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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, 2011

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

For the transition period from ____________to _____________

Commission File No. 001-34076

CHINA INFORMATION TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)

Nevada
98-0575209
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 

21st Floor, Everbright Bank Building
Zhuzilin, Futian District
Shenzhen, Guangdong, 518040
People’s Republic of China
(Address of principal executive offices)

(+86) 755-8370-8333
(Registrant’s telephone number, including area code)

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

Title of each class Name of each exchange on which registered
Common Stock, par value $0.01 per share The NASDAQ Stock Market LLC
  (NASDAQ Global Select Market)

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes [  ]             No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes [  ]             No [X]

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]             No [  ]


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 [X]             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 registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes [  ]             No [X]

As of June 30, 2011 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of the shares of the registrant’s common stock held by non-affiliates (based upon the closing sale price of such shares as reported on the NASDAQ Global Select Market) was approximately $67.3 million. Shares of the registrant’s common stock held by each executive officer, director and person who owns 10% or more of the outstanding common stock have been excluded from the calculation in that such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

There were a total of 55,182,924 shares of the registrant’s common stock outstanding as of February 29, 2012.

DOCUMENTS INCORPORATED BY REFERENCE

None.


Annual Report on Form 10-K

TABLE OF CONTENTS

PART I
     
Item 1. Business. 2
Item 1A. Risk Factors. 17
Item 1B. Unresolved Staff Comments. 32
Item 2. Properties. 32
Item 3. Legal Proceedings. 33
Item 4. Mine Safety Disclosures. 33
     
PART II
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 33
Item 6. Selected Financial Data 34
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 35
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 49
Item 8. Financial Statements and Supplementary Data. 50
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 50
Item 9A. Controls and Procedures. 50
Item 9B. Other Information. 51
     
 PART III 
     
Item 10. Directors, Executive Officers and Corporate Governance. 52
Item 11. Executive Compensation. 58
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. 63
Item 13. Certain Relationships and Related Transactions, and Director Independence. 63
Item 14. Principal Accounting Fees and Services 68
     
 PART IV 
     
Item 15. Exhibits, Financial Statement Schedules. 69


Special Note Regarding Forward Looking Statements

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believe,” “expect,” “anticipate,” “project,” “target,” “plan,” “optimistic,” “intend,” “aim,” “will” or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; and any statements regarding future economic conditions or performance, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements. Potential risks and uncertainties include, among other things, the possibility that third parties hold proprietary rights that preclude us from marketing our products, the emergence of additional competing technologies, changes in domestic and foreign laws, regulations and taxes, changes in economic conditions, uncertainties related to China’s legal system and economic, political and social events in China, a general economic downturn, a downturn in the securities markets, and other risks and uncertainties.

Additional disclosures regarding factors that could cause our results and performance to differ from results or anticipated performance are discussed in Item 1A, “Risk Factors” included herein. All statements other than statements of historical fact are statements that could be deemed forward-looking statements. We assume no obligation and do not intend to update these forward-looking statements, except as required by law.

Use of Terms

Except as otherwise indicated by the context and for the purposes of this report only, references in this report to:

  • “CNIT,” “we,” “us,” or “our” and the “Company” are to the combined business of China Information Technology, Inc. and its consolidated subsidiaries, Bocom, CITH, HPC, Huipu, ISS, ISSI, ISIID, IST, and iASPEC, to whose operations we succeeded on October 9, 2006 and which became our variable interest entity effective July 1, 2007, and its 52.54% majority-owned subsidiary, Geo and 81.65% majority-owned subsidiary, Zhongtian;
  • “Bocom” are to Shenzhen Bocom Multimedia Display Technology Co., Ltd., a PRC company;
  • “CITH” are to China Information Technology Holdings Limited, a British Virgin Islands company;
  • “Geo,” are to Wuda Geoinformatics Co., Ltd., a PRC company;
  • “HPC” are to HPC Electronics (China) Company Limited (formerly Topwell Treasure Ltd.), a Hong Kong company;
  • “Huipu” are to Huipu Electronics (Shenzhen) Co., Ltd., a PRC company;
  • “iASPEC” are to iASPEC Software Co., Ltd., a PRC company;
  • “ISSI” are to Information Security Software Investment Limited, a Hong Kong company;
  • “IST” are to Information Security Technology (China) Co., Ltd., a PRC company;
  • “ISIID” are to Information Security International Investment and Development Limited, a Hong Kong company;
  • “ISS” are to Information Security Software (China) Co., Ltd., a PRC company;
  • “Zhongtian,” are to Shenzhen Zhongtian Technology Development Company Ltd., a PRC company;
  • “Hong Kong” are to the Hong Kong Special Administrative Region of the People’s Republic of China;
  • “PRC” and “China” are to the People’s Republic of China;
  • “SEC” are to the Securities and Exchange Commission;
  • “Exchange Act” are to the Securities Exchange Act of 1934, as amended;
  • “Securities Act” are to the Securities Act of 1933, as amended;
  • “Renminbi” and “RMB” are to the legal currency of China; and
  • “U.S. dollars,” “dollars” and “$” are to the legal currency of the United States.

1


We completed a reverse stock split on March 1, 2012, pursuant to which every two shares of our common stock were combined into one share of common stock. Except for the number of shares outstanding stated on the cover page of this report, all references in this report to share and per share data have been adjusted, including historical data which have been retroactively adjusted, to give effect to the reverse stock split unless specified otherwise.

PART I

ITEM 1. BUSINESS.

Overview of Our Business

We are a leading provider of information and display technologies in the PRC. We provide a broad portfolio of software, hardware and fully integrated solutions to customers in a variety of technology sectors including Geographic Information Systems, or GIS, Digital Public Security Technologies, or DPST, Digital Hospital Information Systems, or DHIS, education, media, and consumer products.

We were founded in 1993 and are headquartered in Shenzhen, China. As of December 31, 2011, we had approximately 1,540 employees and 23 sales offices nationwide.

Our customers are mostly public sector entities that use our products and services to improve the service quality and management level and efficiency of public security, traffic control, fire control, medical rescue, border control, and surveying and mapping. Our typical customers include some of the most important governmental departments in China, including the Ministry of Public Security, the public security, fire fighting, traffic and police departments of several provinces, the Shenzhen General Station of Exit and Entry Frontier Inspection, and several provincial personnel, urban planning, civil administration, land resource, and mapping and surveying bureaus. Over the past several years, we have diversified our customer base beyond our local reach. In the future, we expect to continually expand our market and product offerings in the public and other sectors, through geographic expansion and enhancement of our technical capabilities.

We generate revenues through the sale of our software and hardware products, through our fully integrated total solutions, and through the provision of related support services. A significant portion of our operations are conducted through iASPEC , our variable interest entity. iASPEC is a PRC domestic company owned by Mr. Jiang Huai Lin, our Chairman and Chief Executive Officer, who is a PRC citizen and resident. iASPEC is able to obtain governmental licenses that are restricted to PRC entities that have no foreign ownership. These licenses allow iASPEC to perform Police-use Geographic Information Systems, or PGIS, services for PRC governmental customers. Under our Amended and Restated Management Services Agreement among our subsidiary, IST, iASPEC and Mr. Lin, or the MSA, IST is entitled to receive 95% of the net received profit of iASPEC during the term of the agreement, less costs and expenses related to sales and operations, and accrued but uncollected accounts receivable. In fiscal years 2011, 2010 and 2009, 47.1%, 39.1% and 48.6% of our revenues, respectively, were generated under this exclusive commercial arrangement with iASPEC.

We report financial and operating information in the following two segments:

(1)

Information Technology, or IT, segment: IT includes revenues from products and services surrounding our variety of software core competencies, currently primarily in GIS, DPST and DHIS. IT segment revenues are generated from the sales of software and system integration services, as well as hardware other than display products.

   
(2)

Digital Technology, or DT, segment: DT includes revenues from products and services surrounding our display technology core competencies, currently primarily in GIS, DPST, education, media, and consumer products. DT segment revenues are generated from sales of hardware and total solutions of hardware integrated with proprietary software and content, as well as services.

Our History and Background

We were originally organized under the laws of the State of Florida on September 19, 1979 under the name Mark Thomas Publishing Inc. and on April 29, 2003 we changed our name to Irish Mag, Inc. From our inception through October 8, 2006, we provided consulting services in the offset printing industry, targeting individual retail consumers as well as small to mid-size companies. However, as a result of the reverse merger transaction described below, our business operations changed to the provision of integrated GIS services. On January 26, 2007, we changed our name to China Public Security Technology, Inc. to more accurately reflect our new business and commercial objectives.

2


On April 7, 2008, we reincorporated to the State of Nevada by merging into China Information Security Technology, Inc., a subsidiary that we established in Nevada to effect the reincorporation. As a result, our name changed to China Information Security Technology, Inc. and we became a Nevada corporation.

On August 26, 2010, we changed our name to China Information Technology, Inc.

Share information included in this section does not give retroactive effect to our one-for-two reverse stock split effected on March 1, 2012.

Reverse Merger Transaction

Between October 6, 2006 and January 31, 2007, our shareholders approved a series of transactions whereby we purchased all the issued and outstanding stock of CITH from our current Chairman and Chief Executive Officer Jiang Huai Lin, for 25,500,000 shares of our common stock. As a result of these transactions, CITH and its wholly-owned subsidiary, IST, became our wholly-owned subsidiaries, and Mr. Lin became the beneficial owner of 25,500,000 shares of our common stock, which, at January 31, 2007, constituted 80.8% of our issued and outstanding common stock.

Management Services Agreement (MSA)

From October 9, 2006 through June 30, 2007, we operated under a Business Turnkey Agreement, or Turnkey Agreement, with iASPEC, pursuant to which iASPEC exclusively engaged IST as its subcontractor to provide iASPEC with outsourcing services (to the extent that those services do not violate any special governmental permits held by iASPEC and do not involve the improper transfer of any sensitive confidential governmental or other data).

Effective July 1, 2007, iASPEC and iASPEC’s shareholders, Mr. Lin and Mr. Jin Zhu Cai agreed to terminate the Turnkey Agreement and replaced it on the same day with a Management Service Agreement. Pursuant to the terms of the Management Service Agreement, iASPEC granted IST an exclusive, royalty-free, transferable, worldwide, license to use and install for a ten-year term, certain iASPEC software, along with copies of source and object code relating to such software, in any manner permitted by applicable laws, and IST licensed back to iASPEC a royalty-free, limited, non-exclusive license to the software, without right of sub-license, for the sole purpose of permitting iASPEC to carry out its business as presently conducted. IST will also have the right to designate two Chinese citizens to serve as senior managers of iASPEC, to serve on iASPEC’s Board of Directors and assist in managing the business and operations of iASPEC. In addition, both iASPEC and IST will require the affirmative vote of the majority of our Board of Directors, as well as at least one non-insider director, for certain material actions with respect to iASPEC, including, but not limited to: (a) the nomination, appointment, election or replacement of any board members; (b) the distribution of any dividend or profits; (c) any merger, division, change of corporate form, dissolution or liquidation; (d) any reimbursement of net losses or other payments or transfers of funds from IST to iASPEC; (e) the formation or disposition of a subsidiary or the acquisition or disposition of any interest in any other entity; and (f) the encumbrance of any assets under any lien not in the ordinary course of business. Furthermore, under the Management Service Agreement, IST will receive 100% of the net received profit of iASPEC and will reimburse iASPEC for all net losses incurred by iASPEC. The net profit of iASPEC will be paid to IST, and the net losses of iASPEC will be reimbursed by IST, no later than the last day of the month following the end of each calendar quarter, commencing on July 1, 2007. IST is also obligated to pay iASPEC $180,000 per year, no later than the last day of the month following the end of each calendar year, commencing on July 1, 2007, and this amount may be retained by iASPEC out of any net received profit due and payable to IST as of such payment date. IST may also advance to iASPEC, at IST’s sole discretion, amounts to be credited against IST’s future obligations to iASPEC, but any such advances will be treated as prepayments and not as loans. iASPEC will have no obligation to repay any such advances except by crediting the amount of such advances against IST’s obligation to reimburse net losses, or by adding the amount thereof to net profit when and as requested by IST. If iASPEC or any of the iASPEC shareholders materially breaches the Management Service Agreement and fails to remedy the breach within 60 days after notice from IST of such breach, they will be jointly and severally obligated to pay to IST liquidated damages in an amount equal to the higher of (a) eight times the annualized revenues of IST for the last completed fiscal quarter, or (b) US$50 million.

3


In connection with the Management Service Agreement, IST also entered into a purchase option agreement, or Option Agreement, with iASPEC and its shareholders, effective as of July 1, 2007, pursuant to which the iASPEC shareholders granted IST, or its designee(s), an exclusive, irrevocable option to purchase from the iASPEC shareholders, from time to time, all or a part of iASPEC’s shares, pursuant to an equity transfer agreement, or all or a part of iASPEC’s assets, pursuant to an asset purchase and transfer agreement. However, according to the Option Agreement, the option may not be exercised by IST if the exercise would violate any applicable laws and regulations in China or cause any license or permit held by, and necessary for the operation of iASPEC, to be cancelled or invalidated. Under the terms of the Option Agreement, the option is immediately exercisable at an exercise price of $1,800,000, in the aggregate, subject to regulatory approval. In addition, iASPEC and the iASPEC shareholders agreed to use their best efforts to acquire all necessary government approvals and other consents to complete a share purchase under the Option Agreement. The Option Agreement may be rescinded by IST upon 30 days’ notice and will terminate on the date that we purchase all remaining shares or assets of iASPEC pursuant to the terms of the Option Agreement. If any of the parties breaches the Option Agreement and fails to remedy the breach, the breaching party will pay a penalty of RMB5,000,000 (approximately $683,600) to the non-breaching party or parties, and compensate the non-breaching party or parties for any losses caused by the breach.

As a result of the restructuring of its relationship with iASPEC, iASPEC became a variable interest entity of our Company. A variable interest represents a contractual or ownership interest in another entity that causes the holder to absorb the changes in fair value of the other entity’s net assets. Potential variable interests include: holding economic interests, voting rights, or obligations to an entity; issuing guarantees on behalf of an entity; transferring assets to an entity; managing the assets of an entity; leasing assets from an entity; and providing financing to an entity. In such cases consolidation of the variable interest entity is required by the enterprise that controls the economic risks and rewards of the entity, regardless of ownership. While we have held an economic interest in iASPEC since October 9, 2006, the Management Service Agreement and the Option Agreement have now given us control over the business and operations of iASPEC. As a result, iASPEC’s financial data is subject to consolidation with our financial data, commencing July 1, 2007.

On July 1, 2008, our Chairman and Chief Executive Officer, Mr. Jiang Huai Lin, entered into an Equity Transfer Agreement with Mr. Jin Zhu Cai, the owner of a 24% minority interest in iASPEC, pursuant to which Mr. Lin purchased Mr. Cai’s minority interest for a total consideration of RMB60 million (approximately $8.72 million). As a result of the Equity Transfer Agreement, Mr. Lin holds 100% of the equity interests of iASPEC.

On December 13, 2009, IST, iASPEC and Mr. Lin, as the sole shareholder of iASPEC, amended and restated the Management Service Agreement, pursuant to which IST will continue to provide management and consulting services to iASPEC, subject to the following changes:

  • iASPEC agreed that IST will be entitled to receive ninety five percent (95%) of the net received profit of iASPEC during the term of the agreement, to be calculated as follows: accrued accounts receivable plus net turnover (revenue), minus cost of sales, minus operating expenses, and minus accrued but not collected accounts receivable, but only if the result is a positive number. iASPEC is obligated to calculate and pay the net received profit due to IST no later than the last day of the first month following the end of each fiscal quarter;

  • Mr. Lin agreed to enter into a pledge agreement with IST to pledge all his equity interests in iASPEC as security for his and iASPEC’s fulfillment of their respective obligations under the Management Service Agreement, and to register the pledge agreement with the local Administration for Industry and Commerce;

  • Mr. Lin confirmed his status as the sole shareholder of iASPEC and his assumption of all the obligations of the iASPEC shareholder under the agreement, including a confirmation of his continuing obligation under a written guaranty, dated August 1, 2007, executed by the iASPEC shareholders in connection with the Management Service Agreement;

  • Based on iASPEC’s needs for its development and operation, IST has the right, from time to time, at its sole discretion, to provide iASPEC with capital support either as an entrustment of funds to iASPEC, or as an advance to Mr. Lin, as iASPEC’s shareholder, for the sole purpose of making a capital contribution to iASPEC for use in the business of iASPEC; provided that, any such advance for capital contribution will be evidenced by an “advance agreement” in the form attached to the Amended and Restated Management Services Agreement; and

  • IST agreed that it will not interfere in any business of iASPEC covered by iASPEC’s State Secret related Computer Information System Integration Certificate, including but not limited to, seeking access to relevantn documents regarding such business; provided, however, that iASPEC agreed that it will cooperate with the requests of the Company as necessary to comply with the Company’s reporting obligations to the SEC.

4


In addition, during the term of the amended MSA, certain material actions with respect to iASPEC will require the affirmative vote of the majority of the Board of Directors of the Company, including the affirmative vote of at least one member of which who is not employed by IST, iASPEC, or any affiliate of either of them. Such material actions include: (a) the nomination, appointment, election or replacement of any members of any Board of Directors of iASPEC (who must be a citizen of the PRC); (b) the approval of any profit distribution plan and loss compensation plan; (c) any merger, division, change of corporate form, dissolution or liquidation of iASPEC; (d) any loan or advance or other payments or transfers of funds from IST to iASPEC; (e) any declaration of any dividend or any distribution of profits by iASPEC; (f) the formation or disposition of any subsidiary by iASPEC, or the acquisition or disposition of any equity interest or other interest in any other entity by iASPEC; (g) any corporate borrowing or lending by iASPEC except for routine extension of terms to trade creditors; (h) the encumbrance of any of the assets of iASPEC under any lien, except in the ordinary course of business; (i) any change in the methods of accounting or accounting practices of iASPEC; (j) any change in the scope of business of iASPEC, or any decision to engage in any type of business other than those engaged in by iASPEC as of the date of the agreement or (k) any agreement to do any of the foregoing.

Acquisitions

On November 7, 2007, we acquired 100% of the equity interests of ISSI, and its PRC operating subsidiary, ISS, for which we paid approximately $7.1 million in cash and issued 883,333 shares of our common stock.

On February 1, 2008, we acquired 100% of the equity interests of ISIID, and its PRC operating subsidiary, Bocom, for a purchase price of approximately $18,000,000. We paid approximately $9,000,000 of the purchase price in cash and the remaining $9,000,000 was paid in 1,125,000 shares of our common stock.

On April 7, 2008, iASPEC acquired Geo, pursuant to (1) a share purchase and increased capital agreement, dated as of February 16, 2008, by and among iASPEC, Wuhan Wuda Venture Capital Co., Ltd., Song Ai Hong and Geo, for the purchase of 46% of Geo for a purchase price of approximately $4,819,000, and (2) a share purchase agreement, dated as of February 16, 2008, between iASPEC and Li Wei, for the purchase of 2.4% of Geo for a purchase price of approximately $666,700. On September 3, 2010, Geo increased its registered capital from RMB 60,000,000 (approximately $8,849,680) to RMB 79,200,000 (approximately $11,681,588). The RMB 19,200,000 (approximately $2,831,900) increase was contributed by iASPEC and a group of new shareholders, consisting of the management teams of both GEO and iASPEC, including Mr. Jiang Huai Lin, the Company’s chief executive officer. As a result of the capital increase, the equity interest owned by iASPEC in Geo was reduced from 57% to 52.54%, and the management teams of Geo and iASPEC now hold 11.02% of the equity interest in Geo.

On October 31, 2008, we completed the acquisition of Kwong Tai International Technology Limited, a Hong Kong company, or Kwong Tai, and its PRC operating subsidiary, Zhongtian, from Wide Peace International Investments Limited, or Wide Peace, for a purchase price of $16,500,000. We paid $9,900,000 (approximately RMB 67,617,000) in cash and the remaining $6,600,000 was paid in 1,280,807 shares of our common stock.

Wide Peace was obligated to return 355,164 of the purchased shares to us if Zhongtian did not attain an audited minimum after tax net income, or ATNI, of $2,200,000 for fiscal year 2009, and an additional 355,164 of the shares if Zhongtian did not attain an audited minimum ATNI of $2,860,000 for fiscal year 2010. The 2009 and 2010 targets were met by Zhongtian. On May 5, 2011, Kwong Tai and iASPEC entered into an equity transfer agreement, pursuant to which Kwong Tai agreed to transfer 100% of its equity interest in Zhongtian to iASPEC for a purchase price of RMB 20,240,650 (approximately $3,113,946). On December 29, 2011, Zhongtian’s registered capital was increased by RMB 7,470,000 (approximately $1,175,778) from RMB 33,240,650 (approximately $5,232,078) to RMB 40,710,650 (approximately $6,407,856). This contribution was made by members of the management of Zhongtian, including Mr. Jiang Huai Lin, the Company’s chief executive officer. As a result of the capital increase, the equity interest owned by iASPEC in Zhongtian was reduced from 100% to 81.65%, and members of the management of Zhongtian now hold 18.35% of the equity interest in Zhongtian.

5


On October 1, 2009, we completed the acquisition of HPC and its PRC operating subsidiary, Huipu, from Ms. Rita Kwai Fong Leung for a purchase price of $16,000,000. We paid $8,000,000 (approximately RMB54,640,000) of the purchase price in cash and the remaining $4,000,000 in 1,101,930 shares of our common stock. We were also obligated to issue and deliver to Ms. Leung up to an additional 1,101,930 shares of our common stock in accordance with certain make good provisions agreed to between the parties if HCP attained certain audited consolidated ATNI thresholds for fiscal years 2010 through 2012. On August 26, 2011, the parties entered into an amendment to the purchase agreement, pursuant to which we waived the requirement for HPC to attain the ATNI thresholds for fiscal years 2011 and 2012 and we agreed to issue 688,707 shares of our common stock to Ms. Leung in consideration of termination of employment of Ms. Leung and certain other members of HPC’s management with immediate effect and a release of all claims Ms. Leung and the related members of HPC’s management have or may have against us. The parties agreed that the termination of the relationship will put us in a better position to execute our management strategies related to HPC.

Corporate Structure

The following chart reflects our current corporate organizational structure:

Industry Overview

General

Over the past two decades, the PRC government has encouraged the development and use of new technologies for information and communication, or ICTs, and their application in all spheres of government, industry, education and culture. The term “Informatization” or “xinxihua” has been coined in China to describe the overall process of ICT application in China and has in recent years become a linchpin of central and many local economic development strategies.

6


As a part of the Informatization process, the PRC government has launched a series of online programs to accelerate its pace of implementing and using information technology. For example, the Golden Shield Program promotes the use of information technology for public security services. The Public GIS platform aims to integrate the functions of multiple government departments by using the GIS technology. The Golden Health Program strives to improve the efficiency of public health management by using digital hospital technologies. All these initiatives are of top priority to the Chinese government and are driving the demand for our product offerings.

Global GIS Industry

The GIS field is a rapidly growing field that identifies data according to location. GIS incorporates geographical features with data in order to assess real world problems. In the strictest sense, a GIS is a computer system capable of capturing, storing, analyzing, and displaying geographically referenced information. The term GIS also includes the procedures, operating personnel, and spatial data that go into the system.

The power of a GIS comes from the ability to relate different information in a spatial context and reach a conclusion about this relationship. Most of the information we have about our world contains a location reference, placing that information at some point on the globe. However, GIS can be used to emphasize objects on a map, their absolute location on the Earth’s surface and their spatial relationships, in a series of attribute tables—the “information” part of a GIS. For example, while a computer-aided mapping system may represent a road simply as a line, a GIS may also recognize that road as the boundary between wetland and urban development between two census statistical areas. A GIS, therefore, can reveal important new information (such as whether features intersect or whether they are adjacent) that leads to better decision making or solutions.

Data Capture and Integration – In order to utilize a GIS, data must be directly entered into (or captured by) a GIS in digital form, that is, in a form the computer can recognize. A GIS can also convert existing digital information, which may not yet be in map form, into forms it can recognize and use. Map data may also be created by (1) digitizing maps by hand-tracing with a computer mouse on the screen or on a digitizing tablet to collect the coordinates of features, (2) using electronic scanners to convert maps to digits, or (3) uploading coordinates from Global Positioning System, or GPS, receivers into a GIS. Once a time-consuming process, the data capture process is now made easier by the development in the GIS industry of software tools to automatically extract features from satellite images or aerial photographs and create databases in map form for use in a GIS.

Information Retrieval and Data Output – With a GIS you can “point” at a location, object, or area on the screen and retrieve recorded information about it from off-screen files. For example, using scanned aerial photographs as a visual guide, you can ask a GIS about the location of a fire, analyze the area around the fire and determine conditions of adjacency (what is next to it), containment (what is enclosed by it) and proximity (how close is something to it).

Another critical component of a GIS is its ability to produce graphics on the screen or on paper to convey the results of analyses to the people who make decisions about resources. Wall maps, Internet-ready maps, interactive maps and other graphics can be generated, allowing decision makers to visualize and thereby understand the results of analyses or simulations of potential events.

Components of GIS

Hardware – Hardware comprises the equipment needed to support the many activities ranging from data collection to data analysis. A central piece of the equipment is a workstation, which runs the GIS software and is the attachment point for the equipment. Data collection efforts can also require the use of a digitizer for conversion of hard copy data to digital data and a GPS data logger to collect the field. The use of handheld field technology is also becoming an important tool in GIS. With the advent of web-enabled GIS, web servers have become an important piece of equipment for GIS.

Software – Different software packages are important for GIS. Central to this is the GIS application package. Such software is essential for creating, editing and adding spatial and attributed data, therefore these packages contain a myriad of functions inherent to them. Extensions or add-ons are software that extends capabilities of the GIS software package. Component GIS software is the opposite of application software. Component GIS seeks to build software applications that meet a specific purpose and thus are limited in their spatial analysis capabilities. Utilities are stand-alone programs that perform a specific function. For example, a file format utility that converts from one type of GIS file to another. There is also web-GIS software that helps serve data through Internet browsers.

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Data – Data is the core of any GIS. There are two primary types of data that are used in GIS, data in geodatabases and attribute data. A geodatabase is a database that is in some way referenced to locations on earth. Geodatabases are grouped into two different types: vector and raster. A vector image is stored as geometric objects, such as lines and arcs, which are drawn between specific coordinates. If you magnify a vector image you see the lines more accurately, and the line edges stay smooth. A raster image is made up from pixels, like the picture obtained from a scanner, or the screen image on a computer monitor, and has a finite amount of detail which is dependent upon the image size and resolution. However, the closer one looks at a raster image the coarser it appears and one does not see any extra detail. Vector drawings are utilized in GIS and other applications where accuracy is important. Usually coupled with this data is data known as attribute data. Attribute data are data that relate to a specific, precisely defined location. The data are often statistical but may be text, images or multimedia. These are linked in the GIS to spatial data that define the location.

People – Well-trained people knowledgeable in spatial analysis and skilled in using GIS software are essential to the GIS process.

