry forwards
for United States income taxes amounted to $1,042,671 as of December 31, 2009,
which may be available to reduce future years’ taxable income. These
carry forwards will expire, if not utilize, from 2025 through
2027. Management believes that the realization of the benefits from
these losses appears uncertain due to the Company’s limited operating history
and continuing losses for United States income tax
purposes. Accordingly, the Company has provided a 100% valuation
allowance on the deferred tax asset benefit to reduce the asset to
zero. The net change in the valuation allowance for the period ended
December 31, 2009 was $0 and the accumulated valuation allowance as of December
31, 2009 amounted to $354,508. Management reviews this valuation allowance
periodically and makes adjustments as warranted.
The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $72.0 million as of December 31, 2009, which are included in
consolidated retained earnings and will continue to be indefinitely reinvested
in international operations. Accordingly, no provision has been made for
U.S. deferred taxes related to future repatriation of these earnings, nor is it
practicable to estimate the amount of income taxes that would have to be
provided if the Company concluded that such earnings will be remitted in the
future.
Taxes
payable
Taxes
payable consisted of the following:
|
December 31,
2009
|
December 31,
2008
|
||||||
VAT
taxes payable
|
$ | 4,636,786 | $ | 1,094,089 | ||||
Income
taxes payable
|
2,936,047 | 38,406 | ||||||
Sales
taxes
|
1,358,372 | 936,164 | ||||||
Other
taxes payable
|
71,265 | 24,086 | ||||||
Total
|
$ | 9,002,470 | $ | 2,092,745 |
See
report of independent registered public accounting firm
F-28
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note
11 - Retirement plan
The
Company and its subsidiaries are required to participate in a central pension
scheme operated by the local municipal government. The Company is required to
contribute 20% of its payroll costs to the central pension scheme in 2009, 2008
and 2007. The contributions are charged to the consolidated income statement of
the Company as they become payable in accordance with the rules of the scheme.
The aggregate contributions of the Company to retirement benefit schemes
amounted to $416,857, $250,720 and $158,279 for the years ended
December 31, 2009, 2008 and 2007, respectively.
Note
12 - Statutory reserves
The laws
and regulations of the People’s Republic of China require that before an
enterprise distributes profits to its partners, it must first satisfy all tax
liabilities, provide for losses in previous years, and make allocations, in
proportions determined at the discretion of the board of directors, after the
statutory reserve. The statutory reserves include surplus reserve fund and the
enterprise fund. These statutory reserves represent restricted retained
earnings.
Surplus reserve
fund
The
Company is required to transfer 10% of its net income, as determined in
accordance with the PRC accounting rules and regulations, to a statutory surplus
reserve fund until such reserve balance reaches 50% of the Company’s registered
capital.
The
transfer to this reserve must be made before distribution of any dividend to
shareholders. The surplus reserve fund is non-distributable other than during
liquidation and can be used to fund previous years’ losses, if any, and may be
utilized for business expansion or converted into share capital by issuing new
shares to existing shareholders in proportion to their shareholding or by
increasing the par value of the shares currently held by them, provided that the
remaining reserve balance after such issue is not less than 25% of the
registered capital.
Because the balance of surplus reserve
fund already totals 50% of Sureland Industrial, Sureland
Equipment, and Beijing Hua An’s registered capital, the Company did
not reserve any surplus reserve fund for the year ended December 31, 2009 of
these subsidiaries. As of December 31, 2009, the remaining reserve
from Shian
Kexin and Shenyang Hongshida needed to fulfill the 50% registered
capital requirement totaled $586,800.
Enterprise
fund
The
enterprise fund may be used to acquire plant and equipment or to increase the
working capital to expend on production and operation of the business. No
minimum contribution is required and the Company did not make any contribution
to this fund for the years ended December 31, 2009, 2008 and 2007.
See
report of independent registered public accounting firm
F-29
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Note 13 -
Warrants
On April
26, 2007, the Company amended its Series A and Series B warrants issued to
certain investors on October 27 and December 5, 2006 pursuant to the Securities
Purchase Agreement in connection with a private placement (the “Amendment”). The
Amendment eliminates the right of the warrant holders to be paid in cash in the
event of a merger or other types of reorganization. The warrants no longer need
to be accounted for as derivative instrument liabilities. The fair value
of the warrants were transferred to equity on the signing date and no further
accounting (i.e., no mark-to-market) is required going forward. At April 26,
2007, the Company determined the fair value of the warrants was $1,475,020 using
the Cox-Ross-Rubinstein binomial model with the following assumptions:
volatility 25%; risk free interest rate 4.59%; dividend yield of 0% and expected
term of 4.5 years. On April 26, 2007, the fair value of the warrants was
transferred to additional paid-in capital.
In 2007,
492,340 series A warrants were exercised at $3.58 and 492,340 series B warrants
were exercised at $4.88 for a total of 984,680 shares of common stock. The
Company received a total of $4,165,197 from various warrant
holders.
In 2007,
a total of 179,626 warrants were converted into 110,535 shares of common stock
by the warrants holders using the cashless exercise options.
On
February 1, 2007, CFPG issued 50,000 warrants to Hayden Communication, the
Company’s investor relations consultant, as part of its compensation. These
warrants meet the conditions for equity classification pursuant to SFAS 133 and
EITF 00-19. Therefore, the warrants were classified as equity and accounted as
compensation expenses. The warrants vested on February 1, 2008. The Company used
the Black-Scholes model to value the options at the time they were issued, based
on the exercise price of $4.25 and expiration dates of the instruments, a
risk-free rate of 4.84% and volatility at 50%. These 50,000 warrants had a fair
value of $94,274 on the date of grant and were recognized over the one year
service period.
In 2008,
a total of 45,000 warrants were converted into 29,700 shares of common stock by
the warrants holders using the cashless exercise option.
In June
2009, 10,000 warrants were converted into 6,682 shares of common stock by the
warrants holders using the cashless exercise.
See
report of independent registered public accounting firm
F-30
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
The
Company’s warrant activity is as follows:
Weighted
|
Average
|
|||||||||||
Average
|
Remaining
|
|||||||||||
Warrants
|
Exercise
|
Contractual
|
||||||||||
Outstanding
|
Price
|
Life (years)
|
||||||||||
Outstanding,
December 31, 2006
|
1,169,306 | $ | 4.23 | 4.58 | ||||||||
Granted
|
50,000 | 4.25 | ||||||||||
Forfeited
|
||||||||||||
Exercised
|
(1,164,306 | ) | 4.23 | |||||||||
Outstanding,
December 31, 2007
|
55,000 | $ | 4.19 | 4.08 | ||||||||
Granted
|
4.25 | |||||||||||
Forfeited
|
||||||||||||
Exercised
|
(45,000 | ) | 4.24 | |||||||||
Outstanding,
December 31, 2008
|
10,000 | $ | 4.25 | 2.09 | ||||||||
Granted
|
||||||||||||
Forfeited
|
||||||||||||
Exercised
|
(10,000 | ) | ||||||||||
Outstanding,
December 31, 2009
|
- | $ | - | - |
Note
14 - Options issued to employees
On April
20, 2007, CFPG issued 9,500 options to the Company’s four independent directors
as part of their compensation. The options will vest one year from the issuance
date. The fair value of these options was determined to be $19,428 using the
Black Sholes model with the following assumptions: volatility 45%; risk free
interest rate 4.57%; dividend yield of 0% and expected term of 5 years. Options
were vested immediately at exercise price of $4.51 per share which was the close
price of the Company’s stock on April 19, 2007. Because the services that the
independent directors are to provide started from the second quarter of 2007 and
will last for one year, the related compensation expense is recognized on a
straight-line basis over the total service period.