Public Sector Use of GIS

GIS can be used by the public sector in the following ways:

Pubic Safety and Emergency Response Planning – GIS technology gives public safety personnel the ability to manage and analyze large amounts of location-based information. Data (including files from legacy systems) can be stored in a geodatabase and used to visualize spatial relationships and reveal trends critical to public safety response and planning. Computer-generated maps can be shared across a network or the Internet with multiple agencies to coordinate efforts and maximize resources.

Law Enforcement – GIS software uses geography and computer-generated maps as an interface for integrating and accessing massive amounts of location-based information. GIS allows law enforcement and criminal justice personnel to effectively plan for emergency response, determine mitigation priorities, analyze historical events, and predict future events. GIS can also be used to get critical information to emergency responders upon dispatch or while en route to an incident to assist in tactical planning and response. While law enforcement agencies collect vast amounts of data, only a very small part of this information can be absorbed from spreadsheets and database files. GIS provides a visual, spatial means of displaying data, allowing law enforcement agencies to integrate and leverage their data for more informed decision-making.

Public Works and Development – Use of GIS software in public works improves efficiency and productivity to better serve citizens. For example, GIS applications are in demand in connection with the construction of the Pan Asia Railway and development of the Meigong River and Tumen River in northwestern China. Such public works systems could use GIS to connect all divisions in a public works department from engineering to accounting, which streamlines work flows, asset management, operations, and planning. Using a GIS throughout the department allows all sections to share and easily access geographic data. GIS promotes data integrity and facilitates better communication and decision-making throughout the organization.

Economic Development – GIS may be used to foster economic development. Agencies could work to advance the quality of life and strengthen the economic base of their region by retaining and growing existing businesses and attracting new investment.

Urban Planning and Site Selection – Information regarding a proposed site for parcel zoning, transportation planning, waste disposal or other use may be combined and manipulated in a GIS to address planning and natural resource issues (such as the location of a water well near a proposed waste disposal site) to guarantee the quality of life for everyone in livable communities. Planning agencies have realized the power of enterprise GIS to identify problems, respond to them efficiently, and share the results with the public.

GIS Industry in China

GIS is becoming an increasingly important component of business, healthcare, security, government, trade, media, transportation and tourism industries and operations in China. GIS software is playing an increasingly strategic role for the Chinese government to increase its efficiency and enable the geographic information consolidation for information sharing and exchange, and for Chinese companies to analyze and manage business operations. GIS has been put to use in many spheres by the Chinese public and private sectors, including land survey, mineral exploitation, water conservancy and environmental protection. It also has applications in power generation, mapping, telecommunication, and the management of public administration and public services.

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According to the National Administration of Surveying, Mapping and Geoinformation of China, the GIS industry in China was valued at RMB 100 billion in 2010. China’s GIS software market by itself was valued at RMB 9 billion in 2010. It was further expected that this market would grow by 25% over the next 5 years.

Our Growth Strategy

Our objective is to be the leading provider of integrated solutions for both of our Information Technology, or IT, business, and our Display Technology, or DT, business, which provides primarily high-end digital display products, integrated software and related services specialized for GIS, DPST, education, media, and other various industry uses.

Our intelligence solutions can help organizations make more insightful decisions and improve the efficiency of their internal processes. Our strategy for achieving this objective includes the following key elements:

  • Expand geographic footprint to cover all major markets in China. We intend to leverage our strengths to expand into new geographic markets. For the fiscal year ended December 31, 2011, approximately 44% of our total revenue was generated through our operations in Guangdong Province. We manage our nationwide operations in strategic development areas in China’s south, north, east, center, southwest, northwest, and northeast. We have established offices in Guangzhou, Beijing, Wuhan, and Hunan Province, and Xinjiang Uyghur Autonomous Region, and work through representatives in Nanning (Guangxi Province), Dongguan (Guangdong Province), Chongqing Municipality, Nanjing (Jiangsu Province), Harbin (Heilongjiang Province), Shandong Province, and other cities and provinces in China. Our nationwide distribution network in China covers 32 provinces and provincial cities throughout China. We believe that expanding our presence in new geographic areas will allow us to increase our cross-selling opportunities for our product and service offerings.

  • Strengthen R&D capability to enhance and expand core products and further penetrate customer base. To provide our clients with innovative solutions, we expect to offer additional value-added services and add-ins to our current platform through continuous research and development, to enhance our product and service offerings and to maintain our leadership position in our core areas of focus.

  • Continue to maintain our leading position in the GIS and public security technology market. We plan to leverage our strong industry reputation and brand recognition to obtain new customers and new projects from existing customers.

  • Expand into the private sector. We are witnessing market readiness to adopt our IT and DT solutions that used to serve highly specialized activities of public agencies. As the private sector grows in technological sophistication, we plan to penetrate into this new sector of the market with both IT and DT solutions.

  • Move up the value-chain. As we integrate our core competencies within our software and display technology groups we are creating innovative multifunctional products that can open up whole new markets for us. For example, our industry leading interactive digital education system (IT-Pad) and our multifunctional digital display products (DS-Pad) will help us to transition our DT segment away from low-margin LCD TV products and into the more high value and differentiated product markets.

We expect to execute these key elements of our growth strategy through a combination of investments in internal initiatives. Internal initiatives will focus on expanding capacity and enhancing our technology and services capabilities.

Our Products and Services

Through the operations of our China-based subsidiaries and the subcontracting services provided for under our MSA, we are a provider of products and integrated solutions for China’s IT and DT markets in GIS, DPST, DHIS, education, media, and consumer products.

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Geographic Information Systems (GIS) Software Services and Operations

We provide system management and support services in connection with our PGIS platform. The PGIS platform is a set of GIS solutions that was developed by iASPEC and licensed exclusively to us, for use in creating, editing and adding data to our customers’ systems. The PGIS platform allows us to provide our law enforcement customers with different services, including specialized mapping services, positioning services, messaging services and services which monitor access to their GIS by users of different levels. We offer the PGIS platform with a full complement of services, including providing basic map image data from the GIS and specific data in connection with that map image (such as a bus stop), a consolidation of both basic data and specific data services for data inquiry services, and application system services, which is the application of consolidated services to a specific service requirement, such as the position of a police officer in the field.

We also provide application interface services which ensure that our PGIS platform is equipped to interact with other programs to the benefit of our customers. The data from different law enforcement command systems can be integrated with our PGIS platform to provide our law enforcement customers with more robust communication and location information. Typically, our platforms are integrated with the City Emergency Commanding System, the Police Resource Consolidated Management System, the Residence Management System, the Internet Surveillance System, the Traffic Commanding System, the Criminal Investigation System and the City Surveillance System. Our core PGIS technology has been selected for use in the Ministry of Public Security’s PGIS Project, which when complete, is expected to standardize and interconnect all PGIS systems in China.

In the Civil-use GIS sector, we have obtained the highest level of qualifications (some of them are mentioned in the sections under the heading “Competition – High Barriers to Entry” and “Regulation” below) with the widest range of applications, through its affiliation with Geo. In addition, Geo’s copyrighted GIS software, “Geostar,” has been widely applied in many mission-critical projects covering national defense, surveying and mapping, land resource, city planning and electricity. Management believes that these qualifications and intellectual property have positioned the Company to benefit for the next few years from the PRC government’s recent emphasis on and promulgation of favorable policies to encourage more applications of domestic-grown GIS software.

In January 2010, China’s State Bureau of Surveying and Mapping announced its plan to build a National Geographic Information Public Service Platform. The whole program will include the construction of one national level master node, 31 provincial level nodes, and 333 city level nodes throughout China, and each city level node will centralize approximately 20 local government departments’ different applications. This program aims to improve the capability and efficiency of geographic information public service, and optimize the utilization of national geographic information resources in China. The whole program will be completed in 5 years.

Digital Public Security Technology (DPST)

First Responder Coordination Platform – The First Responder Coordination Platform is a software program which integrates the contact numbers for general police, fire, traffic and other related government organizations into one contact number and enables these agencies to consolidate and improve their public emergency response. Through this platform, our public security customers are able to command and coordinate joint responses to provide the public with immediate, efficient and reliable assistance. The PRC government, through its “Police Force Technology Reinforcement” initiative, has mandated the adoption of the first responder system to consolidate and improve public emergency response. Approximately 660 cities across China are expected to initiate the deployment of their coordinated emergency response platforms, creating significant opportunities for us.

Intelligent Recognition Systems – Our Intelligent Recognition product is used by the Ministry of Public Security for effective border control management. The Recognition System stores biometric information, such as finger-prints and facial features from passengers in a database and integrates it with infrared and license plate recognition technologies to enable the automation of border control checkpoints for faster and more accurate processing of passengers, while at the same time helping to safeguard borders from stowaways, and greatly improving overall efficiency and the effectiveness of border control management. The rapid development of China in recent years has also led to growing passenger traffic across its borders, which reached over 400 million people in 2011. To address the increasing requirement and faster and more accurate checkpoint processing of passenger traffic, Exit and Entry Frontier Stations throughout China are in the process of implementing their own intelligent border control systems. These systems can also be used to strengthen port control and surveillance in China’s over 200 air, sea and land ports and have many alternative private sector applications, including the management and control of stadium attendance, parking lot traffic, work attendance and toll road traffic.

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Residence Card Information Management System – This system is designed to apply the latest information technology to automate the Shenzhen Residence Card System, and will integrate with police GIS systems. Through an integrated information transfer platform, the system will facilitate several social programs, including social welfare management, education management, and house rental service management. Various government and functional departments can access information regarding the immigrant population in the system to improve work efficiency and increase managing capability. In the near future, the system may be expanded to be compatible with other applications, such as medical, personal credit history, and driving records. In many mid-to-large cities, the population of recent immigrants from rural areas exceeds the resident population. As a key pilot project for the Ministry of China Public Security, our Residence Card information Management System will be deployed in Shenzhen first for evaluation.

Digital Hospital Information Systems (DHIS)

We provide various hospital information management software and solutions, such as Medical Case Statistics Software and Electronic Medical Case Management System, to help build modern, scientific and digital hospitals. Our products have been widely used to efficiently manage hospital fiscal information, clinic information, medical technologies, equipment and inventory, as well as comprehensive hospital information.

Medical Case Statistics Software serves the growing demand for digital hospital and electronic medical record systems in China. Medical records, including health examinations, medical care, immunity or infectious diseases, will be integrated into one centralized system so that doctors within the network can review a patient’s complete medical history. Such digital hospital systems are expected to reduce medical errors and improve the efficiency of delivering healthcare services, so as to benefit patients, while helping to minimize medical claims fraud. Our Medical Case Statistics Software can also be used to provide public health authorities with an integrated command and decision system for public health and disease control.

Our Electronic Medical Case Management System is able to integrate Hospital Information System, Laboratory Information System, Picture Archiving & Communication System, Radiology Information System and Corporate Identity System, to digitize all clinic information. The System also provides access interfaces with related agencies such as Social Insurance and Bank.

Display Technology

After years of effort, we have developed new digital display technologies products embedded with our industry-leading software development and customization capabilities. We have recently introduced, or expect to introduce in 2012, our new generation of advanced digital technology products including:

CNIT IT-Pad The CNIT IT-Pad is a display device with a built-in, customizable computer, and a digital high-definition touch-screen. The CNIT IT-Pad is tailored for “Interactive Teaching” and is intended to provide innovative and multimedia-rich interactive education and conferencing tools for our customers.

CNIT DS-Pad The CNIT DS-Pad is a type of multimedia advertising device that can display compelling advertisements by means of video, animation, pictures and text. The CNIT DS-Pad comes in various sizes, with screens ranging from 15 to 82 inches. The product is also customizable to fit different needs, with styles including free-standing or wall-mountable, indoor or outdoor, and with traditional or touch-screen technology.

Product Warranty

We usually offer a one-year service warranty for our system integration services. The warranty includes support services, minimal updates and system maintenance. In our experience the cost of providing this warranty has been immaterial. We also offer warranties for our hardware sales, but the suppliers of such hardware provide the final warranty services.

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Our Intellectual Property

Our success depends, in part, on our ability to maintain and protect our proprietary technology and to conduct our business without infringing on the proprietary rights of others. We rely primarily on a combination of copyrights, patents, trademarks and trade secrets, as well as employee and third-party confidentiality agreements, to safeguard our intellectual property.

As of December 31, 2011, we had 118 registered and copyrighted software products and had 21 applications pending, and held 17 patents.

We protect our know-how and technologies through confidentiality provisions in the employment contracts we enter into with our employees. In addition, our engineers are generally divided into different project groups, each of which generally handles only a portion of the project. As a result, no one engineer generally has access to the entire design process and documentation for a particular product.

Sales and Marketing

We develop new business by identifying and contacting potential new customers and through referrals, or as a result of new customers contacting us because of our strong brand recognition and reputation in the industry. We strengthen our market presence through various types of marketing campaigns, such as participating in exhibitions, trade fairs and seminars, developing distributors and dealers, and presenting solutions to prospective customers. We participate in several domestic and international trade fairs such as the China High-Tech Fair in Shenzhen and the e-Gov China Fair and the China Education Devices Exhibition in Beijing. We also participate in seminars held by Esri, IBM, and other prominent market participants each year, to raise our recognition and promote our products. These trade fairs not only promote our reputation, but also our brand name.

Our Major Customers

In fiscal years 2011, 2010 and 2009, no single customer represented 10% or more of our total revenue. The following tables provide revenue by our major customers for the years ended December 31, 2011, 2010 and 2009.

Year 2011    
    Revenues     Percentage of  
    (Thousands)     Total Sales  
Changfeng Technology Industrial Group $  7,016   $  6%  
Shenzhen Huipuchaungxin Technology Limited   4,142     4%  
Shenzhen Huipukaichuang Technology Limited   3,846     3%  
Shenzhen Municipal Public Security Bureau Information Office   2,768     2%  
Jincheng Municipal Public Security Bureau, Shanxi Province   2,325     2%  
TOTAL $  20,097   $  17%  
             
Year 2010    
    Revenues     Percentage of  
    (Thousands)     Total Sales  
Shenzhen Municipal Public Security Bureau Information Office $  7,017   $  4%  
Shenzhen Municipal Public Security Bureau Residence Card Program Office   6,946     4%  
Shenzhen Huipuchaungxin Technology Limited   5,578     3%  
Guangzhou Municipal Public Security Bureau ,Guangdong Province   4,955     3%  
Changfeng Technology Industrial Group   4,288     3%  
TOTAL $  28,784   $  17%  

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Year 2009    
    Revenues     Percentage of  
    (Thousands)     Total Sales  
Haikou Boshuntong Software Development Company $  6,288   $  6%  
Shenzhen Longtushenzhou Information Limited   5,204     5%  
Shenzhen Municipal Public Security Bureau   4,967     5%  
Huipu Electronics (Shenzhen) Co., Ltd. (prior to acquisition)   4,566     5%  
Shenzhen Tianshengji Technology Limited   4,393     4%  
TOTAL $  25,418   $  25%  

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Competition

The markets for the GIS, DPST and DHIS sectors in China have developed in recent years but are still in an emerging stage. There are currently only a few key players engaged in each of these fields. In the PGIS area, Beijing Founder Digital Company Limited and Beijing Easymap Information Technology Co., Ltd. are two important competitors. In the GIS platform software business, we consider Esri, Super Map Software Co., Ltd., or SuperMap, and Zondy Cyber Group Co., Ltd., or Zondy Cyber, as meaningful competitors. In the DHIS sector, our main competitors include Neusoft Corporation, or Neusoft, and DHC Software Company Limited, or DHC Software.

In the digital display field, we believe that we have become a leading supplier in China. Only a few major players in this market have comparably strong hardware and software capabilities.

We believe that we will be able to effectively compete with these companies in the future. We believe that our pioneering solutions, our ongoing customer relationships and our reputation for success in the industry have enabled us to maintain our competitive advantages.

We believe the following are our key competitive strengths.

  • Broad and Growing Portfolio of Software and Services. We offer our customers a growing portfolio of software and services offerings in each of the two segments and four categories in which we operate. We are therefore able to provide multiple integrated solutions for our clients. Public entities use our core products to incorporate ever-growing data into their decision-making processes to drive more effective results. Through our platforms, our customers can develop customized applications, which can be extended across their agencies to support a variety of needs and generate more valuable insights. As a complement to these offerings, we offer related services, such as application development, software upgrades, follow-on phases, and systems integration, which help our customers quickly implement and customize our solutions.

  • Successful Implementation of High Profile Contracts. Our management team has a proven track record of successful implementation of high profile government contracts in China. This track record has enabled us to expand our customer base, which has grown beyond its historical geographic area in the Guangdong province and now includes customers in over 32 provinces throughout China. We have completed numerous high-profile mission-critical projects related to our core DPST, GIS and DHIS businesses, including the Police-use GIS for the 2010 Shanghai Expo, the security system for the 2011 Shenzhen Summer Universiade, the intelligent traffic management system for the 2010 Guangzhou Asian Games, the Police-use GIS for 15 major cities under China’s National PGIS Standardization Project, and the exclusive contract with the Guangdong Department of Health for our patented Medical Case Statistics (MCS) software to be rolled out to 2,000 hospitals within the province. In 2010, our proprietary Geoglobe and Geostar was selected by China’s State Grid Corporation as the sole domestic GIS software provider for the build-out of the Smart Grid project; China’s newly released state-sponsored online mapping service “Map World” are entirely run on our GIS platform software. In addition, as of March 2012, all of the Company’s operating entities have been awarded the National High-Tech Enterprise Status, which allows us to receive significant benefits including lower income tax rate, government subsidies, etc. In 2011, we were ranked among Deloitte Technology Fast 500 Asia Pacific for the fourth consecutive year and were named 13th among 2010 Forbes China Best SMEs.

  • High Barriers to Entry. We believe our qualifications, our successful contract implementation record, and the high cost of switching to other providers provide us with a “first mover” advantage in the PRC market and pose high barriers to entry for our potential competitors. Examples of our unique position in our industry, particularly the PGIS sector, include our government-sponsored Internet-based global mapping project, Map World Platform, and essential permits and qualifications in China, including iASPEC’s Computer System Integration Level 2 license from the PRC Ministry of Information, the Information System Security Service qualification from Guangdong Province, and a State Secret-related Computer Information Integration Certificate, and Geo’s Level A Certificate of Surveying and Mapping. As discussed above, we are gaining wider market recognition from our successful contract execution record. In addition, after investing in our systems, our existing customers have a strong incentive to purchase follow-on phases from us in order to expedite implementation and save costs.

Regulation

Because all of our operating entities are located in the PRC, we are regulated by the national and local laws of the PRC. This section summarizes the major PRC regulations relating to our business.

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Permits and Certificates

Our PRC subsidiary IST is a Shenzhen City Software Enterprise and holds ISO 9001:2000 Certification, Maturity Level 2 of Capability Maturity Model Integration and National High-Tech Enterprise. However, fulfillment of certain PGIS contracts with PRC Government customers is restricted to entities possessing the necessary government licenses and approvals which IST does not have.

Through our exclusive commercial arrangements with iASPEC, we benefit from the following governmental licenses and permits previously awarded and currently held by iASPEC:

Name

Grant Date and Duration

Computer System Integration Level II Qualification from PRC Ministry of Information

June 11, 2010 – June 10, 2013

State Secret related Computer Information System Integration Certificate

March 29, 2009 – March 28, 2012 (subject to renewal)

Guangdong Province Computer Information System Security Service Level II Qualification

July 29, 2010 – July 28, 2014

Shenzhen City Key Software Enterprise Certification

August 17, 2011 – August 16, 2012 (subject to annual renewal)

Guangdong Province Security Technology Surveillance System Design, Implementation and Repair Level I Qualification

December 10, 2011 – December 9, 2013

ISO 9001:2000 Certification

April 14, 2011 – April 13, 2012 (subject to annual renewal)

Honor the Contract and Keep the Promise Enterprise

June 1, 2011 – May 31, 2012 (subject to annual renewal)

National High-Tech Enterprise

June 27, 2009 – June 26, 2012

In addition, our PRC operating subsidiaries hold the following certifications and qualifications:

Name

Grant Date and Duration

Company

ISO 9001:2000 Certification

September 27, 2010 – September 26, 2013

IST

National High-tech Enterprise

June 27, 2009 – June 26, 2012

IST

Guangdong Province Security Technology Surveillance System Design, Implementation and Repair Qualification

August 24, 2011 – August 23, 2013

ISS

Guangdong Province Computer Information System Security Service Qualification

July 29, 2010 – July 28, 2014

ISS

Computer System Integration Level III Qualification from PRC Ministry of Information

August 15, 2011 – August 14, 2014

ISS

National High-tech Enterprise

September 6, 2010 – September 5, 2013

ISS

Certificate for China Compulsory Product Certification

March 15, 2011 – June 21, 2015

Bocom

National High-Tech Enterprise

October 29, 2011 – October 28, 2014

Bocom

Shenzhen Software Enterprise Certification

October 30, 2011 – October 29, 2012 (subject to annual renewal)

Bocom

National High-tech Enterprise

September 6, 2010 – September 5, 2013

Zhongtian

Computer System Integration Level IV Qualification from PRC Ministry of Information

November 18, 2011 – November 17, 2014

Zhongtian

National High-tech Enterprise

Approved, certificate to be received

Huipu

Taxation

On March 16, 2007, the National People’s Congress of China passed a new Enterprise Income Tax Law, or EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008.

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Before the implementation of the EIT Law, foreign invested enterprises, or FIEs, established in the PRC, unless granted preferential tax treatments by the PRC government, were generally subject to an earned income tax, or EIT, rate of 33.0%, which included a 30.0% state income tax and a 3.0% local income tax. The EIT Law and its implementing rules impose a unified EIT of 25.0% on all domestic-invested enterprises and FIEs, unless they qualify under certain limited exceptions. However, the EIT Law gives FIEs established before March 16, 2007, or Old FIEs, a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatments. During this five-year grandfather period, Old FIEs that enjoyed tax rates lower than 25% under the original EIT Law can gradually increase their EIT rate by 2% per year until their tax rate reaches 25%. In addition, the Old FIEs that are eligible for the “two-year exemption and three-year half reduction” or “five-year exemption and five-year half-reduction” under the original EIT law, are allowed to continue enjoying their preference until these holidays expire. Companies are also eligible for a preferential tax rate of 15% if they are approved as High Technology Enterprises by the PRC government.

In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our public holding company’s global income will be subject to PRC income tax of 25%. For detailed discussion of PRC tax issues related to resident enterprise status, see Item 1A “Risk Factors – Risks Related to Doing Business in China – Under the New Enterprise Income Tax Law, we may be classified as a ‘resident enterprise’ of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.”

Foreign Currency Exchange

The principal regulation governing foreign currency exchange in China is the Foreign Currency Administration Rules (1996), as amended (2008). Under these Rules, RMB is freely convertible for current account items, such as trade and service-related foreign exchange transactions, but not for capital account items, such as direct investment, loan or investment in securities outside China unless the prior approval of, and/or registration with, the State Administration of Foreign Exchange of the People’s Republic of China, or SAFE, or its local counterparts (as the case may be) is obtained. Pursuant to the Foreign Currency Administration Rules, FIEs in China may purchase foreign currency without the approval of SAFE for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. They may also retain foreign exchange (subject to a cap approved by SAFE) to satisfy foreign exchange liabilities or to pay dividends. In addition, if a foreign company acquires a company in China, the acquired company will also become an FIE. However, the relevant PRC government authorities may limit or eliminate the ability of FIEs to purchase and retain foreign currencies in the future. In addition, foreign exchange transactions for direct investment, loan and investment in securities outside China are still subject to limitations and require approvals from, and/or registration with, SAFE.

Dividend Distributions

Under applicable PRC regulations, FIEs in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, a FIE in China is required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves until the accumulative amount of such reserves reach 50% of its registered capital. These reserves are not distributable as cash dividends. The board of directors of a FIE has the discretion to allocate a portion of its after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation.

After-tax profits/losses with respect to the payment of dividends out of accumulated profits and the annual appropriation of after-tax profits as calculated pursuant to PRC accounting standards and regulations do not result in significant differences as compared to after-tax earnings as presented in our financial statements. However, there are certain differences between PRC accounting standards and regulations and U.S. generally accepted accounting principles, arising from different treatment of items such as amortization of intangible assets and change in fair value of contingent consideration rising from business combinations.

In addition, under the EIT law, the Notice of the State Administration of Taxation on Negotiated Reduction of Dividends and Interest Rates, which was issued on January 29, 2008, the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion, which became effective on December 8, 2006, and the Notice of the State Administration of Taxation Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties, which became effective on October 27, 2009, dividends from our PRC operating subsidiaries paid to us through our Hong Kong subsidiaries may be subject to a withholding tax at a rate of 10%, or at a rate of 5% if our Hong Kong subsidiaries are considered a “beneficial owner” that is generally engaged in substantial business activities and entitled to treaty benefits under the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion.

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Our Employees

As of December 31, 2011, we had approximately 1,540 full-time employees. The following table illustrates the allocation of these employees among the various job functions conducted at our company.

Department     Number of Employees  
Software Development     445  
Sales & Marketing     329  
Administration & Human Resources     165  
Finance and Accounting     57  
Management     29  
Production     361  
Project Execution     154  
TOTAL     1,540  

We believe that our relationship with our employees is good. Our Chinese subsidiaries have trade unions which protect employees’ rights, aim to assist in the fulfillment of our economic objectives, encourage employee participation in management decisions and assist in mediating disputes between us and union members. We have not experienced any significant problems or disruption to our operations due to labor disputes, nor have we experienced any difficulties in recruitment and retention of experienced staff. The remuneration payable to employees includes basic salaries and allowances. We also provide training for our staff from time to time to enhance their technical knowledge.

As required by applicable Chinese law, we have entered into employment contracts with all of our officers, managers and employees.

Our employees in China participate in a state pension scheme organized by Chinese municipal and provincial governments. We are required to contribute to the scheme at rates ranging from 13% to 18% of the average monthly salary. As of the date of this report, we have complied with the regulation and have paid the state pension plan as required by law. In addition, we are required by Chinese law to cover employees in China with various types of social insurance. We have purchased social insurance for all of our employees.

ITEM 1A. RISK FACTORS.

An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this report, before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. You should read the section entitled “Special Note Regarding Forward Looking Statements” above for a discussion of what types of statements are forward-looking statements, as well as the significance of such statements in the context of this report.

RISKS RELATED TO OUR BUSINESS

If the trading price of our common shares fails to comply with the continued listing requirements of The NASDAQ Global Select Market, we would face possible delisting, which would result in a limited public market for our common stock and make obtaining future debt or equity financing more difficult for us.