On July
1, 2007, CFPG issued 20,000 options to the Company’s Principal Accounting
Officer, who joined the Company as on the same day. The options will
vest over four years. The Company used the Black Sholes model to value the
options at the time they were issued, based on the exercise price of $6.70,
which was the close price of the Company’s stock on June 30, 2007 and expiration
dates of the instruments and using a risk-free rate of 4.84% and the volatility
of 40% that was estimated by analyzing the trading history of the Company’s
stock. The 20,000 employee options had a fair value of $57,178. The related
compensation expense is recognized on a straight-line basis over the four year
vesting period.
On
January 30, 2008, the Company’s 2008 Omnibus Long-term Incentive Plan was
adopted and approved by shareholders. Pursuant to the 2008 Omnibus Long-term
Incentive Plan, the Company reserved 2,000,000 shares of our common stock for
issuance.
See
report of independent registered public accounting firm
F-31
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
On
December 31, 2008, pursuant to the Company's 2008 Omnibus Long-term Incentive
Plan, the Company's Board of Directors authorized the issuance of 1,000,000
shares of options for its employee with total 800,000 shares options issued to
executive officers. The options will vest evenly each quarter over the following
four years, starting from the first quarter of 2009. The Company used the Black
Scholes Model to value the options at the time they were issued, based on the
exercise price of $6.81, which was the close price of the Company’s stock on
December 31, 2008 and using the risk-free rate of 0.875%, 1.125%, 1.313% and
1.5% and the volatility of 86% that was estimated by analyzing the trading
history of the Company’s stock. Because the Company do not have historical
history exercise period from its previous issued option, the Company used the
simplified method to calculate the term, which is the midpoint between the start
vesting date and expiration date of the options, as a variable of the model. The
1,000,000 employee options had a fair value of $3,863,606. The related
compensation expense is recognized on a straight-line basis over the four year
vesting period.
In
December 2009, 3,500 options were converted into 2,266 shares of common stock by
the warrants holders using the cashless exercise.
The total
stock option compensation expense recognized for the years ended December 31,
2009, 2008 and 2007 was $980,196, $40,152 and $190,719, respectively. As of
December 31, 2009, approximately $2.93 million of estimated expense with respect
to un-vested stock-based awards has yet to be recognized and will be recognized
in expense over the employee’s remaining service period of
approximately 2.97 years.
The
Company has stock options as follows:
|
Weighted
|
|||||||||||
|
Average
|
Aggregate
|
||||||||||
|
Options
|
Exercise
|
Intrinsic
|
|||||||||
Outstanding
|
Price
|
Value
|
||||||||||
Outstanding,
December 31, 2006
|
750,000 | $ | 1.25 | $ | 2,250,000 | |||||||
Granted
|
29,500 | 5.99 | - | |||||||||
Forfeited
|
||||||||||||
Exercised
|
||||||||||||
Outstanding,
December 31, 2007
|
779,500 | $ | 1.43 | $ | 8,925,615 | |||||||
Granted
|
||||||||||||
Forfeited
|
||||||||||||
Exercised
|
||||||||||||
Outstanding,
December 31, 2008
|
779,500 | $ | 1.43 | $ | 4,194,190 | |||||||
Granted
|
1,000,000 | 6.81 | - | |||||||||
Forfeited
|
||||||||||||
Exercised
|
(3,500 | ) | 4.51 | - | ||||||||
Outstanding,
December 31, 2009
|
1,776,000 | $ | 4.45 | $ | 16,120,860 |
See
report of independent registered public accounting firm
F-32
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Following
is a summary of the status of options outstanding at December 31,
2009:
Outstanding Options
|
Exercisable Options
|
|||||||||||||||||||
|
|
Average
|
|
|
Average
|
|||||||||||||||
|
|
Remaining
|
|
|
Remaining
|