Companies listed on The NASDAQ Stock Market, or NASDAQ, are subject to delisting for, among other things, failure to maintain a minimum closing bid price per share of $1.00 for 30 consecutive business days. On December 23, 2011, we received a letter from NASDAQ indicating that for the last 30 consecutive business days, the bid price of our common stock closed below the minimum $1.00 per share requirement pursuant to NASDAQ Listing Rule 5450(a)(1) for continued inclusion on The NASDAQ Global Select Market. In accordance with NASDAQ Listing Rule 5810(c)(3)(A), we have an initial grace period of 180 calendar days, or until June 20, 2012, to regain compliance with the minimum bid price requirement. We cannot be sure that our share price will comply with the requirements for continued listing of our common stock on The NASDAQ Global Select Market in the future. If our common stock loses its status on The NASDAQ Global Select Market and we are not successful in obtaining a listing on The NASDAQ Capital Market, our common stock would likely trade in the over-the-counter market. If our shares were to trade on the over-the-counter market, selling our common stock could be more difficult because smaller quantities of shares would likely be bought and sold, transactions could be delayed, and security analysts’ coverage of us may be reduced. In addition, in the event our common stock is delisted, broker-dealers have certain regulatory burdens imposed upon them, which may discourage broker-dealers from effecting transactions in our common stock, further limiting the liquidity of our common stock. These factors could result in lower prices and larger spreads in the bid and ask prices for our common stock. Such delisting from The NASDAQ Global Select Market and continued or further declines in our share price could also greatly impair our ability to raise additional necessary capital through equity or debt financing, and could significantly increase the ownership dilution to shareholders caused by our issuing equity in financing or other transactions.

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Unfavorable economic conditions may affect the level of technology spending by our customers which could cause the demand for our products and services to decrease.

The revenue growth and profitability of our business depend on the overall demand for software products and related services, particularly within the private sector. Our strategy involves a sale of our products and services primarily to customers in the private sector, so our business depends on the overall economy and the economic and business conditions within this market. The current stock market decline and the global economic slowdown may affect the demand for our software products and related services and decrease technology spending of many of our customers and potential customers. These events could have a material effect on us in the future, including, without limitation, on our future revenue and earnings.

Our quarterly operating results are difficult to predict and could fall below investor expectations or estimates by securities research analysts, which may cause the trading price of our common stock to decline.

Our revenues and operating results can vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control, such as variations in the volume of business from customers resulting from changes in our customers’ operations, the business decisions of our customers regarding the use of our products and services, delays or difficulties in expanding our operational facilities and infrastructure, changes to our pricing structure or that of our competitors, inaccurate estimates of resources and time required to complete ongoing projects and currency fluctuations. As many of our employees take long vacations during the Chinese New Year in the first quarter, our revenues in that quarter are relatively low compared to the other quarters. Moreover, our results may vary depending on our customers’ business needs and spending patterns. Due to the annual budget cycles of most of our customers, we may not be able to estimate accurately the demand for our products and services beyond the immediate calendar year, which could adversely affect our business planning and may have a material adverse effect on our business, results of operations and financial condition. In addition, the volume of work performed for specific customers is likely to vary from year to year. Thus, a major customer in one year may not provide the same amount or percentage of our revenues in any subsequent year.

These fluctuations are likely to continue in the future and operating results for any period may not be indicative of our performance in any future period. If our operating results for any quarterly period fall below investor expectations or estimates by securities research analysts, the trading price of our common stock may decline.

We face risks once a business is acquired and the acquired companies may not perform to our expectations, either of which may adversely affect our results of operations.

We face risks when we acquire other businesses. These risks include:

  • difficulties in the integration of acquired operations and retention of personnel,
  • unforeseen or hidden liabilities,
  • tax, regulatory and accounting issues, and
  • inability to generate sufficient revenues to offset acquisition costs.

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Acquired companies may not perform to our expectations for various reasons, including the loss of key personnel or, as a result, key customers, and our strategic focus may change. As a result, we may not realize the benefits we anticipated. If we fail to integrate acquired businesses or realize the expected benefits, we may lose the return on the investment in these acquisitions, incur transaction costs and our results of operations could be materially and adversely affected as a result.

If we are unable to raise additional financing or identify suitable merger or acquisition targets, we may be unable to implement our long-term business plan, develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures on a timely basis.

Our long-term business plan includes the identification of suitable targets for horizontal or vertical mergers or acquisitions, so as to enhance overall productivity and to benefit from economies of scale. Due to the current global financial crisis, we may not be able to obtain adequate levels of additional financing, whether through equity financing, debt financing or other sources. To raise funds, we may need to issue new equities or bonds which could result in additional dilution to our shareholders, and additional financings could result in significant dilution to our earnings per share or the issuance of securities with rights superior to our current outstanding securities or contain covenants that would restrict our operations and strategy. In addition, we may grant registration rights to investors purchasing our equity or debt securities in the future. If we are unable to raise additional financing, we may be unable to implement our long-term business plan, develop or enhance our products and services, take advantage of future opportunities or respond to competitive pressures on a timely basis, if at all. In addition, a lack of additional financing could force us to substantially curtail or cease operations.

We also may not be able to identify merger or acquisition targets or, after a merger or acquisition, may not be able to integrate the target’s business or operations successfully with ours. Such failure to execute our long-term business plan likely will negatively impact our results of operations.

We generally do not have exclusive or long-term agreements with our customers and we may lose their engagement if they are not satisfied with our products and services or for other reasons.

We generally do not have exclusive or long-term agreements with our customers. As a result, we must rely on the quality of our products and services, industry reputation and favorable pricing to attract and retain customers. There is no assurance, however, that we will be able to maintain our relationships with current and/or future customers. Our customers may elect to terminate their relationships with us if they are not satisfied with our services. If a substantial number of our customers choose not to continue to purchase products and services time from us, it would have a material adverse effect on our business and results of operations.

If we are unable to develop competitive new products and service offerings our future results of operations could be adversely affected.

Our future revenue stream depends to a large degree on our ability to utilize our technology in a way that will allow us to offer new types of software applications and services to a broader client base. We will be required to make investments in research and development in order to continue to develop new software applications and related service offerings, enhance our existing software applications and related service offerings and achieve market acceptance of our software applications and service offerings. We may incur problems in the future in innovating and introducing new software applications and service offerings. Our development-stage software applications may not be successfully completed or, if developed, may not achieve significant customer acceptance. If we are unable to successfully define, develop and introduce competitive new software applications, and enhance existing software applications, our future results of operations would be adversely affected. Development schedules for software applications are difficult to predict. The timely availability of new applications and their acceptance by customers are important to our future success. A delay in new the development of new applications could have a significant impact on its results of operations.

If we are unable to keep pace with the rapid technological changes in our industry, demand for our products and services could decline which would adversely affect our revenue.

Our industry is characterized by extremely rapid technological change, evolving industry standards and changing customer demands. These conditions require continuous expenditures on product research and development to enhance existing products, create new products and avoid product obsolescence. We believe that the timely development of new products and continuing enhancements to existing products is essential to maintain our competitive position in the marketplace. Our future success depends in part upon customer and market acceptance of our products and initiatives, which is uncertain. Any failure to achieve increased acceptance of these and other new product offerings could have a material adverse effect on our business and results of operations.

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Our software products may contain defects or errors, which could decrease sales, injure our reputation or delay shipments of our products.

The software products that we develop are complex and must meet the stringent technical requirements of our customers. In addition, to keep pace with the rapid technological change in our industry and to avoid the obsolescence of our software products, we must quickly develop new products and enhancements to existing products. Because of this complexity and rapid development cycle, we cannot assure that our software products are free of errors, especially in newly released software products and new versions of existing software products. If our software is not free of errors, this could result in litigation, fewer sales, increased product returns, damage to our reputation and an increase in service and warranty costs, which would adversely affect our business.

Our technology may become obsolete which could materially adversely affect our ability to sell our products and services.

If our technology, products and services become obsolete, our business operations would be materially adversely affected. The market in which we compete is characterized by rapid technological change, evolving industry standards, introductions of new products, and changes in customer demands that can render existing products obsolete and unmarketable. Our current products will require continuous upgrading or our technology will become obsolete. Our future success will depend upon our ability to address the increasingly sophisticated needs of our customers by supporting existing and emerging hardware, software, database, and networking platforms and by developing and introducing enhancements to our existing products and new products on a timely basis that keep pace with technological developments, evolving industry standards, and changing customer requirements. Research and development expenses were $4,483,754, $3,016,693 and $2,705,669 for the years ended December 31, 2011, 2010 and 2009, respectively.

We face the risk of systems interruptions and capacity constraints, possibly resulting in adverse publicity, revenue loss and erosion of customer trust.

The satisfactory performance, reliability and availability of our network infrastructure are critical to our reputation and our ability to attract and retain customers and to maintain adequate customer service levels. We may experience temporary service interruptions for a variety of reasons, including telecommunications or power failures, fire, water damage, vandalism, computer bugs or viruses or hardware failures. We may not be able to correct a problem in a timely manner. Any service interruption that results in the unavailability of our system or reduces its capacity could result in real or perceived public safety issues that may affect customer confidence in our services and result in negative publicity that could cause us to lose customer accounts or fail to obtain new accounts. Any inability to scale our systems may cause unanticipated system disruptions, slower response times, degradation in levels of customer service, or impaired quality and speed of transaction processing. We are not certain that we will be able to project the rate or timing of increases, if any, in the use of our services to permit us to upgrade and expand our systems effectively or to integrate smoothly any newly developed or purchased modules with our existing systems.

If we are not able to adequately secure and protect our patent, trademark and other proprietary rights our business may be materially affected.

Under the MSA, we license 30 copyrighted software applications from iASPEC on an exclusive basis. To protect the intellectual property underlying these applications and our other intellectual property, we rely on a combination of copyright, trademark, and trade secret laws. We also rely on non-disclosure agreements and other confidentiality procedures and contractual provisions to protect our intellectual property rights. Some of these technologies, other than the iASPEC copyrighted software applications, are very important to our business and are not protected by copyrights or patents. It may be possible for unauthorized third parties to copy or reverse engineer our products, or otherwise obtain and use information that we regard as proprietary. Further, third parties could challenge the scope or enforceability of our copyrights. In certain foreign countries, including China where we operate, the laws do not protect our proprietary rights to the same extent as the laws of the United States. Any misappropriation of our intellectual property could have a material adverse effect on our business and results of operations, and we cannot assure you that the measures we take to protect our proprietary rights are adequate.

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Claims that we infringe the proprietary rights of third parties could result in significant expenses or restrictions on our ability to sell our products and services.

Third parties may claim that our products or services infringe their proprietary rights. Any infringement claim, with or without merit, would be time-consuming and expensive to litigate or settle and could divert our management’s attention from our core business. In the event of a successful infringement claim against us, we may have to pay significant damages, incur substantial legal fees, develop costly non-infringing technology, or enter into license agreements that require us to pay substantial royalties and that may not be available on terms acceptable to us, if at all.

A significant portion of our sales are derived from a limited number of customers, and results from operations could be adversely affected and stockholder value harmed if we lose any of these customers.

Historically, a significant portion of our revenues have been derived from a limited number of customers. For the years ended December 31, 2011, 2010 and 2009, 17%, 17% and 25% of our revenues, respectively, were derived from our five largest customers. The loss of any of these significant customers would adversely affect our revenues and stockholder value.

The digital security, geographic, and hospital information systems markets in China are highly competitive, and we may fail to compete successfully, thereby resulting in loss of customers and decline in our revenues.

The digital security, geographic, and hospital information systems markets in China are intensely competitive and are characterized by frequent technological changes, evolving industry standards and changing customer demands. We have competition from multiple domestic competitors in each segment. Increased competition may result in price reductions, reduced margins and inability to gain or hold market share.

We have limited insurance coverage for our operations in China.

The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited insurance products. We have determined that the risks of disruption or liability from our business, the loss or damage to our property, including our facilities, equipment and office furniture, the cost of insuring for these risks, and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. As a result, we do not have any business liability, disruption, litigation or property insurance coverage for our operations in China except for insurance on some company owned vehicles. Any uninsured occurrence of loss or damage to property, or litigation or business disruption may result in the incurrence of substantial costs and the diversion of resources, which could have an adverse effect on our operating results.

We depend heavily on key personnel, and turnover of key employees and senior management could harm our business.

Our future business and results of operations depend in significant part upon the continued contributions of our key technical and senior management personnel, including Jiang Huai Lin, our Chairman and Chief Executive Officer, Daniel K. Lee, our Chief Financial Officer, Zhi Qiang Zhao, our Chief Operating Officer, Yi Fu Liu, our Chief Marketing Officer, and Zhi Xiong Huang, our Chief Technology Officer. They also depend in significant part upon our ability to attract and retain additional qualified management, technical, marketing and sales and support personnel for our operations. If we lose a key employee or if a key employee fails to perform in his or her current position, or if we are not able to attract and retain skilled employees as needed, our business could suffer. Significant turnover in our senior management could significantly deplete our institutional knowledge held by our existing senior management team. We depend on the skills and abilities of these key employees in managing the technical, marketing and sales aspects of our business, any part of which could be harmed by further turnover.

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We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have the operating effectiveness of our internal controls attested to by our independent auditors.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, the SEC adopted rules requiring public companies to include a report of management on their internal controls over financial reporting in their annual reports, on Form 10-K. We are subject to this requirement commencing with our fiscal year ending December 31, 2008 and a report of our management is included under Item 9A of this Annual Report on Form 10-K. In addition, SOX 404 requires the independent registered public accounting firm auditing a company’s financial statements to also attest to and report on the operating effectiveness of such company’s internal controls. This annual report includes an attestation report since we are deemed to be an accelerated filer. We can provide no assurance that we will comply with all of the requirements imposed thereby. There can be no assurance that we will receive a positive attestation from our independent registered public accountants. In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent registered public accountants with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements.

Our holding company structure may limit the payment of dividends.

We have no direct business operations, other than our ownership of our subsidiaries. While we have no current intention of paying dividends, should we decide in the future to do so, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants in loan agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions as discussed below. If future dividends are paid in RMB, fluctuations in the exchange rate for the conversion of RMB into U.S. dollars may reduce the amount received by U.S. stockholders upon conversion of the dividend payment into U.S. dollars.

Chinese regulations currently permit the payment of dividends only out of accumulated profits as determined in accordance with Chinese accounting standards and regulations. Our subsidiaries in China are also required to set aside a portion of their after tax profits according to Chinese accounting standards and regulations to fund certain reserve funds. Currently, our subsidiaries in China are the only sources of revenues or investment holdings for the payment of dividends. If they do not accumulate sufficient profits under Chinese accounting standards and regulations to first fund certain reserve funds as required by Chinese accounting standards, we will be unable to pay any dividends.

After-tax profits/losses with respect to the payment of dividends out of accumulated profits and the annual appropriation of after-tax profits as calculated pursuant to PRC accounting standards and regulations do not result in significant differences as compared to after-tax earnings as presented in our financial statements. However, there are certain differences between PRC accounting standards and regulations and U.S. generally accepted accounting principles, arising from different treatment of items such as amortization of intangible assets and change in fair value of contingent consideration rising from business combinations.

RISKS RELATING TO OUR COMMERCIAL RELATIONSHIP WITH IASPEC

Jiang Huai Lin’s association with iASPEC could pose a conflict of interest which may result in iASPEC decisions that are adverse to our business.

Jiang Huai Lin, our president and Chief Executive Officer and the beneficial owner of 41% of our common stock also beneficially owns 100% of the equity interests in iASPEC, from whom we derived 47.1%, 39.1% and 48.6% of our revenue in the fiscal years ended December 31, 2011, 2010 and 2009, respectively pursuant to existing commercial arrangements. As a result, conflicts of interest may arise from time to time and these conflicts may result in management decisions that could negatively affect our operations and potentially result in the loss of opportunities.

If iASPEC or its shareholders violate our contractual arrangements with it, our business could be disrupted and we may have to resort to litigation to enforce our rights which may be time consuming and expensive.

Our operations are currently dependent upon our commercial relationship with iASPEC. During the fiscal years ended December 31, 2011, 2010 and 2009, we derived 47.1%, 39.1% and 48.6% of our revenues, respectively, from the provision of services to iASPEC customers. A significant portion of these revenues have not yet been collected. Amounts owed by iASPEC under the MSA for each quarter will be due and payable no later than the last day of the month following the end of each such quarter. Our contractual arrangements may not be as effective as direct ownership, if iASPEC or its shareholders are unwilling or unable to perform their obligations under our commercial arrangements with it, including payment of revenues under the MSA as they become due each quarter, we will not be able to conduct our operations in the manner currently planned. In addition, iASPEC may seek to renew these agreements on terms that are disadvantageous to us. Although we have entered into a series of agreements that provide us with substantial ability to control iASPEC, we may not succeed in enforcing our rights under them. If we are unable to renew these agreements on favorable terms, or to enter into similar agreements with other parties, our business may not be able to operate or expand, and our operating expenses may significantly increase.

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Uncertainties in the PRC legal system may impede our ability to enforce the commercial agreements that we have entered into with iASPEC or any arbitral award thereunder and any inability to enforce these agreements could materially and adversely affect our business and operation.

While disputes under the MSA and the Option Agreement with iASPEC are subject to binding arbitration before the Shenzhen Branch of the China International Economic and Trade Arbitration Commission, or CIETAC, in accordance with CIETAC Arbitration Rules, the agreements are governed by PRC law and an arbitration award may be challenged in accordance with PRC law. For example, a claim that the enforcement of an award in our favor will be detrimental to the public interest, or that an issue does not fall within the scope of the arbitration would require us to engage in administrative and judicial proceedings to defend an award. China’s legal system is a civil law system based on written statutes and unlike common law systems, it is a system in which decided legal cases have little value as precedent. As a result, China’s administrative and judicial authorities have significant discretion in interpreting and implementing statutory and contractual terms, and it may be more difficult to evaluate the outcome of administrative and judicial proceedings and the level of legal protection available than in more developed legal systems. These uncertainties may impede our ability to enforce the terms of the MSA, the Option Agreement and the other contracts that we may enter into with iASPEC. Any inability to enforce the MSA and Option Agreement or an award thereunder could materially and adversely affect our business and operation.

If iASPEC fails to comply with the confidentiality requirements of certain of its customer contracts, then iASPEC could be subject to sanctions and could lose its business license which in turn would significantly disrupt or shut down our operations.

The business and operations of iASPEC, the owner and licensor to us of the copyrighted software applications and other intellectual property that are essential to the operation of our business, is subject to Chinese contractual obligations and laws and regulations that restrict its use of security information and other information that it obtains from its customers in the public security sector. For some of its contracts with government agencies, iASPEC has agreed to keep confidential all technical and commercial secrets obtained during the performance of services under the contract. iASPEC or its shareholders could violate these contractual obligations and laws and regulations by inadvertently or intentionally disclosing confidential information or by otherwise failing to operate its business in a manner that complies with these contractual and legal obligations. A violation of these agreements could result in the significant disruption or shut down of our business or adversely affect our reputation in the market. If iASPEC or its shareholders violate these contractual and legal obligations, we may have to resort to litigation to enforce our rights under our contractual obligations with iASPEC. This litigation could result in the disruption of our business, diversion of our resources and the incurrence of substantial costs.

All of the share capital of iASPEC is held by our major shareholder, who may cause these agreements to be amended in a manner that is adverse to us.

Our major shareholder, Mr. Jiang Huai Lin, owns and controls iASPEC. As a result, Mr. Lin may be able to cause our commercial arrangements with iASPEC to be amended in a manner that will be adverse to our company, or may be able to cause these agreements not to be renewed, even if their renewal would be beneficial for us. Although we have entered into an agreement that prevents the amendment of these agreements without the approval of the members of our Board other than Mr. Lin, we can provide no assurances that these agreements will not be amended in the future to contain terms that might differ from the terms that are currently in place. These differences may be adverse to our interests.

Our arrangements with iASPEC and its shareholders may be subject to a transfer pricing adjustment by the PRC tax authorities which could have an adverse effect on our income and expenses.

We could face material and adverse tax consequences if the PRC tax authorities determine that our contracts with iASPEC and its shareholders were not entered into based on arm’s length negotiations. Although our contractual arrangements are similar to other companies conducting similar operations in China, if the PRC tax authorities determine that these contracts were not entered into on an arm’s length basis, they may adjust our income and expenses for PRC tax purposes in the form of a transfer pricing adjustment. Such an adjustment may require that we pay additional PRC taxes plus applicable penalties and interest, if any.

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The exercise of our option to purchase part or all of the equity interests in or assets of iASPEC under the Option Agreement might be subject to approval by the PRC government. Our failure to obtain this approval may impair our ability to substantially control iASPEC and could result in actions by iASPEC that conflict with our interests.

Our Option Agreement with iASPEC gives our Chinese operating subsidiary, IST, the option to purchase all or part of the equity interests in or assets of iASPEC, however, the option may not be exercised by IST if the exercise would violate any applicable laws and regulations in China or cause any license or permit held by, and necessary for the operation of iASPEC, to be cancelled or invalidated. Under the laws of China, if a foreign entity, through a foreign investment company that it invests in, acquires a domestic related company, China’s regulations regarding Mergers and Acquisitions would technically apply to the transaction. Application of these regulations requires an examination and approval of the transaction by China’s Ministry of Commerce, or MOFCOM, or its local counterparts. Also, an appraisal of the equity or assets to be acquired is mandatory. However, the Zhong Lun Law Firm, our local PRC counsel has advised us that Shenzhen and other local counterparts of MOFCOM hold the view that such a transaction would not require their approval. Therefore, we do not believe at this time that an approval and an appraisal are required for IST to exercise its option to acquire iASPEC in Shenzhen. In light of the different views on this issue, however, it is possible that the central MOFCOM office in Beijing will issue a standardized opinion imposing the approval and appraisal requirement. If we are not able to purchase the equity or assets of iASPEC, then we will lose a substantial portion of our ability to control iASPEC and our ability to ensure that iASPEC will act in our interests.

Our right to elect a majority of the members on iASPEC’s Board of Directors and other provisions of the MSA may be viewed by iASPEC’s customers as a change in control of iASPEC, which could subject iASPEC to sanctions and loss of its business license, which in turn would significantly disrupt or possibly terminate our operations.

Our new commercial arrangement with iASPEC gives us the right to designate two Chinese citizens to serve as senior managers of iASPEC, serve on iASPEC’s Board of Directors and assist in managing the business and operations of iASPEC. In addition, iASPEC will require the affirmative vote of the majority of the our Board of Directors, as well as at least one non-insider director, for completing certain material actions with respect to iASPEC, including, but not limited to: (a) the nomination, appointment, election or replacement of any board members; (b) the distribution of any dividend or profits; (c) any merger, division, change of corporate form, dissolution or liquidation; (d) any reimbursement of net losses or other payments or transfers of funds from IST to iASPEC; (e) the formation or disposition of a subsidiary or the acquisition or disposition of any interest in any other entity; and (f) the encumbrance of any assets under any lien not in the ordinary course of business. However, fulfillment of certain PGIS contracts with PRC Government customers is restricted to entities, such as iASPEC, that possess the necessary PRC government licenses and approvals, and any change in control may be viewed under PRC law as creating a new entity. If iASPEC’s government customers view these MSA provisions as a change in control of iASPEC or as evidence of iASPEC’s failure to operate its business in a manner that complies with its contractual obligations or with related laws and regulations. Such a perception could result in the cancellation or invalidation of iASPEC’s licenses and permits. A loss by iASPEC of its licenses and permits could result in the significant disruption or possible termination of our business or adversely affect our reputation in the market.

RISKS RELATED TO DOING BUSINESS IN CHINA

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

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

  • Level of government involvement in the economy;
  • Control of foreign exchange;
  • Methods of allocating resources;
  • Balance of payments position;
  • International trade restrictions; and
  • International conflict.

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The Chinese economy differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development, or OECD, in many ways. For example, state-owned enterprises still constitute a large portion of the Chinese economy, and weak corporate governance and the lack of a flexible currency exchange policy still prevail in China. 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 was similar to those of the OECD member countries.

Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.

We conduct substantially all of our business through our operating subsidiaries in the PRC. Our operating subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to FIEs. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to evolve rapidly, the interpretations of many laws, regulations, and rules are not always uniform, and enforcement of these laws, regulations, and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, most of our executive officers and directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiary.

You may have difficulty enforcing judgments against us.

Most of our assets are located outside of the United States and most of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Our counsel as to PRC law has advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. Courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security, or the public interest. So it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.

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

The PRC 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 the jurisdictions in which we operate 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 or joint ventures.

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The enforcement of the PRC labor contract law may materially increase our costs and decrease our net income.

China adopted the new Labor Contract Law , or Labor Contract Law, effective on January 1, 2008, and issued its implementation rules, effective on September 18, 2008. The Labor Contract Law and related rules and regulations impose more stringent requirements on employers with regard to, among others, minimum wages, severance payment and non-fixed-term employment contracts, time limits for probation periods, as well as the duration and the times that an employee can be placed on a fixed-term employment contract. Due to the limited period of effectiveness of the Labor Contract Law and its implementation rules and regulations, and the lack of clarity with respect to their implementation and potential penalties and fines, it is uncertain how they will impact our current employment policies and practices. In particular, compliance with the Labor Contract Law and its implementation rules and regulations may increase our operating expenses. In the event that we decide to terminate some of our employees or otherwise change our employment or labor practices, the Labor Contract Law and its implementation rules and regulations may also limit our ability to effect those changes in a manner that we believe to be cost-effective or desirable, and could result in a material decrease in our profitability.

If we fail to obtain or maintain all licenses and approvals required to operate our businesses in the PRC, our business and operations may be adversely affected.

Fulfillment of certain PGIS contracts with PRC Government customers is restricted to entities possessing the necessary government licenses and approvals which our subsidiary IST does not have. We currently perform PGIS contracts through iASPEC, which possesses the requisite licenses and approvals, pursuant to our MSA with iASPEC, whereby iASPEC exclusively engages IST as its subcontractor to provide iASPEC with outsourcing services (to the extent that those services do not violate any special governmental permits held by iASPEC and do not involve the improper transfer of any sensitive confidential governmental or other data). If the PRC government determines that we are operating without the requisite licenses we may become subject to administrative penalties or an order to discontinue our business operations, both of which could have a material adverse effect on our business and results of operations.

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

In recent years, the Chinese economy has experienced periods of rapid expansion and highly fluctuating rates of inflation. During the past ten years, the rate of inflation in China has been as high as 5.9% and as low as -0.8% . 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. 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 and our company.

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

The majority of our sales will be settled in RMB, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB 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 RMB for current account transactions, significant restrictions still remain, including primarily the restriction that FIEs 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 RMB 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 RMB.

Fluctuations in exchange rates could adversely affect our business and the value of our securities.

The value of our common stock will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.

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Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.

Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.

Restrictions under PRC law on our PRC subsidiaries’ ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.

Substantially all of our sales are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent companies. PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in said fund reaches 50% of their registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.

Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise materially adversely affect us.

SAFE has promulgated several regulations, including the Notice Concerning Foreign Exchange Controls on Domestic Residents’ Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles , or Circular 75, effective on November 1, 2005, and Operating Procedures on Foreign Exchange Administration for Domestic Residents Engaging in Financing and Round-trip Investment via Offshore Special Purpose Vehicles, or Circular 19, effective on July 1, 2011. These regulations and rules require PRC residents and corporate entities to register with, and obtain approval from, provincial SAFE branches in connection with their direct or indirect offshore investment activities. Under Circular 75 and related rules, a PRC resident who makes, or has previously made, a direct or indirect investment in an offshore company is required to register that investment. In addition, any PRC resident who is a direct or indirect shareholder of an offshore company is required to update the previously filed registration with the relevant provincial SAFE branch to reflect any material change with respect to the offshore company’s roundtrip investment, capital variation, merger, division, long-term equity or debt investment or creation of any security interest.