|||||||||||||||
Number of
|
Exercise
|
Contractual
|
Number of
|
Exercise
|
Contractual
|
|||||||||||||||
Options
|
Price
|
Life
|
Options
|
Price
|
Life
|
|||||||||||||||
750,000
|
$ | 1.25 | 6.50 | 750,000 | $ | 1.25 | 6.50 | |||||||||||||
6,000
|
$ | 4.51 | 2.33 | 6,000 | $ | 4.51 | 2.33 | |||||||||||||
20,000
|
$ | 6.70 | 2.50 | 12,500 | $ | 6.70 | 2.50 | |||||||||||||
1,000,000
|
$ | 6.81 | 4.00 | 250,000 | $ | 6.81 | 4.00 |
Note
15 - Restricted stocks issued to employees
On
December 1, 2009, pursuant to the Company's 2008 Omnibus Long-term Incentive
Plan, the Company's Board of Directors authorized the issuance of 1,000,000
shares of restricted stocks for its employee with total 285,000 shares of
restricted stocks issued to executive officers. The restricted stocks will vest
evenly each year over the following four years, starting from the December 1,
2009. The Company used closing price of the Company’s stock at the time they
were issued, based on the close price of $12.65, which was the close price of
the Company’s stock on November 30, 2009. The 1,000,000 employee restricted
stocks had a fair value of $12,650,000. The related compensation expense is
recognized on a straight-line basis over the vesting periods.
The total
restricted stock compensation expense recognized for the years ended December
31, 2009, 2008 and 2007 was $263,542, $0, and $0 respectively.
Note
16 - Commitments and contingencies
Contingencies
In 2009,
the Company filed four lawsuits against four different companies for the
infringement of the Company’s intellectual properties in linear heat detectors
and these four cases are still pending. The Company expects these four pending
cases filed in 2009 will be settled in the Company’s favor. In 2009, the Company
was counter-sued by one of the companies we filed suit against in two
cases for the invalidation of the Company’s intellectual properties in linear
heat detectors. As of March 10, 2010, these two cases are still
pending. The Company expects these two pending cases will be settled
in the Company’s favor.
See
report of independent registered public accounting firm
F-33
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
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 effect on our business or results of operations.
Note
17 – Restructuring of subsidiaries
On April
2, 2007, the Company evaluated the operations of its subsidiary, Beijing Zhong
Xiao Fire Safety Technology Co., Ltd. (“Beijing Zhong Xiao”) and noted
efficiencies could be obtained by consolidating the operations of Beijing Zhong
Xiao into Sureland Equipment.
Beijing
Zhong Xiao was a subsidiary of Sureland Industrial established in the PRC as a
limited liability company on March 18, 2003. On April 3, 2007, Sureland
Industrial signed an agreement to transfer 100% ownership in Beijing Zhong Xiao
to Gong Gang Qiang, a Chinese individual, for consideration price equal to the
net assets of Beijing Zhong Xiao as of March 31, 2007.
After the
restructuring of Beijing Zhong Xiao, the Company still has a significant
continuing involvement in the historical operations of the manufacturing of fire
safety and protection products through Sureland Equipment, which results in the
Company failing the test in ASC 205-20-45 The failure of this test therefore
does not require the classification of the disposal of Beijing Zhong Xiao as a
discontinued operation.
Note
18 – Subsequent events
Investment of 5% interest in
Sureland Fire & Security India Private Ltd (“Sureland
India”)
Sureland
India was incorporated in New Delhi of India with registered capital amounted to
$51,398 (INR2,500,000). Sureland India engages in project design, consulting and
construction service for the fire protection industry in India. In January,
2010, Sureland India received the approval from authorities of India government
to accept foreign investment of 5% equity from China Fire Protection Group, Inc.