We have asked our stockholders who are PRC residents as defined in Circular 75 and related rules to register with the relevant branch of SAFE, as currently required, in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiaries. However, we cannot provide any assurances that they can obtain the above SAFE registrations required by Circular 75 and related rules. Moreover, because of uncertainty over how Circular 75 and related rules will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries’ ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 and related rules by our PRC resident beneficial holders.

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In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75 and related rules. We also have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75 and related rules, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries’ ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.

We may be unable to complete a business combination transaction efficiently or on favorable terms due to complicated merger and acquisition regulations which became effective on September 8, 2006.

On August 9, 2006, six PRC regulatory agencies, including the China Securities Regulatory Commission promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, which became effective on September 8, 2006 and was amended in 2009. This regulation, among other things, governs the approval process by which a PRC company may participate in an acquisition of assets or equity interests. Depending on the structure of the transaction, the new regulation will require the PRC parties to make a series of applications and supplemental applications to the government agencies. In some instances, the application process may require the presentation of economic data concerning a transaction, including appraisals of the target business and evaluations of the acquirer, which are designed to allow the government to assess the transaction. Government approvals will have expiration dates by which a transaction must be completed and reported to the government agencies. Compliance with the new regulations is likely to be more time consuming and expensive than in the past and the government can now exert more control over the combination of two businesses. Accordingly, due to the new regulation, our ability to engage in business combination transactions has become significantly more complicated, time consuming and expensive, and we may not be able to negotiate a transaction that is acceptable to our stockholders or sufficiently protect their interests in a transaction.

The new regulation allows PRC government agencies to assess the economic terms of a business combination transaction. Parties to a business combination transaction may have to submit to MOFCOM and other relevant government agencies an appraisal report, an evaluation report and the acquisition agreement, all of which form part of the application for approval, depending on the structure of the transaction. The regulations also prohibit a transaction at an acquisition price obviously lower than the appraised value of the PRC business or assets and in certain transaction structures, require that consideration must be paid within defined periods, generally not in excess of a year. The regulation also limits our ability to negotiate various terms of the acquisition, including aspects of the initial consideration, contingent consideration, holdback provisions, indemnification provisions and provisions relating to the assumption and allocation of assets and liabilities. Transaction structures involving trusts, nominees and similar entities are prohibited. Therefore, such regulation may impede our ability to negotiate and complete a business combination transaction on financial terms that satisfy our investors and protect our stockholders’ economic interests.

Our existing contractual arrangements with iASPEC and its shareholders may be subject to national security review by MOFCOM, and the failure to receive the national security review could have a material adverse effect on our business and operating results.

In August 2011, MOFCOM promulgated the Rules of Ministry of Commerce on Implementation of Security Review System of Merger and Acquisition of Domestic Enterprises by Foreign Investors, or the MOFCOM Security Review Rules, to implement the Notice of the General Office of the State Council on Establishing the Security Review System for Merger and Acquisition of Domestic Enterprises by Foreign Investors promulgated on February 3, 2011, or Circular 6. The MOFCOM Security Review Rules became effective on September 1, 2011. Under the MOFCOM Security Review Rules, a national security review is required for certain mergers and acquisitions by foreign investors raising concerns regarding national defense and security. Foreign investors are prohibited from circumventing the national security review requirements by structuring transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements or offshore transactions. The application and interpretation of the MOFCOM Security Review Rules remain unclear. Based on our understanding of the MOFCOM Security Review Rules, we do not need to submit our existing contractual arrangements with iASPEC and its shareholders to the MOFCOM for national security review because, among other reasons, (i) we gained de facto control over iASPEC in 2007 prior to the effectiveness of Circular 6 and the MOFCOM Security Review Rules; and (ii) there are currently no explicit provisions or official interpretations indicating that our current businesses fall within the scope of national security review. Although we have no plan to submit our existing contractual arrangements with iASPEC and its shareholders to MOFCOM for national security review, the relevant PRC government agencies, such as MOFCOM, may reach a different conclusion. If MOFCOM or another PRC regulatory agency subsequently determines that we need to submit our existing contractual arrangements with iASPEC and its shareholders for national security review by interpretation, clarification or amendment of the MOFCOM Security Review Rules or by any new rules, regulations or directives promulgated, we may face sanctions by MOFCOM or another PRC regulatory agency. These sanctions may include revoking the business or operating licenses of our PRC subsidiary, IST, or iASPEC and its subsidiaries, discontinuing or restricting our operations in China, confiscating our income or the income of iASPEC, and taking other regulatory or enforcement actions, such as levying fines, that could be harmful to our business. Any of these sanctions could cause significant disruption to our business operations.

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The MOFCOM Security Review Rules may make it more difficult for us to make future acquisitions or dispositions of our business operations or assets in China.

The MOFCOM Security Review Rules, effective as of September 1, 2011, provides that when deciding whether a specific merger or acquisition of a domestic enterprise by foreign investors is subject to the national security review by MOFCOM, the principle of substance-over-form should be applied and foreign investors are prohibited from circumventing the national security review requirement by structuring transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements or offshore transactions. If the business of any target company that we plan to acquire falls within the scope subject to national security review, we may not be able to successfully acquire such company by equity or asset acquisition, capital increase or even through any contractual arrangement.

Under the Enterprise Income Tax Law, we may be classified as a “resident enterprise” of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.

The EIT Law and its implementing rules became effective on January 1, 2008. Under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a “resident enterprise,” meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. The implementing rules of the EIT Law define de facto management as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the EIT Law and its implementation non-Chinese enterprise or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its substantial assets and properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) at least half of its directors with voting rights or senior management often resident in China. A resident enterprise would be subject to an enterprise income tax rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10% when paying dividends to its non-PRC shareholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person. Nor are detailed measures on imposition of tax from non-domestically incorporated resident enterprises are available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

We may be deemed to be a resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares. We are actively monitoring the possibility of “resident enterprise” treatment for the 2011 tax year and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.

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If we were treated as a “resident enterprise” by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax.

We face uncertainty from China’s Circular on Strengthening the Administration of Enterprise Income Tax on Non-Resident Enterprises’ Share Transfer that was released in December 2009 with retroactive effect from January 1, 2008.

The Chinese State Administration of Taxation, or SAT, released a circular on December 15, 2009 that addresses the transfer of shares by nonresident companies, generally referred to as Circular 698. Circular 698, which is effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRC’s “substance-over-form” principle and deny the existence of the offshore holding company that is used for tax planning purposes. There is uncertainty as to the application of Circular 698. For example, while the term “indirectly transfer” is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide “abuse of form of organization” and “reasonable commercial purpose,” which can be utilized by us to balance if our Company complies with the Circular 698. As a result, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.

We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business.

We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute, for the purpose of obtaining or retaining business. We have operations, agreements with third parties, and make most of our sales in China. The PRC also strictly prohibits bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by the employees, consultants, sales agents, or distributors of our Company, even though they may not always be subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. However, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents, or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA or Chinese anti-corruption laws may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the U.S. government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.

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If we become directly subject to the recent scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.

Recently, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits and SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company, our business and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our company. This situation will be costly and time consuming and distract our management from growing our company.

The disclosures in our reports and other filings with the SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the PRC. Accordingly, our public disclosure should be reviewed in light of that fact.

We file reports with the SEC and our reports and other filings with the SEC are subject to SEC review in accordance with the rules promulgated by the SEC under the Securities Act and the Exchange Act. Unlike public reporting companies whose operations are located primarily in the United States, however, substantially all of our operations are located in China. Since substantially all of our operations and business takes place in China, it may be more difficult for the Staff of the SEC to overcome the geographic and cultural obstacles that are present when reviewing our disclosure. These same obstacles are not present for similar companies whose operations or business take place entirely or primarily in the United States. Our SEC reports and other disclosure and public pronouncements are not subject to the review or scrutiny of the China Securities Regulatory Commission or any other PRC regulatory authority. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any due diligence on our company and that none of our SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local regulator.

RISKS RELATED TO THE MARKET FOR OUR STOCK

If we were delisted from NASDAQ, we may become subject to the trading complications experienced by “Penny Stocks” in the over-the-counter market.

Delisting from NASDAQ may cause our common stock to become the SEC’s “penny stock” rules. The SEC generally defines a penny stock as an equity security that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to specific exemptions. One such exemption is to be listed on the NASDAQ Stock Market. The market price of our common stock is currently less than $5.00 per share. Therefore, were we to be delisted from the NASDAQ Stock Market, our common stock may become subject to the SEC’s “penny stock” rules. These rules require, among other things, that any broker engaging in a purchase or sale of our securities provide its customers with: (i) a risk disclosure document, (ii) disclosure of market quotations, if any, (iii) disclosure of the compensation of the broker and its salespersons in the transaction and (iv) monthly account statements showing the market values of our securities held in the customer’s accounts. A broker would be required to provide the bid and offer quotations and compensation information before effecting the transaction. This information must be contained on the customer’s confirmation. Generally, brokers are less willing to effect transactions in penny stocks due to these additional delivery requirements. These requirements may make it more difficult for stockholders to purchase or sell our common stock. Because the broker, not us, prepares this information, we would not be able to assure that such information is accurate, complete or current.

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The market price of our common stock is volatile, leading to the possibility of its value being depressed at a time when you want to sell your holdings.

The market price of our common stock is volatile, and this volatility may continue. Numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly. These factors include:

  • our earnings releases, actual or anticipated changes in our earnings, fluctuations in our operating results or our failure to meet the expectations of financial market analysts and investors;
  • changes in financial estimates by us or by any securities analysts who might cover our stock;
  • speculation about our business in the press or the investment community;
  • significant developments relating to our relationships with our customers or suppliers;
  • stock market price and volume fluctuations of other publicly traded companies and, in particular, those that are in the our industries;
  • customer demand for our products;
  • investor perceptions of the our industry in general and our company in particular;
  • the operating and stock performance of comparable companies;
  • general economic conditions and trends;
  • major catastrophic events;
  • announcements by us or our competitors of new products, significant acquisitions, strategic partnerships or divestitures;
  • changes in accounting standards, policies, guidance, interpretation or principles;
  • loss of external funding sources;
  • sales of our common stock, including sales by our directors, officers or significant stockholders; and
  • additions or departures of key personnel.

Securities class action litigation is often instituted against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs to us and divert our management’s attention and resources. Moreover, securities markets may from time to time experience significant price and volume fluctuations for reasons unrelated to operating performance of particular companies. For example, in July 2008, the securities markets in the United States, China and other jurisdictions experienced the largest decline in share prices since September 2001. These market fluctuations may adversely affect the price of our common stock and other interests in our company at a time when you want to sell your interest in us.

We do not intend to pay dividends for the foreseeable future.

For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not anticipate paying any cash dividends on our common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board deems relevant.

ITEM 1B. UNRESOLVED STAFF COMMENTS.

We have no outstanding or unresolved comments from the SEC staff.

ITEM 2. PROPERTIES.

All land in China is owned by the state or collectives. 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 according to the relevant Chinese laws. Granted land use rights are transferable and may be used as security for borrowings and other obligations.

Prior to June 2007, our subsidiary IST occupied space in offices pursuant to a six month rental agreement. In June 2007, we moved into our new executive offices located on the 21st Floor of the Everbright Bank Bldg., Zhuzilin, Futian District, Shenzhen, China, for which IST currently has land use rights. Our new executive offices consist of approximately 1,200 square meters, all of which are dedicated to administrative office space. We have fully paid the land use fees. Our other property primarily consists of computer equipment, servers, licensed software, some furniture and fixtures. There is no lien on any of our property and we currently do not have any intention to make large scale improvements or developments with respect to these properties.

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iASPEC and Bocom lease offices, employee dormitories and factory space in Shenzhen, Guangzhou, Beijing and Wuhan in the PRC, pursuant to lease agreements that will expire on various dates through September 2013. Rent expense for the years ended December 31, 2011, 2010 and 2009, was approximately $468,000, $380,000 and $386,200, respectively.

We believe that all our properties have been adequately maintained, are generally in good condition, and are suitable and adequate for our business.

ITEM 3. LEGAL PROCEEDINGS.

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

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common stock is traded on the NASDAQ Global Select Market under the symbol “CNIT.”

The following table sets forth, for the periods indicated, the high and low closing prices of our common stock. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.

    Market Prices(1)
    High Low  
Year Ended December 31, 2011            
1st Quarter $  10.62   $  5.06  
2nd Quarter   6.02     2.80  
3rd Quarter   5.70     1.84  
4th Quarter   2.30     1.24  
             
             
Year Ended December 31, 2010            
1st Quarter $  13.60   $  9.04  
2nd Quarter   14.88     9.26  
3rd Quarter   11.96     8.92  
4th Quarter   13.56     9.62  

(1) The above table sets forth the range of high and low market prices per share of our common stock as reported by Yahoo! Finance for the periods indicated. Prices have been adjusted to reflect the one-for-two reverse stock split effected on March 1, 2012.

Approximate Number of Holders of Our Common Stock

As of February 29, 2012, there were approximately 86 holders of record of our common stock. This number excludes the shares of our common stock owned by stockholders holding stock under nominee security position listings.

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Dividend Policy

We have never declared dividends or paid cash dividends. Our board of directors will make any future decisions regarding dividends. We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the near future.

Securities Authorized for Issuance Under Equity Compensation Plans

See Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters - Securities Authorized for Issuance under Equity Compensation Plans.”

Recent Sales of Unregistered Securities

We have not sold any equity securities during the fiscal year ended December 31, 2011 that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the 2011 fiscal year.

Purchases of Equity Securities

During the fourth quarter of fiscal year 2011, we repurchased shares of common stock. Below is a table containing information about our repurchases. Prices and share amounts have been retroactively adjusted to give effect to the one-for-two reverse stock split effected on March 1, 2012.

Period   Total Number of
Shares Purchased(1)
  Average Price
Paid Per Share
    Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
    Approximate Dollar
Value of Shares that
May Yet Be
Purchased Under the
Plans or Programs
 
October 1, 2011 to October 31, 2011   10,542   $ 1.9998     10,542     4,978,499  
November 1, 2011 to November 30, 2011   260,930   $ 1.931     260,930     4,563,294  
December 1, 2011 to December 31, 2011   106,156   $ 1.6952     106,156     4,377,977  

(1) All purchases were made pursuant to our amended and restated Rule 10b5-1 repurchase plan. This plan was originally announced on September 24, 2010; an extension to the plan was announced on September 16, 2010; and an amendment to the plan was announced on November 17, 2011. Under the plan as amended, up to $5 million of shares may be repurchased by the Company. The plan expires no later than September 15, 2012. To the extent applicable, the Company does not intend to make further purchases under the plan.

(2) During December 2011, the Company’s broker sold 20,000 of the Company’s shares of common stock held in its account to meet cash calls on previous purchase. The purchase information included in this table does not reflect these sales.

ITEM 6. SELECTED FINANCIAL DATA.

The selected consolidated statement of income and comprehensive income data for the years ended December 31, 2011, 2010 and 2009 and the selected balance sheet data as of December 31, 2011 and 2010 are derived from our audited consolidated financial statements included elsewhere in this report. The selected consolidated financial data for the years ended December 31, 2008 and 2007 and the selected balance sheet data as of December 31, 2009 and 2008 are derived from our audited consolidated financial statements not included in this report.

The following selected historical financial information should be read in conjunction with our consolidated financial statements and related notes and the information contained in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Earnings per share and share amount data have been retroactively adjusted to give effect to the one-for-two reverse stock split effected on March 1, 2012.

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(All amounts, except for share and per share amounts, in U.S. dollars)

    2011     2010     2009     2008     2007  
Revenues $  114,535,553   $  163,845,597   $  100,996,094   $  85,301,184   $  30,342,709  
Income From Operations   9,527,133     42,563,452     32,156,443     23,882,882     13,310,477  
Net Income $  8,570,179   $  35,473,630   $  30,137,645   $  24,028,173   $  13,421,452  
Income from Operations Per Share                              
Basic $  0.36   $  1.64   $  1.32   $  1.03   $  0.67  
Diluted $  0.36   $  1.63   $  1.32   $  1.02   $  0.66  
Total Assets $  361,792,142   $  339,401,724   $  250,828,938   $ 148,468,182   $  88,853,795  
Total Current Liabilities   107,764,628     100,222,271     75,823,003     25,463,055     4,787,196  
Total Long Term Liabilities   1,487,828     13,603,759     7,107,101              
Net Assets $  252,539,686   $  225,575,694   $ 167,898,834   $ 123,005,127   $  84,066,599  
Weighted Average Number of Shares                              
Outstanding                              
Basic   26,737,638     25,907,217     24,338,196     23,199,300     19,859,484  
Diluted   26,965,006     26,072,506     24,338,196     23,426,414     20,076,428  
Total Equity $  252,539,686   $  225,575,694   $ 167,898,834   $ 123,005,127   $  84,066,599  
Capital Stock (excluding long term debt                              
and treasury stock) $  286,326   $  255,115   $  233,548   $  209,121   $  190,891  
Number of Shares Issued and Outstanding   27,591,462     26,030,894     24,952,571     23,731,202     22,819,698  
Net Income Per Share                              
Basic $  0.30   $  1.33   $  1.24   $  1.03   $  0.67  
Diluted $  0.29   $  1.32   $  1.24   $  1.02   $  0.66  

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following management’s discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion contains certain forward-looking information. See “Special Note Regarding Forward Looking Statements” above for certain information concerning those forward looking statements. Our financial statements are prepared in U.S. dollars and in accordance with U.S. GAAP. All share and earnings per share information in this item has been retroactively adjusted to reflect a one-for-two reverse stock split effected on March 1, 2012.

Overview

We are a leading provider of information and display technologies in the PRC. We provide a broad portfolio of software, hardware and fully integrated solutions to customers in a variety of technology sectors including GIS, DPST, DHIS, and DT.

We were founded in 1993 and are headquartered in Shenzhen, China. As of December 31, 2011, we had approximately 1,540 employees and 23 sales offices throughout China.

Our customers are mostly public sector entities that use our products and services to improve the service quality and management level and efficiency of public security, traffic control, fire control, medical rescue, border control, and surveying and mapping. Our typical customers include some of the most important governmental departments in China, including the Ministry of Public Security, the public security, fire fighting, traffic and police departments of several provinces, the Shenzhen General Station of Exit and Entry Frontier Inspection, and several provincial personnel, urban planning, civil administration, land resource, and mapping and surveying bureaus. Over the past several years, we have diversified our customer base beyond our local reach. In the future, we expect to continually expand our market and product offerings in the public and other sectors, through geographic expansion and enhancement of our technical capabilities.

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We generate revenues through the sale of our software and hardware products, through our fully integrated total solutions, and through the provision of related support services. A significant portion of our operations are conducted through iASPEC , our variable interest entity. iASPEC is a PRC domestic company owned by Mr. Jiang Huai Lin, our Chairman and Chief Executive Officer, who is a PRC citizen and resident. iASPEC is able to obtain governmental licenses that are restricted to PRC entities that have no foreign ownership. These licenses allow iASPEC to perform Police-use Geographic Information Systems, or PGIS, services for PRC governmental customers. Under our MSA among our subsidiary, IST, iASPEC and Mr. Lin, IST is entitled to receive 95% of the net received profit of iASPEC during the term of the agreement, less costs and expenses related to sales and operations, and accrued but uncollected accounts receivable. In fiscal years 2011, 2010 and 2009, 47.1%, 39.1% and 48.6% of our revenues, respectively, were generated under this exclusive commercial arrangement with iASPEC.

Recent Developments

Effective March 1, 2012, we effected a one-for-two reverse split of our issued and outstanding common stock by filing a Certificate of Change pursuant to Section 78.209 of the Nevada Revised Statutes with the Secretary of State of Nevada. Each two shares of then issued and outstanding common stock were reverse split into one share of common stock, and each holder who would receive a fractional share as a result of the reverse split received one full share in lieu of the fractional share. The reverse split became effective on the NASDAQ Stock Market on March 2, 2012. Concurrently with the reverse stock split, the Certificate of Change is deemed to amend the Company’s Articles of Incorporation to decrease the authorized number of shares of the Company’s Common Stock from two hundred million (200,000,000) shares to one hundred million (100,000,000) shares.

Financial Performance Highlights

Some of our key business segments experienced slower public-sector sales for our products and services during the fiscal year ended December 31, 2011 than in previous years, which resulted in a decline in revenue and net income. The following are some financial highlights for the year:

  • Revenue: Revenue decreased $49.31 million, or 30.1%, to $114.54 million for the year ended December 31, 2011, from $163.85 million for 2010.

  • Gross profit: Gross profit decreased $26.24 million, or 37.19%, to $44.32 million for the year ended December 31, 2011, from $70.56 million for 2010. Gross margin decreased by 438 basis points to 38.69% in 2011 from 43.07% in 2010.

  • Net income: Net income decreased $26.9 million, or 75.84%, to $8.57 million for the year ended December 31, 2011, from $35.47 million for 2010. Net income margin decreased by 1,417 basis points to 7.48% in 2011 from 21.65% in 2010.

  • Net income attributable to the company: Net income attributable to the company was $7.91 million for the year ended December 31, 2011, as compared to $34.4 million for 2010, a 77.01% decrease. As a result, net margin decreased by 1,409 basis points to 6.91% in 2011 from 21% in 2010.

  • Fully diluted net income per share: Fully diluted net income per share was $0.29 for the year ended December 31, 2011, as compared to $1.32 for the same period in 2010, representing a decrease of 78.02%.

Principal Factors Affecting Our Financial Performance

Demand for Software Products and Services

The revenue growth and profitability of our business depend on the overall market demand for software products and related services. Over the past two decades, the PRC government has encouraged the development and use of new technologies for information and communication and their application in all spheres of government, industry, education and culture. The term “Informatization” or “xinxihua” has been coined in China to describe the overall process of ICT application in China and has in recent years become a linchpin of central and many local economic development strategies.

For example, the Golden Shield Program promotes the use of information technology for public security services; the Digital City Program aims to ultimately integrate the functions of multiple government departments by using the GIS technology; the Golden Health Program strives to improve the efficiency of public health care by using digital hospital technologies. All these initiatives are of top priority to the Chinese government and are driving the demand for our DPST, GIS and DHIS offerings.

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Taxation

CNIT is subject to United States tax at a tax rate of 34%. No provision for income taxes in the United States has been made as CNIT has no income taxable in the United States.

CITH was incorporated in the BVI, but is not subject to taxation in that jurisdiction.

ISSI, ISIID, and HPC were incorporated in Hong Kong and under the current laws of Hong Kong, and are subject to a Hong Kong Profits Tax of 16.5% .

Under the PRC’s EIT Law, Geo, iASPEC, Bocom, ISS and Zhongtian, are approved as High Technology Enterprises and are subject to EIT at a rate of 15%. Huipu is subject to EIT at a rate of 24%. IST benefitted from a two-year tax exemption, followed by a 50% exemption for three years, retroactive to as of January 1, 2007. 2011 was the fifth year that IST was entitled to the tax holiday and subject to a favorable tax rate of 12%. For 2012, IST will be subject to a 15% tax rate, as an approved High Technology Enterprise. See Item 1 “Business – Regulation – Taxation” for a detailed description of the EIT Law and tax regulations applicable to our PRC subsidiaries and variable interest entities.

Business Segment Information

Segment information is consistent with how management reviews the businesses, makes investing and resource allocation decisions and assesses operating performance. Transfers and sales between reportable segments, if any, are recorded at cost.

In connection with the changes in our business portfolio and realignment of management, management conducted a review of our operating business segments during the first quarter of 2011. The review resulted in changing the segment reporting.

Our new segment reporting, which has been used for all periods presented, follows the organizational structure reflected in our internal management reporting systems, which are the basis for assessing the financial performance of the business segments and for allocating resources to the business segments.

We report financial and operating information in the following two segments:

(1)

IT segment: IT includes revenues from products and services surrounding a variety of our software core competencies, currently primarily in GIS, DPST and DHIS. IT segment revenues are generated from the sales of software and system integration services, as well as hardware other than display products.

   
(2)

DT segment: DT includes revenues from products and services surrounding our display technology core competencies, currently primarily in GIS, DPST, education, media, and consumer products. DT segment revenues are generated from sales of hardware and total solutions of hardware integrated with proprietary software and content, as well as services.

For more information regarding our operating segments, see Note 16 (Consolidated Segment Data) to our audited consolidated financial statements included elsewhere in this report.

Results of Operations

Comparison of Years Ended December 31, 2011 and 2010

The following table sets forth key components of our results of operations for fiscal years ended December 31, 2011 and 2010, both in dollars and as a percentage of our revenue.

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    Year Ended December 31, 2011     Year Ended December 31, 2010  
          %           %  
    Amount     of Revenue     Amount     of Revenue  
Revenue $  114,535,553     100.00%   $  163,845,597     100.00%  
Costs of revenue   70,216,049     61.31%     93,282,442     56.93%  
Gross profit   44,319,504     38.69%     70,563,155     43.07%  
Administrative expenses   (22,785,631 )   (19.89% )   (18,623,523 )   (11.37)%  
Research and development expenses   (4,483,754 )   (3.91% )   (3,016,693 )   (1.84)%  
Selling expenses   (7,522,986 )   (6.57% )   (6,359,487 )   (3.88)%  
Income from operations   9,527,133     8.32%     42,563,452     25.98%  
Subsidy income   1,939,787     1.69%     948,630     0.58%  
Other (loss) income, net   538,624     0.47%     1,237,933     0.76%  
Interest income   317,190     0.28%     126,459     0.08%  
Interest expense   (2,948,406 )   (2.57% )   (1,539,407 )   (0.94)%  
Income before income taxes   9,374,328     8.18%     43,337,067     26.45%  
Income tax expense   (804,149 )   (0.70% )   (7,863,437 )   (4.80)%  
Net income   8,570,179     7.48%     35,473,630     21.65%  
Less: net income attributable to non-controlling interest   (660,781 )   (0.58% )   (1,071,626 )   (0.65)%  
Net income attributable to Company $  7,909,398     6.91%   $  34,402,004     21.00%  

Revenue. Our revenue is generated from the sales of our software and hardware products, our fully integrated total solutions, and the related after-sales services. For the year ended December 31, 2011, our revenue was $114.54 million, compared to $163.85 million for the year ended December 31, 2010, a decrease of $49.31 million, or 30.1% . The decrease was primarily due to the Chinese government’s implementation of macroeconomic tightening policies, which led to a slowdown in projects for our government customers, which traditionally have been our core customer base; and, secondarily due to the weak global demand and challenging industry dynamics for flat-screen TV products.

Product sales decreased by $6.89 million, or 12.93%, to $46.44 million for the year ended December 31, 2011, as compared to $53.33 million for the year ended December 31, 2010. Product sales constituted 40.54% of total revenue during 2011 as compared with 32.54% during 2010. The decrease in product sales primarily reflected 1) our efforts to transition our DT segment from the increasingly competitive and low-margin flat-screen TV market into the multi-functional and interactive display technology markets, which caused total product unit sales to fall, and 2) lower pricing of our traditional flat-screen TVs in the midst of increasing industry competition and weak global consumer demand for flat-screen TVs.

Software sales decreased by $51.12 million, or 56.53%, to $39.3 million for the year ended December 31, 2011, from $90.42 million for the year ended December 31, 2010. Software sales constituted 34.31% of our total revenue during 2011, compared with 55.19% during 2010. The decrease was mainly due to the Chinese government’s implementation of macroeconomic tightening policies and the curtailment of the massive government economic stimulus package, which led to a slowdown in software projects for our government customers. In addition, during 2011, the Company instituted more stringent customer acceptance policies, which limited new projects to those with solid credit credentials and long-term business prospects in light of the unfavorable government fiscal environment.

Sales of system integration services increased by $11.40 million, or 70.03%, to $27.68 million for the year ended December 31, 2011, as compared to $16.28 million for the year ended December 31, 2010. As a percentage of revenue, it increased from 9.94% during 2010 to 24.17% during 2011. Such growth primarily resulted from an increase in demand for system integration solutions in connection with the Shenzhen Summer Universiade, which was held in August 2011, and other new projects during 2011.

Other revenue decreased from $3.82 million for the year ended December 31, 2010 to $1.12 million for the year ended December 31, 2011, a decrease of $2.70 million, or 70.68% . Other revenue was mainly derived from maintenance services in 2011, while in 2010, in addition to maintenance services, we also generated royalty income from Huipu by licensing other manufacturers to use the HPC trademark.

The following table shows our revenue, percentage of revenue, cost of revenue and gross margin, by revenue categories:

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    Year Ended December 31, 2011     Year Ended December 31, 2010  
          % of     Cost of     Gross           % of     Cost of     Gross  
      Revenue     Revenue     Revenue     Margin     Revenue       Revenue     Revenue     Margin  
Products $  46,435,133     40.54%   $  36,815,966     20.72%   $  53,328,214     32.54%   $  46,052,309     13.64%  
Software   39,301,812     34.31%     13,302,464     66.15%     90,419,181     55.19%     38,574,738     57.34%  
System integration   27,678,685     24.17%     19,625,349     29.10%     16,278,860     9.94%     8,259,899     49.26%  
Others   1,119,923     0.98%     472,270     57.83%     3,819,342     2.33%     395,496     89.64%  
Total $  114,535,553     100.00%   $  70,216,049     38.69%   $ 163,845,597     100.00%   $  93,282,442     43.07%  

A breakdown of revenue, percentage of revenue, cost of revenue and gross margin by segments is as follows:

    Year Ended December 31, 2011     Year Ended December 31, 2010  
          % of     Cost of     Gross           % of     Cost of     Gross  
    Revenue     Revenue     Revenue     Margin     Revenue     Revenue     Revenue     Margin  
IT segment $  68,281,729     59.62%   $  33,078,316     51.56%   $  113,700,273     69.39%   $  53,403,510     53.03%  
DT segment   46,253,824     40.38%     37,137,733     19.71%     50,145,324     30.61%     39,878,932     20.47%  
Total $  114,535,553     100.00%   $  70,216,049     38.69%   $  163,845,597     100.00%   $  93,282,442     43.07%  

Cost of revenue and gross profit. As indicated in the tables above, our cost of revenue decreased $23.07 million, or 24.73%, to $70.22 million, for the year ended December 31, 2011, from $93.28 million for the year ended December 31, 2010. As a percentage of revenue, our cost of revenue increased to 61.31% during the year ended December 31, 2011, from 56.93% during the year ended December 31, 2010. As a result, gross profit as a percentage of revenue was 38.69% for the year ended December 31, 2011, a decrease of 438 basis points from 43.07% for the year ended December 31, 2010.

The decrease in gross profit margins, as displayed in the tables above, resulted from several factors. First, in 2011 we continued our effort to increase our DT solutions as a percentage of total revenues. The percentage of DT revenue increased from 30.61% during 2010 to 40.38% during 2011. The increase in contribution from DT revenues resulted in a decrease in gross profit margin for 2011 as our DT solutions business has lower average gross margins than other segments of our business. Second, due to the Chinese government’s implementation of macroeconomic tightening policies, our government customers reduced software project orders. As a result, the percentage of software revenue decreased from 55.19% during 2010 to 34.31% in 2011. The decrease in contribution from software revenues resulted in a decrease in gross profit margin for 2011 as, on average, software projects have higher average gross margins than other segments of our business. Third, the gross profit margin for our system integration business decreased from 49.26% during 2010 to 29.10% in 2011, primarily due to the high profit margin of certain projects in the 2010 period. Finally, the Company lowered its LCD TV prices in the face of increased competition and weak global consumer demand, while costs of manufacturing continued to rise in 2011. All of these factors resulted in a decrease in overall gross profit margin for the year ended December 31, 2011. However, as we became more selective with our acceptance of orders in an effort to improve the quality of our earnings, the gross margin for product and software sales were higher in the fiscal year ended December 31, 2011 compared to the fiscal year ended December 31, 2010.

Administrative expenses. Our administrative expenses consist primarily of compensation and benefits to our general management, finance and administrative staff, professional advisor fees, audit fees and other expenses incurred in connection with general operations. Administrative expenses increased by $4.16 million, or 22.35%, to $22.79 million for the year ended December 31, 2011, from $18.62 million for the year ended December 31, 2010. As a percentage of revenue, administrative expenses increased to 19.89% for 2011, from 11.37% for 2010. Notable changes year-over-year that resulted in increased administrative expenses were: First, inventory write downs increased by $6.63 million; and second, depreciation and amortization expenses increased by $1.41 million. These changes were offset by the decrease in share based compensation and bonus expenses to employees of $3.9 million. Our DT segment’s inventory was written down mainly for the following reasons: 1) the DT business’s transition from its traditional flat-screen TV products to multi-functional interactive digital display technologies resulted in some electronic components in inventory becoming incompatible with, and thus not usable for, the new advanced DT products; and 2) the global flat-screen, especially LCD TV market faced major challenges in 2011, including weak global consumer demand, a supply glut, and the emergence of new display technologies and products such as 3D-TV and OLED technology that is expected to replace LCD technology in the coming years, leading to the obsolescence of many flat-screen display products and components.

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Research and development expenses. Our research and development expenses consist primarily of personnel-related expenses, as well as costs associated with new software and hardware development and enhancement. Research and development expenses increased by $1.47 million, or 48.63%, to $4.48 million for the year ended December 31, 2011, from $3.02 million for the year ended December 31, 2010. As a percentage of revenue, research and development expenses increased to 3.91% for 2011, from 1.84% in 2010. The increase was primarily a result of our efforts in improving product profitability and developing new products.

Selling expenses. Our selling expenses consist primarily of compensation and benefits to our sales and marketing staff, sales and after-sales traveling costs, and other sales-related costs. Selling expenses increased $1.16 million, or 18.3%, to $7.52 million for the year ended December 31, 2011, from $6.36 million for the year ended December 31, 2010. As a percentage of revenue, our selling expenses increased to 6.57% for 2011, from 3.88% for 2010. The increase in selling expenses reflected our heightened efforts in our PRC market expansion.

Subsidy income. For the years ended December 31, 2011 and 2010, in connection with research and development activities in a designated locale, we received $1,939,787 and $948,630, respectively, as a subsidy from the local governmental agency in China.

Other income, net. Other income, net of $538,624 for the year ended December 31, 2011, a decrease from $1.2 million from the previous year. The decrease was the result of a loss from the disposal of inventory of approximately $0.76 million during the current year. The decrease was offset by the change in the estimated fair value of contingent shares paid towards the HPC acquisition. The gain of approximately $1.48 million resulted from a decrease in the fair value of the liability associated with issuing contingent consideration that was recorded during the year ended December 31, 2011. Because our stock price declined during the year, the contingent liability, which is based on our stock price, also decreased in fair value. This decrease in contingent liability resulted in an increase in our income.

Income tax expense. Income tax expense for the year ended December 31, 2011 was $0.8 million, a decrease from $7.86 million for the year ended December 31, 2010. The decrease was largely due to the following factors: a) income before taxes from PRC subsidiaries decreased $39.59 million, causing approximately $5.94 million of the decrease; and b) our subsidiary, ISS, obtained the High Technology Enterprise designation during 2011 and was approved for the EIT rate of 15% with retroactive effect to fiscal year 2010, causing approximately $0.5 million of the decrease.

Non-controlling interest. Non-controlling interest of $0.66 million for the year ended December 31, 2011 represents the $0.39 million fee retained by iASPEC under the MSA, and $0.27 million of Geo retained by the 47.46% non-controlling interest in Geo.

Net income attributable to Company. As a result of the cumulative effect of the foregoing factors, net income attributable to the Company decreased $26.49 million, or 77.01%, to $7.91 million for the year ended December 31, 2011, from $34.4 million for the year ended December 31, 2010.

Comparison of Years Ended December 31, 2010 and 2009

The following table sets forth key components of our results of operations for fiscal years ended December 31, 2010 and 2009, both in dollars and as a percentage of our revenue.

    Year Ended December 31, 2010     Year Ended December 31, 2009  
          %           %  
    Amount     of Revenue     Amount     of Revenue  
Revenue $  163,845,597     100.00%   $  100,996,094     100.00%  
Costs of revenue   93,282,442     56.93%     50,344,427     49.85%  
Gross profit   70,563,155     43.07%     50,651,667     50.15%  
Administrative expenses   (18,623,523 )   (11.37)%   (12,653,175 )   (12.53)%
Research and development expenses   (3,016,693 )   (1.84)%   (2,705,669 )   (2.68)%
Selling expenses   (6,359,487 )   (3.88)%   (3,136,380 )   (3.11)%
Income from operations   42,563,452     25.98%     32,156,443     31.84%  
Subsidy income   948,630     0.58%     833,429     0.83%  
Other income (loss), net   1,237,933     0.76%     1,153,288     1.14%  
Interest income   126,459     0.08%     270,666     0.27%  
Interest expenses   (1,539,407 )   (0.94)%   (388,686 )   (0.38)%
Income before income taxes   43,337,067     26.45%     34,025,140     33.70%  
Income tax expense   (7,863,437 )   (4.80)%   (3,887,495 )   (3.85)%
Net income   35,473,630     21.65%     30,137,645     29.84%  
Less: net income (loss) attributable to non-controlling interest   (1,071,626 )   (0.65)%   (43,076 )   -  
Net income attributable to Company $  34,402,004     21.00%   $  30,094,569     29.80%  

40


Revenue. For the year ended December 31, 2010, our revenue was $163.85 million, compared to $101 million for the year ended December 31, 2009, an increase of $62.85 million, or 62.23% . The total revenue exceeded our plan primarily because progress on a few contracts was accelerated at client’s requests. In addition, our new offering of display technology products turned out faster than expected. Finally, we also liquidated some of HPC’s inventory that is not aligned with the new strategic direction as part of the restructuring process. During the year, Huipu, which was acquired in October 2009, contributed $42.26 million to revenues. Excluding the impact of Huipu, organic revenue growth was 26.23% .

Product sales increased by $36.54 million, or 217.72%, for the year ended December 31, 2010, as compared to $16.78 million for the year ended December 31, 2009, primarily due to the sales of display technology products and the liquidation of HPC’s inventory described earlier. Product sales constituted 32.55% of total revenue during 2010 as compared with 16.62% during 2001. Excluding the impact of Huipu, the percentage of organic product revenues decreased to 11.99% for 2010, from 12.35% for 2009.

Software sales increased by 41.66% to $90.42 million for the year ended December 31, 2010, from $63.83 million for the year ended December 31, 2009. Software sales constituted 55.19% of our total revenue for 2010, as compared to 63.20% for 2009. Excluding the impact of Huipu, software sales were 74.37% of organic revenues, which reflects our continued commitment to our core competency in software.

Sales of system integration services decreased by 14.40% for the year ended December 31, 2010, as compared to the year ended December 31, 2009. As a percentage of revenue, it declined from 18.83% during 2009 to 9.94% during 2010. Excluding the impact of Huipu, system integration was 13.39% of organic revenues.

Other revenue increased by 179.60%, from $1.37 million in the year ended December 31, 2009 to $3.82 million in the year ended December 31, 2009. Other revenue mainly derived from maintenance services in 2009, while in 2010, other income consisted of both maintenance services and royalty income from Huipu by licensing other manufacturers to use the HPC trademark.

The following table shows our revenue, percentage of revenue, cost of revenue and gross margin, by revenue categories:

    Year Ended December 31, 2010     Year Ended December 31, 2009  
        % of     Cost of     Gross     Revenue     % of     Cost of     Gross  
     Revenue      Revenue     Revenue     Margin           Revenue     Revenue     Margin  
Products $  53,328,214     32.54%   $  46,052,309     13.64%   $  16,784,910     16.62%   $  13,560,279     19.21%  
Software   90,419,181     55.19%     38,574,738     57.34%     63,827,233     63.20%     22,229,542     65.17%  
System integration   16,278,860     9.94%     8,259,899     49.26%     19,017,962     18.83%     14,251,391     25.06%  
Others   3,819,342     2.33%     395,496     89.64%     1,365,989     1.35%     303,215     77.80%  
Total $  163,845,597     100.00%   $  93,282,442     43.07%   $  100,996,094     100%   $  50,344,427     50.15%  

A breakdown of revenue, percentage of revenue, cost of revenue and gross margin by segments is as follows:

    Year Ended December 31, 2010     Year Ended December 31, 2009  
          % of     Cost of     Gross           % of     Cost of     Gross  
    Revenue     Revenue     Revenue     Margin     Revenue     Revenue     Revenue     Margin  
IT segment $  113,700,273     69.39% $     53,403,510     53.03%   $  89,665,844     88.78% $     41,990,839     53.17%  
DT segment   50,145,324     30.61%     39,878,932     20.47%     11,330,250     11.22%     8,353,588     26.27%  
Total $  163,845,597     100.00%   $  93,282,442     43.07%   $  100,996,094     100.00%   $  50,344,427     50.15%  

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Cost of revenue and gross profit. As indicated in the tables above, our cost of revenues increased $42.94 million, or 85.29%, to $93.28 million, for the year ended December 31, 2010, from $50.34 million for the year ended December 31, 2009. As a percentage of revenues, our cost of revenue increased to 56.93% in 2010, from 49.89% in 2009. As a result, gross profit as a percentage of revenue was 43.07% for the year ended December 31, 2010, a decrease of 7.08%, from 50.15% the year ended December 31, 2009. Huipu yielded a gross margin of 16.81% . Excluding the impact of Huipu, gross margin of organic business was 52.19%, exceeding the organic gross margin of 51.84% in 2009. Such an increase in organic gross margin is primarily due to the increased weight of software business relative to total organic business.

The decrease in the overall gross margin resulted from a number of factors. First, during 2010, our product sales increased in weight relative to total revenues. Such increase was accelerated due to the clearance of HPC’s non-strategic inventory as well as our faster-than expected sales of display technology products. Since the average gross margin of products is lower than the other categories of revenues, the overall gross margin declined. Meanwhile, gross margin of product categories declined by 557 basis points mostly because the clearance of HPC’s non-strategic inventory was done at cost and the sales of the new display technology products did not enjoy economies of scale due to the low volume in the beginning. In addition, we experienced decline of gross margins of software on a year-over-year basis. This is because we were engaged in larger software projects on average than 2009, and larger projects generally offer lower profit margin than smaller ones. The negative impact on gross margin from the above factors was partially mitigated by the improvement in profitability in system integration and increased weight in other revenues.

For the year ended December 31, 2010, approximately $53.4 million of our cost of revenues was attributable to our IT segment and $39.88 million was attributable to our DT segment, compared to $41.99 million to our IT segment and $8.35 million to our DT segment, respectively, for the year ended December 31, 2009.

Administrative expenses. Our administrative expenses increased by $5.97 million, or 47.18%, to $18.62 million for the year ended December 31, 2010, from $12.65 million for the year ended December 31, 2009. As a percentage of revenue, administrative expenses decreased to 11.37% for 2010, from 12.53% for 2009. Some notable changes that resulted in the increase of administrative expenses are the increase in stock-based compensation expenses of $1.67 million, and the increase in depreciation and amortization expenses of $1.85 million, partly because the depreciation and amortization expenses of HPC impacted the full year of 2010, whereas they only affected the last three months of 2009. Also contributing to the increase was the addition of property, plant and equipment for future business growth and the addition of provision for long term investment in Tianhe of $0.85 million. Also contributing was the increase of bad debt provision for accounts receivable of $0.89 million. Also contributing to the increase were the expenses incurred in new representative offices.

Research and development expenses. Our research and development expenses increased by $0.31 million, or 11.5%, to $3.02 million for the year ended December 31, 2010, from $2.71 million for the year ended December 31, 2009. As a percentage of revenue, research and development expenses decreased to 1.84% for 2010, from 2.68% in 2009. Such decrease was due to the fact that research and development investments made from prior years are yielding scalable effects in revenue growth.

Selling expenses. Our selling expenses increased $3.22 million, or 102.77%, to $6.36 million for the year ended December 31, 2010, from $3.14 million for the year ended December 31, 2009. As a percentage of revenue, our selling expenses increased to 3.88% for 2010, from 3.11% in 2009. The selling expenses outpacing revenue growth reflects our heightened efforts in national market expansion.

Subsidy income. For the years ended December 31, 2010 and 2009, in connection with research and development activities in a designated locale, we received approximately $948,630, $833,429, respectively, as a subsidy from the local governmental agency in China.

Income tax expense. Income tax expense increased $3.98 million, or 102.28%, to $7.86 million for the year ended December 31, 2010, from $3.89 million for the year ended December 31, 2009. The increase was mainly due to the increase in pre-tax income and an increase in our effective income tax rate from 11.43% in 2009 to 18.14% in 2010 as a result of the tax unification program in China.

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Non-controlling interest. Non-controlling interest of $1,071,626 for the year ended December 31, 2010 represents the $893,316 fee retained by iASPEC under the MSA and $178,310 of Geo’s profit attributable to its 47.46% non-controlling interest.

Net income attributable to Company. As a result of cumulative effect of the foregoing factors, net income attributable to the Company increased $4.31 million, or 14.31%, to $34.4 million for the year ended December 31, 2010, from $30.09 million for the year ended December 31, 2009.

Liquidity and Capital Resources

As of December 31, 2011, we had cash and cash equivalents of $14.02 million.

Our customers have historically been primarily public sector entities that use our products and services to improve the service quality and management level and efficiency of public security, traffic control, fire control, medical rescue, border control, surveying, mapping, and healthcare management. Over the past several years, especially during 2011 and 2010, we diversified our customer base beyond our historical geographic reach, and expanded our market and product offerings in the public and private sectors, through geographic expansion and the enhancement of our technical capabilities. Along with our expansion in the market, our customer base of accounts receivable increased from 234 as of December 31, 2009, to 289 as of December 31, 2010, and to 378 as of December 31, 2011.

Due to the Chinese government’s implementation of macroeconomic tightening policies since the second quarter of 2011, government customers have slowed their payment of our accounts receivables. Historically, government customers generated over half of our revenues. As a result, the percentage of total accounts receivable attributable to government customers increased to 80% as of December 31, 2011 from 77% as of December 31, 2010.

As the increase in our customer base and sales were primarily a result of an increase in non-public sector customers, the risk of recoverability increased compared with previous periods. Additionally, although we have had no significant experience of failure in the collection of accounts receivable from government customers, the recent slowdown in payments described above has caused us to view these customers’ risk of recoverability as having increased. In this regard, we further noted that turnover days of accounts receivable increased. The accounts receivable that were outstanding for longer than one year accounted for 52% of total accounts receivable as of December 31, 2011 and 6% as of December 31, 2010, and government customers accounted for 91% of all receivables outstanding for longer than one year as of December 31, 2011 compared to 57% as of December 31, 2010.

We generally do not consider receivables from government customers to be past due at any particular point in time primarily for the following reasons: PRC government entities are very safe customers in that they are generally well-established and able to access credit more easily than private-sector customers; we have generally had good collection histories with these customers; the recent government macroeconomic tightening policies have affected government customers relatively equally, and we therefore believe that the resulting slowdown in payments from such customers is outside their immediate control. We also view government customers as important to our business. As a result, we have continued sales relationships with most PRC government customers and extended flexible repayment terms to them, including with respect to those that have slowed down their payments to us.

With respect to private-sector customers, we generally provide for a payment period of 90 days. Typically we are willing to extend the payment period to up to 120 days. For payment extensions beyond this time, we typically evaluate private-sector customers based on the criteria described in Note 2(f) to the audited financial statements contained in this report. Due to their differing credit histories and periods of operations, as described above, we consider the risk of recoverability for these customers to be higher than public-sector customers. However, we have generally been willing to continue the sales relationship with these customers and allow for additional time for them to make payments upon receipt of assurances that payment will be received as soon as practicable, in light of our aim to diversify our customer base and expand our market penetration. All accounts receivables with aging over two years with non-government customers are fully reserved.

Management performs ongoing credit evaluations, and we maintain an allowance for potential credit losses based upon our loss history and our aging analysis. We estimated that the amount of probable credit losses in existing accounts receivable was equal to the allowance for doubtful accounts of $9.37 million at December 31, 2011 and $6.07 million at December 31, 2010. The following table describes the movement in the allowance for doubtful accounts during the year ended December 31, 2011:

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Balance at January 1, 2011 $  6,072,644  
Increase in allowance for doubtful accounts   6,169,941  
Amounts recovered during current period   (3,145,063 )
Foreign exchange difference   275,804  
Balance at December 31, 2011 $  9,373,326  

The following table summarizes the key cash flow components from our consolidated statements of cash flows for the periods indicated.

Cash Flow
(all amounts in U.S. dollars)

    Year Ended December 31,  
    2011     2010     2009  
Net cash provided by operating activities $  16,341,327   $  26,949,537   $  11,477,783  
Net cash used in investing activities   (18,626,690 )   (60,871,618 )   (14,664,274 )
Net cash (used in) provided by financing activities   (2,169,334 )   37,080,368     7,113,658  
Effects of exchange rate changes on cash and cash equivalents   307,474     1,529,937     (13,786 )
Net (decrease) increase in cash and cash equivalents   (4,147,223 )   4,688,224     3,913,381  
Cash and cash equivalents at beginning of the year   18,166,857     13,478,633     9,565,252  
Cash and cash equivalents at end of the year $  14,019,634   $  18,166,857   $  13,478,633  

Operating Activities

Net cash provided by operating activities was $16.34 million for the year ended December 31, 2011, a decrease from $26.95 million for the year ended December 31, 2010. The decrease was primarily due to an increase in our accounts receivable turnover days during 2011. Many government customers slowed down their payments as a result of China’s implementation of macroeconomic tightening policies. Because over half of our total revenues are generated from government projects, accounts receivable turnover days increased from 192 days during 2010 to 322 days during 2011.

Net cash provided by operating activities was $26.95 million for the year ended December 31, 2010, an increase of $15.47 million or, 134.8%, from $11.48 million for the year ended December 31, 2009. This increase far outpaced revenue growth of 62.23% . Such an increase was primarily due to the improvements in working capital turnover, including the speeding up of the turn-over of accounts receivable and inventories.

Investing Activities

Net cash used in investing activities was $18.63 million for the year ended December 31, 2011, as compared to $60.87 million for the year ended December 31, 2010. The decrease was primarily due to: a) a $25.31 million deposit for purchasing land use rights during 2010; b) a $13.08 million decrease in property and equipment purchases during 2011 as compared with 2010, and c) a $2.96 million decrease in software purchases during 2011 as compared with 2010.

Net cash used in investing activities was $62.36 million for the year ended December 31, 2010, as compared to $14.66 million for the year ended December 31, 2009. Approximately $25.31 million of the total was used as the deposit for purchasing land use rights under local government incentives. Details have been provided in Note 10(a) of the financial statements contained in this report and Note 17 (Subsequent Event) of the financial statements contained in our Form 10Q/A for the quarterly period ended June 30, 2010. Approximately $32.82 million was used to purchase machineries, equipment and software as an investment for future business expansion.

Financing Activities

Net cash used in financing activities was $2.17 million for the year ended December 31, 2011, as compared to $37.08 million net cash provided by financing activities for the year ended December 31, 2010. The change was mainly attributable to the net proceeds of $9.38 million raised from an offering of common stock during 2010, and a decrease in net borrowings of $28.59 million during 2011 as compared with 2010.

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Net cash provided by financing activities increased to $37.08 million during the year ended December 31, 2010, as compared to $7.11 million during the year ended December 31, 2009. The increase was mainly attributable to the net proceeds of $9.38 million raised in issuing of common stock, an increase in net bank borrowings of $22.44 million, and an increase in net borrowings from shareholders’ long-term loan of $5 million. Geo also received capital injection of $1.74 million from minority shareholders.

Loan Facilities

As of December 31, 2011 and 2010, our loan facilities were as follows:

Short-term bank loans

    As of December 31,  
    2011     2010  
Secured short-term loans $  39,177,186   $  33,051,066  
Add: amounts due within one year under long-term loan contracts   1,806,271     2,275,500  
Total short-term bank loans $  40,983,457   $  35,326,566  

Long-term bank loans

    As of December 31,  
    2011     2010  
Secured long-term loans $  1,915,795   $  8,138,705  
Less: amounts due within one year under long-term loan contracts   (1,806,271 )   (2,275,500 )
Total long-term bank loans $  109,524   $  5,863,205  

The covenants or financial restrictions related to our outstanding debt obligations as of December 31, 2011 are as follows: (1) a certain subsidiary that is party to the loan should maintain a certain level of tangible assets; (2) the subsidiary should maintain a certain level of cash in its bank accounts; and (3) the subsidiary should inform the bank 30 days before any of the following events occurs (if the bank determines that such event will cause a material impact to the bank loan, the subsidiary may perform the event only upon receipt of the approval of the bank):

  • dispose material assets constituting over 10% of the total net assets by sale, bestowment, lending, transfer, mortgage, pledge or any other means;

  • profit distribution over 30% of the current year’s after tax profits, or over 20% of the total retained earnings; and

  • new investments by the subsidiary outside its current operations which constitute over 20% of its net assets.

As of December 31, 2011, we were in compliance with the above covenants.

Our short-term loan balances as of December 31, 2011 and 2010 were $40.98 million and $35.33 million, respectively. As a percentage of working capital, short-term bank loans accounted for approximately 66.21% and 60.06% as of December 31, 2011 and 2010, respectively. The increase in reliance on bank borrowings to fund working capital in 2011 was mainly due to our efforts to increase display technology R&D and sales. As our newer manufacturing business requires more working capital than our traditional business of software technology and system integration technology, we needed to borrow more to fund working capital needs. As we introduce new products in new markets in 2012, we expect to continue to rely on bank borrowings to fund working capital.

We believe that our current cash and cash equivalents and anticipated cash flow from operations will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our existing cash and amounts available under existing credit facilities is insufficient to meet our requirements, we may seek to sell additional equity securities, debt securities, or borrow from lending institutions. We can make no assurances that financing will be available in the amounts we need, or on terms acceptable to us, if at all. The sale of additional equity securities, including convertible debt securities, would dilute the interests of our current shareholders. The incurrence of debt would divert cash for working capital and capital expenditures to service debt obligations and could result in operating and financial covenants that restrict our operations and our ability to pay dividends to our shareholders. If we are unable to obtain additional equity or debt financing as required, our business operations and prospects may suffer.