China Fire Protection Group, Inc. has completed the payment of $2,710
(INR125,000) by the end of January, 2010. After the transaction, China Fire
Protection Group, Inc. became a minority interest holder of Sureland Indian and
the investment was recorded under the cost accounting method. The Company made
an advance payment to Sureland Fire & Security India Private Ltd. in amount
of $103,174 as of December 31, 2009 for prepayment of service and product
delivery.
See
report of independent registered public accounting firm
F-34
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2009
Acquisition of 100% interest
in Zeetech System Private Ltd (“Zeetech”)
Zeetech
was incorporated in New Delhi of India with registered capital amounted to
$2,215 (INR101,000). On February 4, 2010, China Fire Protection Group, Inc.
signed an agreement to acquire 100.0% ownership in Zeetech from the existing
shareholders for the consideration price of $2,215 (INR101,000) approximately
equal to the net assets of Zeetech as of January 12, 2010, which was
approximately $1,938 (INR88,387). After the closing of the acquisition, Zeetech
is 100% owned by China Fire Protection Group, Inc. Currently, there is no
business operation under the name of Zeetech.
The
Company has performed an evaluation of subsequent events through the date of
these consolidated financial statements were issued to determine whether the
circumstances warranted recognition and disclosure of those events or
transactions in the consolidated financial statements as of December 31,
2009.
Note 19 – Quarterly financial
information (unaudited)
For the
fiscal year ended December 31, 2009, the Company has unaudited quarterly
financial data information as following:
Year 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
profit
|
10,296,759 | 14,500,571 | 13,999,311 | 8,256,635 | 47,053,276 | |||||||||||||||
Net
income
|
5,645,603 | 8,336,222 | 7,553,941 | 2,879,070 | 24,414,836 | |||||||||||||||
Basic
EPS
|
0.20 | 0.30 | 0.27 | 0.11 | 0.88 | |||||||||||||||
Diluted
EPS
|
0.20 | 0.29 | 0.27 | 0.10 | 0.86 |
See
report of independent registered public accounting firm
F-35
EXHIBIT
INDEX
Exhibit
Number
|
||
2.1*
|
|
Securities
Exchange Agreement, dated as of September 1, 2006, by and among the
Company, China Fire Protection Group and Sureland, its
subsidiary
|
3.1**
|
|
Restated
Articles of Incorporation, filed with the state of Florida on October 18,
2006.
|
3.2**
|
|
Articles
of Amendment to Articles of Incorporation & Designating Series A
Convertible present Stock.
|
3.3
|
|
By-Laws
- Incorporated by reference to Exhibit 3.1 to Form 8-K filed on September
4, 2008.
|
4.1**
|
|
Registaration
Rights Agreement dated October 27, 2006 between the Company and named
Investors
|
4.2**
|
|
Registaration
Rights Agreement dated October 27, 2006 between the Company and named
Shareholders
|
4.3**
|
|
Form
of Series A Warrant to Purchase Shares of Common
Stock of the Company.
|
4.4**
|
|
Form
of Series B Warrant to Purchase Shares of Common
Stock of the Company
|
4.5**
|
|
Escrow
Agreement dated October 27, 2006 by and among the Company UNIPRO, H.
C. Wainwright & Co., Inc., the Investor Representative, Gangjin Li,
and Brian Li, and American Stock Transfer & Trust
Company
|
4.6**
|
|
Form
of H. C. Wainwright & Co., Warrant
|
4.7
|
2008
Omnibus Long Term Incentive Plan (Incorporated by reference from Exhibit
4.1 of Form S-8 filed on December 2, 2009)
|
|
4.8
|
Form
Stock Option Agreement (Incorporated by reference from Exhibit 4.2 of Form
S-8 filed on December 2, 2009)
|
|
10.1**
|
|
Construction
Contract between Anshan Iron & Steel Group Corp. and Sureland
Industrial Fire Safety Co., Ltd. Dated October, 2006
|
10.2**
|
|
Contract
between Maanshan Iron & Steel Co., Ltd and. and Sureland Industrial
Fire Safety Co., Ltd.