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Intracompany Transfers

Our subsidiaries that are organized in the PRC may pay dividends only out of their accumulated profits and our PRC subsidiaries are required to set aside at least 10% of their after-tax profit to their general reserves until such reserves cumulatively reach 50% of their respective registered capital. Our PRC subsidiaries’ general reserves are not distributable as cash dividends. Restrictions on our net assets also include the conversion of local currency into foreign currencies, tax withholding obligations on dividend distributions, the need to obtain SAFE approval for loans to a non-PRC consolidated entity and the covenants or financial restrictions related to outstanding debt obligations. We are not aware of other restrictions on our net assets or the transferability of assets via loans or advances to our non-PRC consolidated entities. As our operations are principally based in China, our non-PRC consolidated entities do not have material cash obligations.

The following table provides the amount of our statutory general reserve, the amount of restricted net assets, consolidated net assets, and the amount of restricted net assets as a percentage of consolidated net assets, as of December 31, 2011 and 2010:

    December 31,     December 31,  

 

  2011     2010  

 

           

PRC general reserve

$  14,488,533$     12,968,985  

Restricted net assets and retained earnings related to covenants of existing bank loans

  18,595,200     18,204,400  

 Total restricted net assets

$  33,083,733 $     31,173,385  

Consolidated net assets

$  230,866,530$     207,072,687  

Restricted net assets as percentage of consolidated net assets

  14.33%     15.05%  

An offshore holding company, as a shareholder of an FIE, can make loans to the FIE, provided the parties comply with PRC regulations governing such loans. Our parent company can make a shareholder loan to a PRC subsidiary provided that (i) the amount of the loan does not exceed the difference between the total investment and registered capital as approved by the local Administration for Industry and Commerce that issued the business license of the subsidiary; and (ii) before the loan can be converted into RMB, the subsidiary reports to SAFE the intended use of proceeds (which cannot be to purchase domestic assets). The subsidiary can finance the operations of iASPEC in accordance with the terms of the MSA.

Obligations Under Material Contracts

The following table sets forth our material contractual obligations as of December 31, 2011:

      Payments Due by Period  
                              More  
            Less than                 than  
Contractual Obligations     Total     1 year     1-3 years     3-5 years     5 years  

Operating Lease Obligations

  $  507,416   $  347,781   $  159,635   $  -   $  -  

Purchase Obligations

    5,299,708     5,299,708     -     -     -  

Interest payable on long-term bank loans

    102,454     82,764     13,312     6,378     -  

Long-term bank loans

    1,915,795     1,806,271     71,042     38,482     -  

Total

  $  7,825,373   $  7,536,524   $  243,989   $  44,860   $  -  

Critical Accounting Policies

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

critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following:

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  • Goodwill

    Prior to the beginning of the 2011 fiscal year, management reviewed our businesses so as to make investing and resource allocation decisions and assess operating performance from the perspective of our operating segments, which at the time consisted of our GIS segment, DPST segment, DHIS segment, and Other Products and Services, or Other, segment. In connection with the changes in our business portfolio and realignment of management’s decision-making process, management conducted a review of its operating segments during the first quarter of 2011, which resulted in two new segments, IT and DT. Accordingly, we reallocated our goodwill from each of the four segments to one or both of the two new segments since the first quarter of 2011. The former and current allocations of goodwill by reportable segments were as follows as at December 31, 2010:

   (All amounts in U.S. dollars)    
  Goodwill    
   
  Former segments     Current segments  
            IT     DT        
            segment     segment     Total  
  DPST   19,363,966     2,625,551     16,738,415     19,363,966  
  GIS   13,416,896     4,178,278     9,238,618     13,416,896  
  DHIS   19,137,413     19,137,413     -     19,137,413  
  Other   -     -     -     -  
  Total $  51,918,275   $  25,941,242   $  25,977,033 $     51,918,275  

In accordance with FASB ASC topic 350, we review goodwill impairment annually or more frequently if an event occurs or circumstances change that would reduce the fair value below its carrying value. Due to the Chinese government’s implementation of its macroeconomic tightening policies, our revenue decreased significantly, especially software technology sales during the fiscal year ended December 31, 2011. Although we do not view the slowdown of our growth as a significant adverse change in our business, we performed the goodwill impairment test for the fiscal year ended December 31, 2011.

We used the discounted cash flow method to estimate the fair value of goodwill. The goodwill impairment analysis is a two step test on each reporting unit. Prior to the beginning of the 2011 fiscal year, we considered each subsidiary as one reporting unit, and we used the discounted cash flow method on each reporting unit. During the first fiscal quarter of 2011, we grouped some reporting units with similar economic characteristics together and redefined our reporting units to be our IT and DT operating segments. Determining the fair value of a reporting unit involved the use of significant estimates and assumptions, such as revenue growth rate, gross profit rate, and discount rate. The average revenue increase rate used in the cash flow models approximately ranged from 9% to 11% depending on the reporting unit over the initial five-year forecast period. The discount rate used in the cash flow models was approximately 11.43%, which was calculated by using weighted average cost of capital.

Based on the above calculation in our cash flow models, the test results indicated that the fair value of each reporting unit exceeded its carrying value. The percentage of the excess of the fair value over carrying value of our reporting units ranged from 14% to 41%. We believe that our DT segment reporting unit, whose fair value exceeded its carrying value by approximately 14%, is at risk of failing step one of the goodwill impairment test in the future. During the fiscal year ended December 31, 2011, the Company put more effort in developing its DT business, and revenues generated by the reporting unit increased during this period as compared to the fiscal year ended December 31, 2010. Though management has confidence that it will continue to develop the fair value of our DT segment, we intend to closely monitor any event or change in circumstances that could negatively affect the key assumptions relating to this reporting unit.

Our valuation techniques could yield variable results based on changes in assumptions such as the discount rate and net income increase rate. We performed a sensitivity analysis that indicated that if the discount rate ranged from 10% to 13%, the revenue increase rate ranged from 6% to 8%, the fair value of each reporting unit would continue to exceed the carrying value, and that no goodwill impairment is required.

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Goodwill by segment as of December 31, 2011 and December 31, 2010 was as follows:

(All amounts in U.S. dollars)

  Goodwill   December     December  
      31, 2011     31, 2010  
              IT Segment $  26,980,194   $  25,941,242  
              DT Segment   27,003,493     25,977,033  
  Total $  53,983,687   $  51,918,275  

    Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation shall be treated as assets and liabilities of the foreign operation. Thus they shall be expressed in the functional currency of the foreign operation and shall be translated at the closing rate. As our acquired subsidiaries’ functional currency is RMB, goodwill arising on these acquisitions is denominated in RMB. As our presentation currency is USD, the change of goodwill balance represents the foreign exchange difference between each period or year end.

  • Revenue Recognition—Revenues from products are recognized only when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price to the customer is fixed or determinable, and collectability is reasonably assured. Generally, revenue is recognized (1) upon shipment for equipment and software, (2) as work is performed for professional services and (3) in equal periodic amounts over the term of the contract for software and hardware maintenance.
    The majority of revenues are generated from fixed-price contracts, which provide for licenses to software products, and services to customize such software to meet customers’ use. Generally, when the services are determined to be essential to the functionality of the delivered software, revenue is recognized using the percentage of completion method of accounting. The percentage of completion for each contract is estimated based on the ratio of direct labor hours incurred to total estimated direct labor hours. We review accounts receivable for allowances whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable, losses on accounts receivable are provided when they become evident.

  • Accounts Receivable—We regularly evaluate and monitor the creditworthiness of each customer on a case-by-case basis. We include any account balances that are determined to be uncollectible in an allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. The allowance for doubtful accounts at December 31, 2011 and 2010, totaled $9,373,000 and $6,073,000 respectively, representing management’s best estimate.

  • Inventories —We value inventories at the lower of cost or market. Market is the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated costs necessary to make the sale. We perform an analysis of slow-moving or obsolete inventory periodically and any necessary valuation reserves, which could potentially be significant, are included in the period in which the evaluations are completed.  Inventory impairments result in a new cost basis for accounting purposes.

  • Income Taxes - Income taxes are provided on an asset and liability approach for financial accounting and reporting of income taxes. Deferred income taxes are recognized for all significant temporary differences at enacted rates and classified as current or non-current based upon the classification of the related asset or liability in the financial statements. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion of, or all, the deferred tax asset will not be realized. The Company classifies interest and/or penalties related to unrecognized tax benefits, if any, as a component of income tax provisions.

Recent Accounting Pronouncements

Please refer to Note 2 to our audited financial statements included elsewhere in this report for a discussion of relevant pronouncements.

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Seasonality

The first quarter of the calendar year is typically the slowest season of the year due to the Chinese New Year holiday. During this period, accounts receivable collection is very slow and we also need to prepare for upcoming busier seasons by making payments for inventory.

Inflation

Inflation does not materially affect our business or the results of our operations.

Off-Balance Sheet Arrangements

We do not have any off-balance arrangements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Interest Rate Risk

We deposit surplus funds with Chinese banks earning daily interest. We do not invest in any instruments for trading purposes. Most of our outstanding debt instruments carry fixed rates of interest. Our operations generally are not directly sensitive to fluctuations in interest rates. The amount of long-term debt outstanding as of December 31, 2011 and 2010 was $0.11 million and $5.86 million, respectively. A hypothetical 1.0% increase in the annual interest rates for all of our credit facilities under which we had outstanding borrowings at December 31, 2011 would decrease net income before income taxes by approximately $95,000, or less than 1% for the year ended December 31, 2011. Management monitors the banks’ prime rates in conjunction with our cash requirements to determine the appropriate level of debt balances relative to other sources of funds. We have not entered into any hedging transactions in an effort to reduce our exposure to interest rate risk.

Foreign Exchange Risk

While our reporting currency is the U.S. dollar, substantially all of our consolidated revenues and consolidated costs and expenses are denominated in RMB. Substantially all of our assets are denominated in RMB except for cash. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. dollar and the RMB. If the RMB depreciates against the U.S. dollar, the value of our RMB revenues, earnings and assets as expressed in our U.S. dollar financial statements will decline. Assets and liabilities are translated at exchange rates at the balance sheet dates and revenue and expenses are translated at the average exchange rates and equity is translated at historical exchange rates. Any resulting translation adjustments are not included in determining net income but are included in determining other comprehensive income, a component of equity. An average appreciation (depreciation) of the RMB against the U.S. dollar of 5% would increase (decrease) our comprehensive income by $14.94 million based on our outstanding revenues, costs and expenses, assets and liabilities denominated in RMB as of December 31, 2011. As of December 31, 2011, our accumulated other comprehensive income was $19.93 million. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.

The value of RMB against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. Since July 2005, RMB has not been pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future, PRC authorities may lift restrictions on fluctuations in RMB exchange rate and lessen intervention in the foreign exchange market.

Inflation

Inflationary factors such as increases in the cost of our product and overhead costs may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net revenues if the selling prices of our products do not increase with these increased costs.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Consolidated Financial Statements

The full text of our audited consolidated financial statements for the years ended December 31, 2011, 2010 and 2009 begins on page F-1 of this report.

Quarterly Financial Results

The following table sets forth certain unaudited financial information for each of the eight quarters ended December 31, 2011. The consolidated financial statements for each of these quarters have been prepared on the same basis as the audited consolidated financial statements included in this annual report and, in the opinion of management, include all adjustments necessary for the fair presentation of the results of operations for these periods. This information should be read together with our audited consolidated financial statements and the related notes included elsewhere in this annual report.

 Year 2011     
                         
    1st Quarter     2nd Quarter     3rd Quarter     4th Quarter  
Revenue $  26,948,748   $  27,887,779   $  28,462,571   $  31,236,455  
Gross profit   13,654,840     11,922,556     9,485,348     9,256,760  
Income before income taxes   9,174,573     5,567,461     906,875     (6,274,581 )
Net income $  8,094,055   $  5,328,021   $  895,068   $  (5,746,965 )(1)
Basic income per share $  0.31   $  0.20   $  0.03   $  (0.25 )
Diluted income per share $  0.31   $  0.20   $  0.03   $  (0.25 )
                         

(1) The primary reasons for the net loss in the fourth quarter 2011 were (1) approximately $ 3.16 million of allowance for doubtful accounts was recognized in accounts receivable, and (2) the inventory impairment of approximately $4.51 million was recognized in the fourth quarter.

 Year 2010     
                         
    1st Quarter     2nd Quarter     3rd Quarter     4th Quarter  
Revenue $  25,305,107   $  33,516,888   $  43,806,131   $  61,217,471  
Gross profit   11,117,453     16,798,306     21,085,593     21,561,803  
Income before income taxes   7,563,010     11,817,789     12,832,281     11,123,987  
Net income $  6,391,927   $  9,654,180   $  10,470,688   $  8,956,835  
Basic income per share $  0.24   $  0.36   $  0.42   $  0.32  
Diluted income per share $  0.24   $  0.36   $  0.42   $  0.32  

Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly net earnings per share will not necessarily equal the total for the year. All share and earnings per share information in this item has been retroactively adjusted to reflect a one-for-two reverse stock split effected on March 1, 2012.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). 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 Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

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As required by Rule 13a-15(e), our management has carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer, Mr. Jiang Huai Lin and our Chief Financial Officer, Mr. Daniel K. Lee, of the effectiveness of the design and operation of our disclosure controls and procedures, as of December 31, 2011. Based upon, and as of the date of this evaluation, Messrs. Lin and Lee, determined that, as of December 31, 2011, and as of the date of this report, our disclosure controls and procedures were effective.

Management’s Annual Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our chief executive officer and chief financial officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP, 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 our assets;

  • provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and

  • provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Because of 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.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. In making this assessment, management used the framework set forth in the report entitled Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company’s internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Based on our assessment, we determined that, as of December 31, 2011, our internal control over financial reporting was effective based on those criteria.

Our independent registered public accounting firm, GHP Horwath, P.C., has issued an audit report on our internal control over financial reporting. Their audit report is set forth under Item 8 of this report.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the fourth quarter of fiscal year 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B. OTHER INFORMATION.

There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors.

We have no information to disclose that was required to be disclosed in a report on Form 8-K during the fourth quarter of fiscal year 2011, but was not reported.

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PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

Directors and Executive Officers

The following sets forth information about our directors and executive officers:

NAME   AGE*   POSITION
Jiang Huai Lin   42   President, Chief Executive Officer, and Chairman of the Board
Daniel K. Lee   40   Chief Financial Officer
Zhi Xiong Huang   42   Chief Technology Officer
Yi Fu Liu   38   Chief Marketing Officer
Zhi Qiang Zhao   40   Director and Chief Operating Officer
Yun Sen Huang   65   Director
Qiang Lin   65   Director
Remington Hu   44   Director
*As of December 31, 2011.        

Mr. Jiang Huai Lin. Mr. Lin has been a member of our Board of Directors since September 6, 2006 and he became our President and Chief Executive Officer on October 3, 2006. Mr. Lin has also served as the Chairman and Chief Executive Officer of our subsidiary, IST, since its incorporation in January 2006. During the period from September 2000 to June 2004, Mr. Lin served as the President and Chief Executive Officer of Hong Kong United Development Group, a consolidated enterprise engaging in investment, high technology and education. Before that, during the period from February 1995 through August 2000, Mr. Lin was a Director and the General Manager of Fujian Wild Wolf Electronics Limited, a company engaged in the business of manufacturing electrical consumer products. Mr. Lin holds a Master’s degree in Software Engineering from Wuhan University and a Bachelor’s degree in Industrial Accounting from Xiamen University.

Mr. Daniel K. Lee. Mr. Lee has been our Chief Financial Officer since December 12, 2011. Prior to joining us, he served as a senior investment advisor with PINE Capital, LLC since May 2010. Prior to that, he was chief financial officer of Nutrastar International Inc. (OTCBB: NUIN) from November 2009 to May 2010. Previously, Mr. Lee served as managing partner of CVC Group, a financial and corporate consulting firm to Chinese companies, from December 2007 until November 2009. Earlier in his career, Mr. Lee was senior China equity analyst at Roth Capital Partners, an investment banking firm, from August 2006 to November 2007. From 1999 to 2006, Mr. Lee was an international strategic consultant and a senior financial analyst with the consulting companies SCA International and Zini & Associates. He had previously worked as an equity research analyst with Punk, Ziegel & Co. from 1997 to 1999, and prior to that had worked as a capital market analyst with Morgan Stanley & Co. from 1993 to 1997. Mr. Lee is a Chartered Financial Analyst and a Certified Public Accountant. He received an M.S. Accountancy from the Zicklin School of Business, Baruch College and a B.S. Economics with concentrations in Finance and Multinational Management from The Wharton School of University of Pennsylvania.

Mr. Zhi Xiong Huang. Mr. Huang has been our Chief Technology Officer since September 1, 2008. Prior to that, he served as our Chief Operating Officer from May 10, 2007 and as a member of our Board of Directors from November 28, 2006. Mr. Huang also serves as the President of Zhongtian Technology, a subsidiary of CNIT, since January 2010, and as the Vice-President of IST since its incorporation in January 2006. Since September 2002, he has also been a Vice President of iASPEC, where he supervises iASPEC’s research and development activities and consults on various types of sophisticated, technical issues. Between July 2001 and March 2002, Mr. Huang served as the General Manager of product development of Shenzhen Runsheng Information Systems Company Ltd. and was responsible for overseeing general operations. He holds a B.S. in computer science from Hehai University in China and has over fifteen years’ experience in information systems. Mr. Huang is currently a Director of the Shenzhen Computer Association and is an Expert with the Shenzhen Expert Association, a nonprofit organization.

Mr. Yi Fu Liu. Mr. Liu has been our Chief Marketing Officer since November 2009, when he resigned from the position of Chief Operating Officer. Mr. Liu also served as the President of Wuda Geo since January 2009. Mr. Liu has over ten years’ experience in corporate operations, strategy management and market development. Mr. Liu has served as Deputy General Manager of iASPEC since August 2002, and has been the General Manager of iASPEC since November 2006. Prior to that, Mr. Liu served, from August 1997 to July 2002, as a Senior Sales Manager for Shenzhen Jingpinjia Electronics Company Ltd.. Mr. Liu holds a Bachelor’s degree in Electronics Engineering from Zhejiang University.

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Mr. Zhi Qiang Zhao. Mr. Zhao has been our Chief Operating Officer since November 2009, when he resigned from the position as Chief Administrative Officer. Mr. Zhao also served as member of our Board of Directors since September 1, 2008. In addition, Mr. Zhao has served as the General Manager of Huipu Electronics (Shenzhen) Company Ltd., a CNIT subsidiary, since July 2011. Mr. Zhao has extensive experience in corporate administration and human resources management. Mr. Zhao has served as iASPEC’s Human Resource Manager since April 2005, and as its Deputy General Manager since July 2006. Prior to that, Mr. Zhao served, from March 2003 to March 2005, as Supervisor of Human Resources for Foxconn Technology Group. Mr. Zhao holds a Bachelor’s degree in Mechanical and Electrical Engineering from Inner Mongolia University.

Mr. Yun Sen Huang. Mr. Huang has been a member of our Board of Directors since August 10, 2007. Mr. Huang has been a Professor in the School of Information Engineering at Shenzhen University since September 1984. He has been involved in many computer application projects, and has received many awards, including a First Grade Award of Technology Advancement from Sichuan Province, a Second Grade Award of Technology Advancement from Guangdong Province, and a Third Grade Award of Technology Advancement from the Chemical Ministry. Mr. Huang has published eight books in the field of Networks and Multimedia Applications. In addition, Mr. Huang was a founder of the International Software Development (Shenzhen) Co., Ltd, a co-partnership company incorporated by IBM, East Asia Bank, and Shenzhen SDC Company, and its Chairman between 2001-2006. Currently, Mr. Huang is a Director of the Shenzhen Computer Academy, a Vice Director of the Guangdong Province Computer Academy, as well as Executive Director of the China University Computer Basic Education Committee. Mr. Huang holds a Bachelor’s Degree of Electronics Engineering from Tsinghua University. There is no relationship between Mr. Huang and our Chief Operating Officer, Zhi Xiong Huang.

Mr. Qiang Lin. Mr. Lin has been a member of our Board of Directors since August 10, 2007. Mr. Lin has been a Professor in the School of Information Engineering at Shenzhen University since September 2002. From July 1997 to September 2002, Mr. Lin served as the Director of Computer Science and Technology Department at Shenzhen University. Mr. Lin has been engaged in teaching and research in the Computer Applications field for many years. Presently, he is a postgraduate advisor and teacher and focuses his research in the fields of Computer Networks, Information Systems, Databases, and ERP systems. Mr. Lin has published many research papers in China’s Computer Science. He is also the editor-in-chief of Electrical Business Foundation. Mr. Lin has significant research experience in information systems, electronic business, logistics, and image disposal and has successfully developed many computer application systems as a project principal. He has been awarded with a First Grade Award of Software Development from the Chinese Chemical Ministry and a Third Grade Award of Science and Technology Development by Guangdong Province. Mr. Lin holds a Master Degree of Computing Mathematics from Zhongshan University. There is no relationship between Mr. Lin and our Chief Executive Officer, Jiang Huai Lin.

Mr. Remington C.H. Hu. Mr. Hu has served as an independent member on our board of directors since October 30, 2009. He is a seasoned executive with more than 16 years of experience in corporate finance and investment management, and is currently the founder and CEO of Tomorrow Capital Limited, a financial advisory firm. Prior to founding Tomorrow Capital Limited, Mr. Hu served from February 2008 to July 2009, as Chief Financial Officer of Yucheng Technologies Limited, a Nasdaq listed top IT solutions and BPO company servicing China’s banking industry, and from August 2004 to August 2007, as China Representative for CVM Capital Partners, LLC, Taiwan’s largest VC affiliated with Taiwan’s largest private equity investment group. Earlier in his career, Mr. Hu founded and served from June 1999 to June 2002, as Chief Financial Officer of eSoon Communications International Corp., a software start-up focusing on the then fast-growing CRM/CTI market served from August 1996 to May 1999, as Vice President of Crimson Asia Capital Holdings, Ltd., formerly Asia’s largest venture capital firm backed by Taiwan’s Chinatrust Financial Group. He began his career at Citibank, NA, as an Assistant Vice President in the Taipei and Hong Kong. Mr. Hu holds a Master’s Degree in Business Administration from the Wharton Business School and a Bachelor’s Degree in Computer Science and Information Engineering from the National Chiao Tung University.

There are no agreements or understandings for any of our executive officers or directors to resign at the request of another person and no officer or director is acting on behalf of nor will any of them act at the direction of any other person. To the best of our knowledge and belief, there are no arrangements or understandings with any of our directors, executive officers, principal stockholders, customers, suppliers, or any other person, pursuant to which any of our directors or executive officers were selected.

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Directors and executive officers are elected or appointed until their successors are duly elected or appointed and qualified.

Director Qualifications

Directors are responsible for overseeing our business consistent with their fiduciary duty to shareowners. This significant responsibility requires highly-skilled individuals with various qualities, attributes and professional experience. The Board believes that there are general requirements for service on our Board of Directors that are applicable to all Directors and that there are other skills and experience that should be represented on the Board as a whole but not necessarily by each Director. The Board and the Governance and Nominating Committee of the Board consider the qualifications of Directors and Director candidates individually and in the broader context of the Board’s overall composition and our current and future needs.

Qualifications for All Directors

In its assessment of each potential candidate, including those recommended by shareowners, the Governance and Nominating Committee considers the nominee’s judgment, integrity, experience, independence, understanding of our business or other related industries and such other factors the Governance and Nominating Committee determines are pertinent in light of the current needs of the Board. The Governance and Nominating Committee also takes into account the ability of a Director to devote the time and effort necessary to fulfill his or her responsibilities to the Company.

The Board and the Governance and Nominating Committee require that each Director be a recognized person of high integrity with a proven record of success in his or her field. Each Director must demonstrate innovative thinking, familiarity with and respect for corporate governance requirements and practices, an appreciation of multiple cultures and a commitment to sustainability and to dealing responsibly with social issues. In addition to the qualifications required of all Directors, the Board assesses intangible qualities including the individual’s ability to ask difficult questions and, simultaneously, to work collegially.

The Board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for Board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.

Qualifications, Attributes, Skills and Experience to be Represented on the Board as a Whole

The Board has identified particular qualifications, attributes, skills and experience that are important to be represented on the Board as a whole, in light of the Company’s current needs and business priorities. The Company is a NASDAQ listed company that offers products and services in the information technology industry in China. Therefore, the Board believes that a diversity of professional experiences in the information technology industry, specific knowledge of key geographic growth areas, and knowledge of U.S. capital markets and of U.S. accounting and financial reporting standards should be represented on the Board. In addition, the market in which we compete is characterized by rapid technological change, evolving industry standards, introductions of new products, and changes in customer demands that can render existing products obsolete and unmarketable. Our future success depends upon our ability to address the increasingly sophisticated needs of our customers by supporting existing and emerging hardware, software, database, and networking platforms and by developing and introducing enhancements to our existing products and new products on a timely basis that keep pace with technological developments, evolving industry standards, and changing customer requirements, through strong focus on research and development. Therefore, the Board believes that academic and professional experience in research and development in the information technology industry should also be represented on the Board.

Set forth below is a tabular disclosure summarizing some of the specific qualifications, attributes, skills and experiences of our directors.

Mr. Jiang Huai Lin. Mr. Lin is the co-founder of our Company. He served as Chairman and Chief Executive Officer of our oldest subsidiary, IST., since its incorporation in January 2006, and is also the co-founder and sole stockholder of iASPEC. He has prior experience with an enterprise engaged in investment in high technology and consumer electronics. Mr. Lin contributes invaluable long-term knowledge of our business and operations and knowledge of the information technology industry in China.

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Mr. Zhi Qiang Zhao. Mr. Zhao has 6 years’ experience as Administrative and Human Resources Director of iASPEC. He also has prior experience as Human Resources Supervisor for another technology company, Foxconn Technology Group. Mr. Zao’s experience in corporate operations and integrations, strategy planning and human resources management provides invaluable operational perspective to the Board.

Mr. Yun Sen Huang. Mr. Huang has served as a Professor at Shenzhen University’s School of Information Engineering since September 1984 and is the recipient of many industry accolades, including First Grade Award of Technology Advancement from Sichuan province, Second Grade Award of Technology Advancement from Guangdong province, and Third Grade Award of Technology Advancement from the Chemical Ministry. He has published eight books in the field of Networks and Multimedia Applications. He was a co-founder and Chairman from 2001 – 2006 of the International Software Development (Shenzhen) Co., Ltd., a co-partnership company incorporated by IBM, East Asia Bank and the Shenzhen SDC Company. Mr. Huang’s experiences provides invaluable industry research and development perspective to the Board

Mr. Qiang Lin. Mr. Lin has served as a Professor at Shenzhen University’s School of Information Engineering since September 2002 and is a Director of its Computer Science and Technology Department. He has been engaged in teaching and research in the Computer Applications for many years and currently focuses his research in the fields of Computer Networks, Information Systems, Database, and ERP systems. He serves as editor in chief of Electrical Business Foundation, an industry publication, and has published many research papers regarding computer science in China. He has done significant research experience in information systems, electronic business, logistics, and image disposal and successful development of many computer application systems as a project principal. He holds Master’s Degree of Computing Mathematics from Zhongshan University and has been the recipient of many industry accolades, including a First Grade Award of Software Development from the Chinese Chemical Ministry and a Third Grade Award of Science and Technology Development by Guangdong province. Mr. Lin’s experiences provides invaluable industry research and development perspective to the Board.