|
10.3**
|
|
Contract
between Wuhan Iron & Steel (Group) Corp. and Sureland Industrial Fire
Safety Co., Ltd.
|
10.4**
|
|
Purchase
Contract between Beijing Zhongshiweiye Technologies Co. Ltd.. and Sureland
Industrial Fire Safety Co., Ltd. Dated June 13, 2005
|
10.5**
|
|
Contract
between Hangzhou New Epoch Fire Protection Science & Technology Co.,
Ltd and Sureland Industrial Fire Safety Co., Ltd. Dated December 5,
2005
|
10.6**
|
|
Contract
between Guangzhou Jinshengyang Technologies Co. Ltd. and Sureland
Industrial Fire Safety Co., Ltd. Dated May 20, 2005
|
10.7**
|
|
Purchase
and Sales Contract between Beijing Xinfangsheng Hardware Electric Products
Co. Ltd. and Sureland Industrial Fire Safety Co., Ltd. Dated October,
2005
|
10.8**
|
|
Purchase
and Sales Contract between Sichuan Firefighting Machinery General Factory
and Sureland Industrial Fire Safety Co., Ltd. Dated July 19,
2005
|
10.9**
|
|
Purchase
and Sales Contract between Beijing Tianningyihe Pipeline System Equipments
Co. Ltd. and Sureland Industrial Fire Safety Co., Ltd. Dated July 19,
2005
|
-51-
Exhibit
Number
|
|
|
10.10**
|
|
Acceptance
for Carriage Service Contract between Zhaijisong Express Co., LTD and
Sureland Industrial Fire Safety Co., Ltd.
|
10.11**
|
|
Cooperation
Contract between Lianxin International Trade (Shanghai Waigaoqiao Free
Trade Zone) Co., Ltd. and Sureland Industrial Fire Safety Co.,
Ltd.
|
10.12**
|
|
Marketing
Memorandum between Xi’an Systemsensor Electronic Co., Ltd and Sureland
Industrial Fire Safety Co., Ltd.
|
10.13**
|
|
OEM
Cooperation Agreement between Xi’an System Sensor Electronics, Ltd. and
Sureland Industrial Fire Safety Co., Ltd. Dated May 26,
2004
|
10.14**
|
|
House
Lease Contract between Beijing Bestpower Electrical Technology Ltd. and
Sureland Industrial Fire Safety Co., Ltd. Dated December 1,
2004
|
10.15**
|
|
Stock
Ownership Assignment Agreement
|
10.16****
|
Employment
Agreement between the Company and Mr. Brian Lin
|
|
10.17****
|
Employment
Agreement between the Company and Mr. Xiaoyuan Yuan
|
|
14.1***
|
|
Officers’
and Directors’ Code of Ethics
|
16.1
|
Letter
of Moore Stephens Wurth Frazer and Torbet, LLP dated January 7, 2010.
(Incorporated by reference from Exhibit 16.1 of Form 8-K filed January 7,
2010.)
|
|
21.1
|
List
of Subsidiaries
|
|
23.1
|
Consent
of Frazer Frost, LLP (Successor Entity of Moore Stephens Wurth Frazer and
Torbet, LLP)
|
|
31.1
|
Certification
of Principal Executive Officer under Section 302 of the Sarbanes-Oxley Act
of 2002.
|
|
31.2
|
Certification
of Principal Financial Officer under Section 302 of the Sarbanes-Oxley Act
of 2002.
|
|
32.1
|
Certifications
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
Section 1350
|
*
|
Incorporated by reference from
8-K filed September 5, 2006 where it was filed as Exhibit
99.1
|
**
|
Incorporation by reference from
8-K filed November 2, 2006 where the exhibits were the same
number
|
***
|
Incorporated by reference from
Form 10-QSB, filed with the Commission on May 24,2004 where it was filed
as Exhibit 10.4
|
-52-