Mr. Remington C.H. Hu. Mr. Hu has more than 17 years of experience in corporate finance and investment management. He is the founder and CEO of Tomorrow Capital Limited, a financial advisory firm, and is the former CFO of Yucheng Technologies Limited, a Nasdaq listed, IT solutions company servicing China’s banking industry, former CFO of eSoon Communications International Corp., a software start-up focusing on the CRM/CTI market, former VP of Crimson Asia Capital Holdings, Ltd., formerly Asia’s largest venture capital firm backed by Taiwan’s Chinatrust Financial Group and former Assistant VP for Citibank, NA in Taipei and Hong Kong. He also served as China Representative for CVM Capital Partners, LLC, Taiwan’s largest VC affiliated with Taiwan’s largest private equity investment group. Mr Hu holds an MBA from the Wharton Business School and a BA, Computer Science and Information Engineering from the National Chiao Tung University. Mr. Hu’s experience in global capital markets and his educational background provides invaluable diversity and perspective to the Board.

Family Relationships

There are no family relationships among any of our executive officers and directors.

Involvement in Certain Legal Proceedings

To the best of our knowledge, none of our directors or executive officers has, during the past ten years:

  • been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offences);

  • had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time;

  • been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity;

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  • been found by a court of competent jurisdiction in a civil action or by the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated;

  • been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or

  • been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.

Except as set forth in our discussion below in Item 13 “Certain Relationships and Related Transactions, and Director Independence – Transactions with Related Persons,” none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.

Section 16(A) Beneficial Ownership Reporting Compliance

Section 16(a) of the Exchange Act requires our executive officers, directors and beneficial owners of more than 10% of a registered class of our equity securities to file with the SEC statements of ownership and changes in ownership. The same persons are required to furnish us with copies of all Section 16(a) forms they file. Except as set forth below and in our previous reports filed with the SEC, we believe that all of our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities complied with the applicable filing requirements during fiscal year 2011 or prior fiscal years.

During fiscal year 2011, a Form 4 was filed late to report one transaction by each of Mr. Jiang Huai Lin, our Chairman, CEO and President, Ms. Jackie You Kazmerzak, our former Chief Financial Officer, Mr. Zhi Xiong Huang, our Chief Technology Officer, Mr. Yi Fu Liu, our Chief Marketing Officer, and Mr. Zhiqiang Zhao, our Director and Chief Operating Officer, due to administrative oversight. A Form 3 required to be filed by Mr. Remington Hu, our Director, prior to fiscal year 2011 was not filed until after the end of fiscal year 2011 due to administrative oversight.

In making these statements, we have relied upon examination of the copies of all Section 16(a) forms provided to us and the written representations of our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities.

Code of Ethics

Our amended and restated code of ethics conforms to the rules and regulations of The NASDAQ Stock Market LLC, or NASDAQ. The code of ethics applies to all of our directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer, and addresses, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code. A copy of the code of ethics has been filed as Exhibit 14 to our annual report on Form 10-K, filed on March 31, 2008. Our code of ethics is also posted on the corporate governance page of our website at www.chinacnit.com. During the fiscal year ended December 31, 2011, there were no waivers of our code of ethics.

Board Composition and Committees

The Company is governed by a Board of Directors that currently consists of five members: Jiang Huai Lin, Zhi Qiang Zhao, Yun Sen Huang, Qiang Lin, and Remington C.H. Hu. Yun Sen Huang, Qiang Lin, and Remington C.H. Hu are “independent” directors, within the meaning of the NASDAQ Marketplace Rules. All actions of the Board of Directors require the approval of a majority of the directors in attendance at a meeting at which a quorum is present.

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The Board has established three standing committees: the Audit Committee, the Compensation Committee and the Governance and Nominating Committee. Each of the Audit Committee, Compensation Committee and Governance and Nominating Committee are comprised entirely of independent directors. From time to time, the Board may establish other committees. The Board has adopted a written charter for each of the Committees which are available on the corporate governance page of our website at www.chinacnit.com. Printed copies of these charters may be obtained, without charge, by contacting by contacting the Corporate Secretary, China Information Technology, Inc., 21st Floor, Everbright Bank Building, Zhuzilin, Futian District, Shenzhen, Guangdong 518040, People’s Republic of China.

Audit Committee and Audit Committee Financial Expert

Our Audit Committee is currently composed of three members: Yun Sen Huang, Qiang Lin, and Remington C.H. Hu. Our Board of Directors determined that each member of the Audit Committee meets the independence criteria prescribed by applicable regulation and the rules of the SEC for audit committee membership and is an “independent” director within the meaning of the NASDAQ Marketplace Rules. Each Audit Committee member also meets NASDAQ’s financial literacy requirements. Mr. Hu serves as Chair of the Audit Committee.

Our Audit Committee oversees our accounting and financial reporting processes and the audits of our financial statements. Our Audit Committee is responsible for, among other things:

  • selecting our independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by our independent auditors;
  • reviewing with our independent auditors any audit problems or difficulties and management’s response;
  • reviewing and approving all proposed related-party transactions;
  • discussing the annual audited financial statements with management and our independent auditors;
  • reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of significant internal control deficiencies;
  • annually reviewing and reassessing the adequacy of our Audit Committee charter;
  • meeting separately and periodically with management and our internal and independent auditors;
  • reporting regularly to the full Board of Directors; and
  • such other matters that are specifically delegated to our Audit Committee by our Board of Directors from time to time.

Our Board of Directors has determined that Mr. Hu is the “audit committee financial expert” as such term is defined in Item 407(d) of Regulation S-K promulgated by the SEC and also meets NASDAQ’s financial sophistication requirements.

Compensation Committee

Our Compensation Committee is currently composed of three members: Yun Sen Huang, Qiang Lin, and Remington C.H. Hu, each of whom is “independent” within the meaning of the NASDAQ Marketplace Rules. Mr. Huang serves as Chair of the Compensation Committee.

Our Compensation Committee assists the Board in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. Our Chief Executive Officer may not be present at any committee meeting during which his compensation is deliberated.

The Compensation Committee is responsible for, among other things:

  • approving and overseeing the compensation package for our executive officers;
  • reviewing and making recommendations to the Board with respect to the compensation of our directors;
  • reviewing and approving corporate goals and objectives relevant to the compensation of our chief executive officer, evaluating the performance of our chief executive officer in light of those goals and objectives, and setting the compensation level of our chief executive officer based on this evaluation; and
  • reviewing periodically and making recommendations to the Board regarding any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.

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Governance and Nominating Committee

Our Governance and Nominating Committee is currently composed of three members: Yun Sen Huang, Qiang Lin, and Remington C.H. Hu, each of whom is “independent” within the meaning of the NASDAQ Marketplace Rules. Mr. Lin serves as Chair of the Governance and Nominating Committee.

The Governance and Nominating Committee assists the Board in identifying individuals qualified to become our directors and in determining the composition of the Board and its committees.

The Governance and Nominating Committee is responsible for, among other things:

  • identifying and recommending to the Board nominees for election or re-election to the Board, or for appointment to fill any vacancy;
  • reviewing annually with the Board the current composition of the Board in light of the characteristics of independence, age, skills, experience and availability of service to us;
  • identifying and recommending to the Board the directors to serve as members of the Board’s committees; and
  • monitoring compliance with our code of ethics.

Material Changes to Director Nomination Procedures

There have been no material changes to the procedures by which stockholders may recommend nominees to our Board of Directors since such procedures were last disclosed.

ITEM 11. EXECUTIVE COMPENSATION.

Compensation Discussion and Analysis

Compensation Philosophy

Our executive compensation philosophy is to align the interests of executive management with stockholder interests and with our business strategy and success through an integrated executive compensation program that considers short-term performance, the achievement of long-term strategic goals and growth in total stockholder value. The key elements of our executive compensation philosophy are competitive base salary, annual incentive opportunities and equity participation. Our aggregate compensation package is designed to attract and retain individuals critical to the long-term success of our Company, to motivate these persons to perform at their highest levels, and to reward exceptional performance.

The compensation of our executive officers is determined by the Compensation Committee, except that the entire Board makes the final determination as to the compensation of our Chief Executive Officer. The Chief Executive Officer reviews and revises compensation proposals prepared by Human Resources and presents his recommendations to the Compensation Committee for the Committee’s ultimate review and approval. The Chief Executive Officer does not participate in Compensation Committee meetings and is not involved in decisions relating to his own compensation.

Elements of Compensation

We pay each of our named executive officers a base annual salary. Bonuses and equity incentives may also be provided to supplement base salary. The criteria for determining each of these components of compensation is described below. We do not provide retirement benefits and only minimal perquisites except as described below.

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Base Salary

Base salary levels for executive officers are set forth in their individual employment agreements, and are reflected in the Summary Compensation Table below. The Compensation Committee considered the total compensation paid by other biopharmaceutical companies in Shenzhen, China to persons holding equivalent positions in setting base salary levels. However, the Compensation Committee did not conduct a peer group compensation analysis or target any particular compensation level in establishing the base salaries for named executive officers.

The Compensation Committee believes that any increases in base salary should be based upon a favorable evaluation of individual performance relative to individual goals, the functioning of the executive’s team within the corporate structure, success in furthering corporate strategy and goals, individual management skills and responsibilities, demonstrated loyalty, and our commitment to attract and retain executives. We expect that our Compensation Committee will reward superior individual and company performance with commensurate cash and other compensation. The Compensation Committee did not increase base salary during fiscal year 2011. Salary will next be reviewed when the Compensation Committee deems appropriate, but the Compensation Committee will not review salary more frequently than on an annual basis.

Bonuses

Executives are eligible to receive a discretionary bonus pursuant to the terms of their respective employment agreements. However, in fiscal 2011 we did not set any performance targets and no discretionary bonuses were paid. If our Compensation Committee determines to do so in the future, bonuses may be paid on an ad hoc basis to recognize superior performance. If the Compensation Committee determines to provide bonus compensation as a regular part of our executive compensation package, it will establish performance goals for each of the executive officers and maximum bonuses that may be earned upon attainment of such performance goals. Some of the components of our key performance appraisal index that we may use to consider in establishing these performance goals include the following: cash flow (accounts receivable, inventory, accounts payable); sales (revenue, accounts receivables collection, gross profit, customer credit management and goods delivery management); costs and expenses (financial costs, manufacturing costs, general and administrative expenses, sales and marketing expenses, research and development costs); and capital expenditures.

Equity Incentives

Named executive officers are eligible for equity awards in the form of stock options, stock appreciation rights, performance units, restricted stock, restricted stock units and performance shares under the China Information Technology, Inc. 2007 Equity Incentive Plan, or the Plan. Equity awards are granted at the discretion of the Compensation Committee. The size of an award to any individual, including named executive officers, depends in part on individual performance, including the components of our key performance appraisal index described above and any other indicators of the impact that such employee’s productivity may have on stockholder value over time. Other factors include salary level and competitive data. In addition, in determining the awards granted to each named executive officer, the Compensation Committee considers the future benefits potentially available to the named executive officers from existing awards.

We have no program, plan or practice of granting equity awards that coincide with the release by us of material non-public information.

Retirement Benefits

Currently, we do not provide any company-sponsored retirement benefits or deferred compensation programs to any employee, including the named executive officers (other than a mandatory state pension scheme in which all of our employees in China participate) because it is not customary to provide such benefits and programs in China.

Perquisites

Historically, we have provided our named executive officers with minimal perquisites and other personal benefits that we believe are reasonable, such as company car-related benefits. We do not view perquisites as a significant element of compensation, but do believe they can be useful in attracting, motivating and retaining the executive talent for which we compete.

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Summary Compensation Table — Fiscal Years Ended December 31, 2011, 2010 and 2009

The following table sets forth information concerning all cash and non-cash compensation awarded to, earned by or paid to the named persons for services rendered in all capacities during the noted periods. No other executive officer received total annual salary and bonus compensation in excess of $100,000. All information below this table gives retroactive effect to our one-for-two reverse stock split effected on March 1, 2012.

Name and Principal Position Year Salary
($) (1)
Stock
Awards
($) (2)
Total
($)
Jiang Huai Lin,
Chairman, Chief Executive
Officer and President (3)
2011 114,280 - -
2010 110,760 114,500 225,260
2009 58,644 119,000 117,644
Daniel K. Lee,
Chief Financial Officer (4)
2011 4,127 - 4,127
2010 - - -
2009 - - -
Jackie You Kazmerzak,
former Chief Financial Officer (5)
2011 25,000 - -
2010 50,000 137,400 187,400
2009 12,500 119,000 131,500
Zhi Qiang Zhao,
Director, Chief Operating Officer and former
Interim Chief Financial Officer (6)
2011 80,000 - -
2010 77,520 45,800 123,320
2009 52,780 59,500 112,280
Zhi Xiong Huang,
Chief Technology Officer (7)
2011 79,440 - -
2010 76,980 36,640 113,620
2009 43,983 59,500 103,483
Yi Fu Liu,
Chief Marketing Officer (8)
2011 95,238 - -
2010 92,304 45,800 138,104
2009 61,576 59,500 121,076

Narrative Disclosure to Summary Compensation Table

(1)

The amounts reported in this table have been converted from Renminbi to U.S. dollars based on the average conversion rate between the U.S. dollar and Renminbi for the applicable fiscal year, or $1.00 to RMB 6.30 (fiscal year 2011 exchange rate), $1.00 to RMB 6.50 (fiscal year 2010 exchange rate), and $1.00 to RMB 6.82 (fiscal year 2009 exchange rate).

   
(2)

The amounts represented in the stock and option awards columns reflect the compensation expense recognized by the Company in fiscal years 2009, 2010 and 2011 determined pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”), as superseded by SFAS No. 168 “The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162” (“SFAS No. 168”), as superseded by The FASB Accounting Standards CodificationTM (“ASC”), now included in ASC Topic 718 (“ASC 718”), and no forfeitures are assumed. The value of each restricted stock award was derived by multiplying the closing market price on the date of the grant of the award by the number of shares included in the award. Also see “Grants of Plan-Based Awards” for more detail regarding equity grants to named executive officers in fiscal year 2011.

   
(3)

Mr. Lin became our Chairman on September 6, 2006 and on October 3, 2006 he became our President and Chief Executive Officer. Prior to that, Mr. Lin was (and continues to be) the Chairman and Chief Executive Officer of our subsidiary, IST. The annual, long term and other compensation shown in this table include the amount Mr. Lin received from IST during the applicable periods. In 2011, Mr. Lin earned RMB 50,000 per month (approximately $7, 936) for his services as our Chief Executive Officer and as IST’s Chief Executive Officer and RMB 10,000 (approximately $1,587) per month as the Chairman of our Board of Directors. Mr. Lin earned RMB 50,000 per month (approximately $7,690) for his services as our Chief Executive Officer and as IST’s Chief Executive Officer and RMB 10,000 (approximately $1,540) per month as the Chairman of our Board of Directors during 2010, and earned RMB 28,330 per month (approximately $4,154) as Chief Executive Officer and RMB 5,000 (approximately $733) as the Chairman of our Board of Directors during 2009. In addition, Mr. Lin was granted 10,000 and 12,500 shares of common stock in 2010 and 2011 as compensation for his service in 2009 and 2010, respectively.

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(4)

Mr. Lee became our Chief Financial Officer on December 12, 2011. Mr. Lee earned RMB 26,000 (approximately $4,127) as compensation for his services during 2011. Under his employment agreement, he is entitled to RMB 500,000 per year as compensation.

   
(5)

Ms. Kazmerzak served as our Chief Financial Officer from August 17, 2009 until May 30, 2011. Ms. Kazmerzak earned $5,000 per month for her services as our Chief Financial Officer in 2011, and earned $4,167 per month for her service as our Chief Financial Officer during 2010 and 2009. In addition, Ms. Kazmerzak was granted 10,000 and 15,000 shares of common stock in 2010 and 2011, respectively, as compensation for her service in 2009 and 2010, respectively.

   
(6)

Mr. Zhao has served as a Director since September 2008 and as our Chief Operating Officer since November 2009, when he resigned from the position of Chief Administrative Officer. He also served as our Interim Chief Financial Officer from August 5, 2011 until December 12, 2011. In addition, Mr. Zhao served as the General Manager of the Company’s subsidiary Huipu Electronics (Shenzhen) Co., Ltd., since July 2011, as Human Resource Manager of iASPEC since April 2005 and as Deputy General Manager of iASPEC since July 2006. In 2011, Mr. Zhao earned RMB 37,000 per month (approximately $5,873) for his service as Chief Operating Officer and President of Huipu Electronics, and RMB 5,000 (approximately $794) as a Director. Mr. Zhao earned RMB 37,000 per month (approximately $5,690) for his service as Chief Operating Officer and RMB 5,000 (approximately $770) as a Director during 2010. Mr. Zhao earned RMB 30,000 per month (approximately $4,400) for his services as our Chief Administrative Officer during 2009. Mr. Zhao was also granted 5,000 shares of common stock in each of 2010 and 2011 as compensation for his service in each of 2009 and 2010.

   
(7)

Mr. Huang has served as our Chief Technology Officer since September 1, 2008. Mr. Huang has also served as the President of our subsidiary, Zhongtian Technology since January 2010. Mr. Huang earned RMB 41,700 (approximately $6,620) and RMB 41,700 (approximately $6,415) per month during 2011 and 2010 respectively as our Chief Technology Officer and as Zhongtian’s President. Mr. Huang earned RMB 25,000 per month (approximately $3,668) as our Chief Technology Officer and as IST’s Vice President during 2009. Mr. Huang was also granted 5,000 and 4,000 shares of common stock in 2010 and 2011, respectively, as compensation for his service in 2009 and 2010, respectively.

   
(8)

Mr. Liu resigned from the position of Chief Operating Officer and was appointed as Chief Marketing Officer in November 2009. Mr. Liu also has served as the President of Geo since January 2009. Mr. Liu earned RMB 50,000 (approximately $7,936) and RMB 50,000 (approximately $7,692) per month during 2011 and 2010 respectively for his service as Chief Marketing Officer and the President of Geo. Mr. Liu earned RMB 35,000 per month (approximately $5,131) for his services as our Chief Operating Officer during 2009. Mr. Liu was also granted 5,000 shares of common stock in each of 2010 and 2011 as compensation for his service in 2009 and 2010, respectively.

Grants of Plan-Based Awards

The following table sets forth information regarding equity grants under the Plan to named executive officers during the fiscal year ended December 31, 2011. These equity grants were awarded for services performed during the fiscal year ended December 31, 2010. All information in this table gives retroactive effect to our one-for-two reverse stock split effected on March 1, 2012.

Name

Grant Date

All other stock
awards: Number of
shares of stock or
units
(#)
Grant date
fair value of
stock and option
awards

($)
Jiang Huai Lin February 8, 2011 12,500 9.16
Jackie You Kazmerzak February 8, 2011 15,000 9.16
Zhi Qiang Zhao February 8, 2011 5,000 9.16
Zhi Xiong Huang February 8, 2011 4,000 9.16
Yi Fu Liu February 8, 2011 5,000 9.16

Outstanding Equity Awards at Fiscal Year End

None of our named executive officers had unexercised stock option awards or unvested stock awards as of December 31, 2011.

Option Exercises and Stock Vested

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None of our named executive officers exercised options during the year ended December 31, 2011. The following table sets forth information regarding stock vested for each of our named executive officers on an aggregated basis during the fiscal year ended December 31, 2011. All information in this table gives retroactive effect to our one-for-two reverse stock split effected on March 1, 2012.


Name
Stock awards
Number of shares
acquired on vesting
(#)
Value
realized on
vesting
($)
Jiang Huai Lin 12,500 114,500
Jackie You Kazmerzak 15,000 137,400
Zhi Qiang Zhao 5,000 45,800
Zhi Xiong Huang 4,000 36,640
Yi Fu Liu 5,000 45,800

Pension Benefits

No named executive officer received or held pension benefits during the fiscal year ended December 31, 2011.

Nonqualified Deferred Compensation

No nonqualified deferred compensation was offered or issued to any named executive officer during the fiscal year ended December 31, 2011.

Potential Payments Upon Termination or Change in Control

Our named executive officers are not entitled to severance payments upon the termination of their employment agreements or following a change in control.

Compensation of Directors

The following table sets forth the total director compensation earned by our directors during our fiscal year ended December 31, 2011:

Name Fees earned or
paid in cash
($)
Stock awards
($)
Option awards
($)
All other compensation
($)
Total
($)
Jiang Huai Lin 19,044 - - - 19,044
Zhi Qiang Zhao 9,522 - - - 9,522
Qiang Lin 5,714 - - - 5,714
Yun Sen Huang 5,714 - - - 5,714
Remington C.H. Hu 18,000 - - - 18,000

Narrative to Director Compensation Table

Mr. Jiang Huai Lin earns RMB 10,000 per month (approximately $1,587) for his services as the Chairman of our Board of Directors and Mr. Zhao earns RMB 5,000 per month (approximately $794) for his services as a member of our Board of Directors.

Our independent directors, Messrs Yun Sen Huang, Qiang Lin and Remington Hu, have all entered into our form of independent director agreement. Under the terms of their agreements, Mr. Yun Sen Huang earns RMB 3,000 per month (approximately $476), Mr. Qiang Lin earns RMB 3,000 per month (approximately $476), and Mr. Hu earns $1,500 per month as compensation for their services as independent directors.

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All of our directors are reimbursed for pre-approved reasonable business-related expenses incurred in good faith in the performance of their duties for our Company.

Compensation Committee Interlocks and Insider Participation

Messrs. Yun Sen Huang, Qiang Lin and Remington C.H. Hu served on the Compensation Committee during the fiscal year ended December 31, 2011. None of them was an employee, an officer, or former officer of the Company. No member of the Compensation Committee had any relationship with us requiring disclosure under Item 404 of Regulation S-K during the fiscal year ended December 31, 2011. None of our executive officers has served on the board of directors or compensation committee (or other committee serving an equivalent function) of any other entity, one of whose executive officers served on our Board or Compensation Committee.

Compensation Committee Report

The Compensation Committee of the Company has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management. Based on such review and discussions, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this Annual Report on Form 10-K.

/s/ Compensation Committee
Yun Sen Huang
Qiang Lin
Remington C.H. Hu

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

The following table sets forth information regarding beneficial ownership of our common stock as of February 29, 2012 (except where otherwise indicated) (i) by each person who is known by us to beneficially own more than 5% of our common stock; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group. Unless otherwise specified, the address of each of the persons set forth below is in care of the Company, 21st Floor, Everbright Bank Building, Zhuzilin, Shenzhen 518040, People’s Republic of China. All information in and below this table gives retroactive effect to our one-for-two reverse stock split effected on March 1, 2012.

Name and Address of
Beneficial
Owner
Office, If Any Title of Class Amount and
Nature of
Beneficial
Ownership(1)
Percent of Class(2)
 Officers and Directors   
Jiang Huai Lin President, CEO, Chairman Common Stock 11,023,466 40.0%
Daniel K. Lee Chief Financial Officer Common Stock 0 *
Zhi Xiong Huang Chief Technology Officer Common Stock 9,000 *
Yi Fu Liu Chief Marketing Officer Common Stock 17,500 *
Zhi Qiang Zhao Director, Chief Operating Officer Common Stock 17,500 *
Yun Sen Huang Director Common Stock 0 *
Qiang Lin Director Common Stock 0 *
Remington Hu Director Common Stock 0 *
All officers and directors as a group
(8 persons named above)
Common Stock 11,067,466 40.1%
 5% Security Holders   
Jiang Huai Lin   Common Stock 11,023,466 40.0%
Adam Benowitz (3)   Common Stock 1,737,035 6.3%

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Name and Address of
Beneficial
Owner
Office, If Any Title of Class Amount and
Nature of
Beneficial
Ownership(1)
Percent of Class(2)
20 West 55th Street
5th Fl.
New York, NY 10019
Vision Capital Advisors, LLC(3)
20 West 55th Street
5th Fl.
New York, NY 10019
Common Stock 1,737,035 6.3%
Sansar Capital Asia Pte. Ltd. (4)
16 Raffles Quay
#40-02, Hong Leong Building
Singapore, Singapore 048581
Common Stock 1,617,326 5.9%
Sansar Capital Management,
L.L.C. (4)
16 Raffles Quay
#40-02, Hong Leong Building
Singapore, Singapore 048581
Common Stock 1,617,326 5.9%
Fosun International Limited (5)
Room 808
ICBC Tower
3 Garden Road, Central
Hong Kong, China
Common Stock 2,614,212 9.5%

* Less than 1%

(1)

Beneficial Ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Each of the beneficial owners listed above has direct ownership of and sole voting power and investment power with respect to our common stock.

   
(2)

As of February 29, 2012, a total of 27,591,462 shares of our common stock are considered to be outstanding pursuant to SEC Rule 13d-3(d)(1). For each Beneficial Owner above, any securities that are exercisable or convertible within 60 days have been included in the denominator.

   
(3)

Pursuant to a Schedule 13G filed with the SEC on February 18, 2009 on behalf of (i) Vision Opportunity Master Fund, Ltd., a Cayman Islands company, or the Master Fund, (ii) Vision Opportunity China LP, a limited partnership organized under the laws of Guernsey, or the China Fund and together with the Master Fund, the Funds, (iii) Vision Opportunity China GP Limited, a corporate entity organized under the laws of Guernsey, or the China Fund GP, which serves as the general partner of the China Fund, (iv) Vision Opportunity China Fund Limited, a corporate entity organized under the laws of Guernsey, or the China Fund Ltd., which controls the China Fund GP, (v) Vision Capital Advisors, LLC, a Delaware limited liability company (formerly known as Vision Opportunity Capital Management, LLC), or the Investment Manager, and (vi) Adam Benowitz, the Managing Member of the Investment Manager (all of the foregoing, collectively, the “Filers”). As stated in this filing, each of the Funds is a private investment vehicle engaged in investing and trading in a wide variety of securities and financial instruments for its own account. The Funds directly beneficially own all of the shares reported in this Statement. Mr. Benowitz and the Investment Manager may be deemed to share with the Funds voting and dispositive power with respect to such shares. The China Fund GP and China Fund Ltd. may be deemed to share with the China Fund voting and dispositive power with respect to such shares owned by the China Fund. Each Filer disclaims beneficial ownership with respect to any shares other than those beneficially owned directly by such Filer.

   
(4)

Pursuant to a Schedule 13G/A filed with the SEC on February 14, 2012 on behalf of Sansar Capital Management, L.L.C., a Delaware limited liability company, or Sansar Capital Management, and Sansar Capital Asia Pte. Ltd., a company organized under the laws of Singapore, or Sansar Asia. As stated in this filing, Sanjay Motwani is the managing member of Sansar Family I, L.L.C., which is the managing member of Sansar Capital Management. Sansar Capital Asia L.P., a limited partnership organized under the laws of the Cayman Islands, is the sole shareholder of Sansar Asia. Sansar International L.L.C., a Delaware limited liability company, is the general partner of Sansar Capital Asia, L.P. Sanjay Motwani is the managing member of Sansar International L.L.C. All of the shares of Common Stock beneficially owned by the Reporting Persons are directly held by a fund to which Sansar Capital Management and Sansar Asia act as investment advisors.

   
(5)

Pursuant to a Schedule 13G/A filed with the SEC on February 13, 2012 on behalf of Fosun International Limited (“Fosun International”) and Topper Link Limited. As stated in this filing, Fosun International is a majority-owned subsidiary of Fosun Holdings Limited (“Fosun Holdings”), which in turn is a wholly-owned subsidiary of Fosun International Holdings Ltd (“Fosun International Holdings”). Fosun International Holdings is controlled by Mr. Guo Guangchang, who is also the Executive Director and Chairman of the Board of Fosun International.

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Changes in Control

We are aware of no arrangements which if consummated may result in a change of control of our Company

Securities Authorized for Issuance under Equity Compensation Plans

The following table includes certain information as of December 31, 2011 for each category of our equity compensation plan:

Plan category Number of
securities to
be issued upon
exercise of
outstanding
options, warrants
and rights
(a)
Weighted-average
exercise price of
outstanding options,
warrants and
rights
(b)
Number of
securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column
(a))
(c)
Equity compensation plans approved by security holders - - 3,378,319 (1)
Equity compensation plans not approved by security holders - - -
Total - - 3,378,319 (1)

(1)

Includes 3,378,319 shares of restricted stock that were available for future issuance under the Plan as of December 31, 2011. All information in and below this table gives retroactive effect to our one-for-two reverse stock split effected on March 1, 2012.

On June 13, 2007, our Board of Directors authorized the establishment of the Plan, whereby we are authorized to issue shares of our common stock to certain employees, consultants and directors. At that time we reserved 4,000,000 shares of our common stock for issuance under the Plan.

On November 27, 2007, we issued 35,000 shares of common stock to our senior management and an outside consultant as bonus awards.

On March 20, 2008 our Board of Directors approved the grant of 200,000 stock awards to certain employees of the Company. These newly granted shares vested quarterly at 1/4 over a one-year period following the grant.

On February 2, 2009, we granted eligible employees a total of 30,000 shares of our common stock as compensation under the Plan.

On January 12, 2010, we granted eligible employees a total of 106,682 shares of common stock as compensation under the Plan.

On September 25, 2010, we granted eligible employees a total of 125,000 shares of common stock as compensation under the Plan.

On February 8, 2011, we granted eligible employees a total of 125,000 shares of common stock as compensation under Plan.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

Transactions With Related Persons

The following includes a summary of transactions since the beginning of the 2010 fiscal year, or any currently proposed transaction, in which we were or are to be a participant and the amount involved exceeded or exceeds $120,000 and in which any related person had or will have a direct or indirect material interest (other than compensation described under Item 11 “Executive Compensation”). We believe the terms obtained or consideration that we paid or received, as applicable, in connection with the transactions described below were comparable to terms available or the amounts that would be paid or received, as applicable, in arm’s-length transactions. Share information included in this section gives retroactive effect to our one-for-two reverse stock split effected on March 1, 2012.

  • Approximately 8% of Xiamen Yili Geo Information Technology Co., Ltd., or Yili, is owned by Geo. As December 31, 2010 and 2011, Yili had an outstanding balance due to Geo of $137,289 and $22,823, respectively, consisting of accounts receivable from sales.

  • Shenzhen Kewen Information Technology Co., Ltd., or Kewen, is a private company owned by Mr. Qi Danfeng, who is Chief Executive Officer of Zhongtian, our indirect subsidiary. Prior to our purchase of Zhongtian, Kewen routinely purchased software from Zhongtian and at December 31, 2010 and 2011, accounts receivable from Kewen was $193,587 and zero, respectively.

    Amounts earned from Yili and Kewen during the years ended December 31, 2011 and 2010 were as follows:

    2011     2010  
Revenue $  14,334   $  630,975  
Cost of sales   -     (247,892 )
Gross profit $  14,334   $  383,083  
  • Shenzhen Information Security Investment and Development Co., Ltd., or ISID, was a company under the control of Mr. Lin and a balance of $697,820 due to ISID represented advances from ISID to the Company as of December 31, 2010. These advances are non-interest bearing and due on demand. As Mr Lin transferred control of ISID to a non-affiliated third party during the year 2011, ISID was not our related company as of December 31, 2011.

  • Approximately 9% of Wuhan Geo Navigation and Communication Technology Co., Ltd., or Geo Navigation, is owned by Geo. Prior to our acquisition of Geo, Geo Navigation made non-interest bearing cash advances to Geo, and at December 31, 2010 and 2011, a balance of $596,046 and $593,617, respectively, remained outstanding. We intend to repay this balance as soon as practicable.

  • On January 7, 2010, Mr. Jiang Huai Lin, our Chairman, Chief Executive Officer and President, consummated a secondary offering to certain accredited investors of 800,000 shares of our common stock owned by him, for an aggregate purchase price of $9.84 million, or $12.30 per share. The secondary offering was consummated concurrently with our closing of a primary offering of our securities on the same date. Mr. Lin paid his pro rata share of the offering costs and we did not receive any proceeds from the secondary offering of Mr. Lin’s shares.

  • On January 14, 2010, Mr. Lin loaned the Company a total of $5 million from the proceeds of the sale of his shares for use for general corporate purposes and working capital. In consideration of the loan from Mr. Lin, our Board of Directors approved the issuance and delivery of a one-year, non-interest bearing, convertible promissory note to Mr. Lin, in the principal amount of $5 million. The note was due and payable on January 14, 2011, and was convertible into shares of our common stock at a conversion price of $11.76 per share (the per share closing price on the trading day prior to the delivery date of the note). On March 25, 2010, Mr. Lin surrendered the note to the Company and the Company issued a replacement note, in the principal amount of $6,000,000, to reflect the principal amount of the original note as well as an additional loan of $1,000,000 made to the Company on March 25, 2010. The new additional loan of $1,000,000 was repaid on April 7, 2010. The new note omitted the conversion feature that was contained in the original note and was non-interest bearing. The maturity date of the new note was March 5, 2012 and we were permitted to prepay all or any part of the amounts outstanding under this note at any time before the maturity date without the express written consent of Mr. Lin. In accounting for the new note, we accrued an interest expense at an interest rate of 5% per annum, which is the market interest rate for USD denominated 2-year loans in China. The imputed interest for the year ended December 31, 2010 was $187,500 and was recognized as capital contribution by the shareholder. On August 16, 2011, the Company and Mr. Lin agreed to an amended and restated promissory note to replace the note that was issued by the Company to Mr. Lin on March 25, 2010. Under the note issued on March 25, 2010, the loan was not permitted to be repaid by conversion of the loan balance into shares of common stock of the Company. Pursuant to the amended and restated note, the loan balance could be repaid by conversion of the balance into shares of the Company’s common stock at a conversion price of $5.40 per share. On August 16, 2011, Mr. Lin exercised this conversion right, and therefore agreed to receive a total of 925,926 shares of the Company’s common stock in lieu of cash repayment under the amended and restated note.

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  • Rental expenses from renting buildings and offices from Mr. Lin during the years ended December 31, 2011 and 2010 were $248,653 and $110,795, respectively.

Except as set forth in our discussion above, none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.

Policies and Procedures for Review, Approval or Ratification of Transactions with Related Persons

Our current written policies and procedures for review, approval or ratification of relationships or transactions with related persons are set forth in our code of ethics, our Audit Committee Charter, our Governance and Nominating Committee Charter, and our Board of Directors Charter.

Our Board of Directors Charter requires that our Board of Directors monitor and manage potential conflicts of interest of management and the Board and assume other responsibilities as may be required from time to time. As permitted under the Company’s Bylaws, the Board has delegated some of these responsibilities to the Board’s Audit Committee and Governance and Nominating Committee. Our Audit Committee Charter provides that the Audit Committee is responsible for establishing procedures for the approval of and approve the entry of the Company into any and all related party transactions between the Company and any executive officer or director that would potentially require disclosure pursuant to Item 404 of Regulation S-K. The Audit Committee Charter also mandates that the Audit Committee must approve the entry of the Company into any such related party transaction. Our Governance and Nominating Committee Charter provides that the Governance and Nominating Committee is responsible for reviewing and assessing the adequacy of our code of ethics and other internal policies and guidelines and monitor whether the principles described therein are being incorporated into our culture and business practices.

Our code of ethics provides a number of specific procedures, requirements, and prohibitions relating to related party transactions. It prohibits directors, officers and employees from accepting simultaneous employment with a supplier, customer, developer, or competitor, or from taking part in any activity that enhances or supports a competitor’s position. All directors, officers and employees must disclose to us any interest that may conflict with the Company. A director, officer and employee may accept a position as a director of another company only if he or she obtains approval from the Board of Directors; the other company does not compete with us; and any compensation received in this capacity is commensurate with its responsibilities.

Our code of ethics generally requires our directors, officers, and employees to avoid conducting our business with a relative or significant other, or with a business in which a relative or significant other is associated in any significant manner. Where a director, officer or employee believes that such a transaction is unavoidable, he or she must fully disclose it to our Chief Executive Officer. If the Chief Executive Officer deems it material to the Company, the Governance and Nominating Committee must review and provide advance written approval for such transactions. The Board subsequently reassigned part of this responsibility to the Audit Committee pursuant to the Audit Committee Charter. The most significant related party transactions, especially those involving our directors or executive officers, must be reviewed and approved in writing in advance by our Board of Directors. The Board also delegated part of this function to the Audit Committee under the Audit Committee Charter, as explained above. We must report all such material related party transactions under applicable accounting rules, federal securities laws, SEC rules and regulations, and securities market rules. Any dealings with a related party must be conducted in such a way that no preferential treatment is given.

67


In addition, our code of ethics discourages the employment of relatives and significant others in positions or assignments within the same department and prohibits the employment of such persons in positions that have influence (e.g., an auditing or control relationship, or a supervisor/subordinate relationship). Our Human Resources department is primarily responsible for administering this aspect of our related party transactions policy. If any covered relationship develops or exists between two employees, the senior employee must advise his or her supervisor. We may separate the employees either by reassignment or termination, if necessary.

Our code of ethics permits waivers of the above policies and procedures as to directors or executive officers only if they are approved in writing by the Board of Directors and promptly disclosed. Any waiver with respect to any employee, agent or contractor must be approved in writing by the Company. Under its Charter, our Governance and Nominating Committee is also responsible for reviewing requests for any waivers and recommending to the Board whether a particular request should be granted.

Any type of related party transaction not expressly covered by the above policies and procedures is subject to the review and approval of our Board of Directors.

There were no related party transactions since the beginning of the 2010 fiscal year for which our policies and procedures did not require review, approval or ratification, or where our policies and procedures were not followed.

Director Independence

Each of Messrs. Yun Sen Huang, Qiang Lin and Remington C.H. Hu serves on our board as an “independent” director as defined by the applicable rules of the SEC and NASDAQ.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

Independent Auditors’ Fees

The following is a summary of the fees billed to the Company for professional services rendered for the fiscal years ended December 31, 2011 and 2010:

    Year Ended December 31,  
    2011     2010  
Audit Fees $  569,874   $  526,633  
Audit-Related Fees   -     -  
Tax Fees   25,000     20,000  
All Other Fees   -     -  
TOTAL $  594,874   $  546,633  

“Audit Fees” consisted of fees billed for professional services rendered by the principal accountant for the audit of our annual financial statements and review of the financial statements included in our Form 10-K and 10-Q for services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements.

“Audit-Related Fees” consisted of fees billed for assurance and related services by the principal accountant that were reasonably related to the performance of the audit or review of our financial statements and are not reported under the paragraph captioned “Audit Fees” above.

“Tax Fees” consisted of fees billed for professional services rendered by the principal accountant for tax returns preparation.

“All Other Fees” consisted of fees billed for products and services provided by the principal accountant, other than the services reported above under other captions of this Item 14.

68


Pre-Approval Policies and Procedures

Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by our auditors must be approved in advance by our board of directors to assure that such services do not impair the auditors’ independence from us. In accordance with its policies and procedures, our board of directors pre-approved the audit service performed by GHP Horwath, P.C. for our financial statements as of and for the year ended December 31, 2011.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

Financial Statements and Schedules

The financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.

Exhibit List

The list of exhibits in the Exhibit Index to this report is incorporated herein by reference.

69


SIGNATURES

In accordance with section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereto duly authorized individual.

Date: March 7, 2012

  CHINA INFORMATION TECHNOLOGY, INC.
     
  By: /s/ Jiang Huai Lin                                         
    Jiang Huai Lin
    Chief Executive Officer
     
  By: /s/ Daniel K. Lee                                           
    Daniel K. Lee
    Chief Financial Officer

In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature Title Date
     
/s/ Jiang Huai Lin                      Chairman and Chief Executive Officer March 7, 2012
Jiang Huai Lin (Principal Executive Officer)  
     
/s/ Daniel K. Lee                       Chief Financial Officer March 7, 2012
Daniel K. Lee (Principal Financial and Accounting Officer)  
     
/s/ Zhiqiang Zhao                    Director and Chief Operating Officer March 7, 2012
Zhiqiang Zhao    
     
/s/ Yun Sen Huang                  Director March 7, 2012
Yun Sen Huang    
     
/s/ Qiang Lin                            Director March 7, 2012
Qiang Lin    
     
/s/ Remington Hu                    Director March 7, 2012
Remington Hu    

70


CHINA INFORMATION TECHNOLOGY, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011 AND 2010

Contents Page(s)
Reports of Independent Registered Public Accounting Firms F-2
Consolidated Balance Sheets as of December 31, 2011 and 2010 F-5
Consolidated Statements of Income for the years ended December 31, 2011, 2010 and 2009 F-6
Consolidated Statements of Comprehensive Income for the years ended December 31, 2011, 2010 and 2009 F-7
Consolidated Statements of Changes in Equity for the years ended December 31, 2011, 2010 and 2009 F-8
Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009 F-9
Notes to the Consolidated Financial Statements F-11

F-1


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
China Information Technology, Inc.

We have audited the accompanying consolidated balance sheet of China Information Technology, Inc. and its subsidiaries and variable interest entity (the “Company”) as of December 31, 2011, and the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for the year ended December 31, 2011. We also have audited the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, 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 Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audits 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 audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China Information Technology, Inc. and subsidiaries as of December 31, 2011, and the results of their operations and their cash flows for the year ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, China Information Security Technology, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

/s/ GHP HORWATH, P.C.                 
Denver, Colorado
March 7, 2012

-F- 2 -


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
China Information Technology, Inc.

We have audited the accompanying consolidated balance sheet of China Information Technology, Inc. and its subsidiaries and variable interest entity (the “Company”) as of December 31, 2010 and the related consolidated statements of income, comprehensive income, changes in equity and cash flows for the year ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our 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 the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2010, and the results of its operations and its cash flows for the year ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.

BDO Limited
Hong Kong, March 8, 2011, except for Note 4 which is as of March 7, 2012.

-F- 3 -


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
China Information Technology, Inc.

We have audited the accompanying consolidated statements of income, comprehensive income, changes in equity, and cash flows of China Information Technology, Inc., and its subsidiaries (the “Company”) for the year ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our 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 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of the Company for the year ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America.

/s/ GHP HORWATH, P.C.                
Denver, Colorado
March 5, 2010

-F- 4 -


CHINA INFORMATION TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2011 AND 2010
Expressed in U.S. dollars (Except for share amounts)

 

  NOTE     2011     2010  

ASSETS

                 

 

                 

CURRENT ASSETS

                 

Cash and cash equivalents

      $  14,019,634   $  18,166,857  

Restricted cash

        12,538,049     8,344,147  

Accounts receivable:

                 

Billed, net of allowance for doubtful accounts of $9,373,000 and $6,073,000, respectively

      31,117,415     31,172,599  

Unbilled

        72,225,044     67,622,656  

Bills receivable

        247,338     201,003  

Advances to suppliers

        5,020,747     9,246,437  

Amounts due from related parties

  6     22,823     330,876  

Inventories, net of provision of $5,224,000 and $578,000, respectively

  7     22,317,260     19,931,866  

Other receivables and prepaid expenses

        9,603,954     2,463,562  

Deferred tax assets

  13     2,548,834     1,565,006  

TOTAL CURRENT ASSETS

        169,661,098     159,045,009  

 

                 

Deposit for software purchase

        -     3,034,000  

Deposit for purchase of land use rights

  10(a)   27,564,586     26,566,377  

Long-term investments

  8     2,401,561     3,296,252  

Property, plant and equipment, net

  9     91,161,093     79,348,883  

Land use rights, net

  10(b)   1,956,616     1,929,194  

Intangible assets, net

  10(c)   14,380,459     13,725,274  

Goodwill

        53,983,687     51,918,275  

Deferred tax assets

  13     683,042     538,460  

TOTAL ASSETS

      $  361,792,142   $  339,401,724  

 

                 

LIABILITIES AND EQUITY

                 

 

                 

CURRENT LIABILITIES

                 

Short-term bank loans

  11   $  40,983,457   $  35,326,566  

Accounts payable

        19,013,509     17,249,334  

Bills payable

  12     27,399,393     20,536,475  

Advances from customers

        6,403,966     7,480,686  

Amounts due to related parties

  6     593,617     1,293,866  

Accrued payroll and benefits

        3,060,384     4,304,988  

Other payables and accrued expenses

        6,784,353     6,953,561  

Contingent consideration, current portion

  5     -     3,267,087  

Income tax payable

  13     3,525,949     3,809,708  

TOTAL CURRENT LIABILITIES

        107,764,628     100,222,271  

 

                 

Long-term bank loans

  11     109,524     5,863,205  

Amounts due to related parties, long-term portion

  6     12,624     5,014,949  

Contingent consideration, net of current portion

  5     -     901,171  

Deferred tax liabilities

  13     1,365,680     1,824,434  

TOTAL LIABILITIES

        109,252,456     113,826,030  
COMMITMENTS AND CONTINGENCIES         -     -  
                   
EQUITY                  
Common stock, par $0.01; authorized capital 100,000,000 shares; shares issued 2011: 27,591,462, 2010: 26,030,894 shares  

4

    286,326     255,115  
Treasury stock, 360,627 shares, at cost         (695,514 )   (11,468 )
Additional paid-in capital         101,261,307     92,294,350  
Reserve   14     14,488,533     12,968,985  
Retained earnings         95,600,619     90,240,665  
Accumulated other comprehensive income         19,925,259     11,325,040  
Total equity of the Company         230,866,530     207,072,687  
Non-controlling interest         21,673,156     18,503,007  
TOTAL EQUITY         252,539,686     225,575,694  
                   
                   
TOTAL LIABILITIES AND EQUITY     $  361,792,142   $  339,401,724  

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

-F- 5 -


CHINA INFORMATION TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009
Expressed in U.S. dollars (Except for share amounts)

    NOTE     2011     2010     2009  

 

                       

Revenue - Products

    $ 46,435,133   $  53,328,214   $  16,784,910  

Revenue - Software

        39,301,812     90,419,181     63,827,233  

Revenue - System integration

        27,678,685     16,278,860     19,017,962  

Revenue - Others

        1,119,923     3,819,342     1,365,989  

TOTAL REVENUE

        114,535,553     163,845,597     100,996,094  

 

                       

Cost - Products sold

        36,815,966     46,052,309     13,560,279  

Cost - Software sold

        13,302,464     38,574,738     22,229,542  

Cost - System integration

        19,625,349     8,259,899     14,251,391  

Cost - Others

        472,270     395,496     303,215  

TOTAL COST

        70,216,049     93,282,442     50,344,427  

 

                       

GROSS PROFIT

        44,319,504     70,563,155     50,651,667  

 

                       

Administrative expenses

        22,785,631     18,623,523     12,653,175  

Research and development expenses

        4,483,754     3,016,693     2,705,669  

Selling expenses

        7,522,986     6,359,487     3,136,380  

INCOME FROM OPERATIONS

        9,527,133     42,563,452     32,156,443  

 

                       

Subsidy income

        1,939,787     948,630     833,429  

Other income, net

        538,624     1,237,933     1,153,288  

Interest income

        317,190     126,459     270,666  

Interest expense

        (2,948,406 )   (1,539,407 )   (388,686 )

 

                       

INCOME BEFORE INCOME TAXES

                       

 

        9,374,328     43,337,067     34,025,140  

 

                       

Income tax expense

  13     (804,149 )   (7,863,437 )   (3,887,495 )

 

                       

NET INCOME

        8,570,179     35,473,630     30,137,645  

Less: Net income attributable to the non-controlling interest

  3     (660,781 )   (1,071,626 )   (43,076 )

NET INCOME ATTRIBUTABLE TO THE COMPANY

    7,909,398   $  34,402,004   $  30,094,569  

 

                       

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING

               

Basic

  4     26,737,638     25,907,217     24,338,196  

Diluted

  4     26,965,006     26,072,506     24,338,196  

 

                       

EARNINGS PER SHARE

                       

Basic

4   $ 0.30   $  1.33   $  1.24  

Diluted

4   $ 0.29   $  1.32   $  1.24  

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

-F- 6 -


CHINA INFORMATION TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009
Expressed in U.S. dollars

    2011     2010     2009  

Net income

$  8,570,179   $  35,473,630   $  30,137,645  

Other comprehensive income:

                 

Foreign currency translation gain

  8,903,913     6,668,353     375,380  

Comprehensive income

  17,474,092     42,141,983     30,513,025  

Comprehensive income attributable to the non-controlling interest

  (964,475 )   (1,431,514 )   (46,574 )

Comprehensive income attributable to the Company

$  16,509,617   $  40,710,469   $  30,466,451  

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

-F- 7 -


CHINA INFORMATION TECHNOLOGY, INC
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009
Expressed in U.S. dollars

                                              Accumulated              
    Common stock     Treasury stock     Additional                 other     Non        
    Par value $0.01     Par value $0.01     Paid-in             Retained     comprehensive     controlling        
                                                Shares      Amount     Shares     Amount     Capital       Reserve     earnings     income     interest     Total  

BALANCE AS AT January 1, 2009

  23,731,202   $  209,121     -   $  -   $  64,127,339   $  4,964,597   $  33,748,480   $  4,644,693   $  15,310,897   $  123,005,127  

 

                                                           

Purchase of treasury stock (Note 15)

  -     -     (3,000 )   (11,468 )   -     -     -     -     -     (11,468 )

Common stock issued upon achieving earn-out target

  -     -     -     -     5,745,728     -     -     -     -     5,745,728  

Common stock issued for business acquisitions

  1,191,369     23,827     -     -     8,438,995     -     -     -     -     8,462,822  

Stock-based compensation (Note 15)

  30,000     600     -     -     183,000     -     -     -     -     183,600  

Net income for the year

  -     -     -     -     -     -     30,094,569     -     43,076     30,137,645  

Foreign currency translation gain

  -     -     -     -     -     -     -     371,882     3,498     375,380  

Transfer to reserve (Note 14)

  -     -     -     -     -     3,380,774     (3,380,774 )   -     -     -  

 

                                                           

BALANCE AS AT DECEMBER 31, 2009

  24,952,571     233,548     (3,000 )   (11,468 )   78,495,062     8,345,371     60,462,275     5,016,575     15,357,471     167,898,834  

Issuance of common stock in private placements

  826,017     16,520     -     -     9,113,232     -     -     -     -     9,129,752  

Common stock issued upon the exercise of warrants (Note 15)

  20,625     413     -     -     253,275     -     -     -     -     253,688  

Stock-based compensation (Note 15)

  231,681     4,634     -     -     2,394,876     -     -     -     -     2,399,510  

 

                                                           

Common stock released upon achieving earn-out target

  -     -     -     -     1,850,405     -     -     -     -     1,850,405  

Net income for the year

  -     -     -     -     -     -     34,402,004     -     1,071,626     35,473,630  

 

                                                           

Foreign currency translation gain

  -     -     -     -     -     -     -     6,308,465     359,888     6,668,353  

 

                                                           

Capital injection to Geo

  -     -     -     -     -     -     -     -     1,714,022     1,714,022  

 

                                                           

Imputed interests in relation to shareholder’s loan (Note 6)

  -     -     -     -     187,500     -     -     -     -     187,500  

Transfer to reserve

  -     -     -     -     -     4,623,614     (4,623,614 )   -     -     -  

BALANCE AS AT DECEMBER 31, 2010

  26,030,894     255,115     (3,000 )   (11,468 )   92,294,350     12,968,985     90,240,665     11,325,040     18,503,007     225,575,694  

Purchase of treasury stock (note 15)

  -     -     (357,627 )   (684,046 )   -     -     -     -     -     (684,046 )

Common stock issued upon the settlement of earn-out target (Note 15)

  344,353     6,887     -     -     957,303     -     -     -     -     964,190  

Stock-based compensation (Note 15)

  125,000     2,500     -     -     1,142,499     -     -     -     -     1,144,999  

 

                                                           

Common stock released upon achieving earn-out target (Note 15)

  165,289     3,306     -     -     1,719,006     -     -     -     -     1,722,312  

 

                                                           

Common stock issued on conversion of shareholder’s loan

  925,926     18,518             4,981,482                     5,000,000  

Net income for the year

  -     -     -     -     -     -     7,909,398     -     660,781     8,570,179  

Foreign currency translation gain

  -     -     -     -     -     -     -     8,600,219     303,694     8,903,913  

Imputed interests in relation to shareholder’s loan (Note 6)

  -     -     -     -     166,667     -     -     -     -     166,667  

Changes in an Ownership Interest in Zhongtian (Note 1)

  -     -     -     -     -     -     (1,029,896 )   -     1,029,896     -  

Capital injection to Zhongtian by minority shareholders

  -     -     -     -     -     -     -     -     1,175,778     1,175,778  

Transfer to reserve (Note 14)

  -     -     -     -     -     1,519,548     (1,519,548 )   -     -     -  

 

                                                           

BALANCE AS AT DECEMBER 31, 2011

  27,591,462   $  286,326     (360,627 ) $  (695,514 ) $  101,261,307   $  14,488,533   $  95,600,619   $  19,925,259   $  21,673,156   $  252,539,686  

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

-F- 8 -


CHINA INFORMATION TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2011, 2010 AND 2009
Expressed in U.S. dollars (Except for share amounts)

    2011     2010     2009  

OPERATING ACTIVITIES

                 

Net income

$  8,570,179   $  35,473,630   $  30,137,645  

Adjustments to reconcile net income to net cash provided by operating activities:

                 

 

                 

Provision for losses on accounts receivable and other current assets

  4,072,406     3,652,136     2,765,837  

Depreciation

  10,853,984     7,715,013     4,069,363  

Amortization of intangible assets and land use rights

  1,757,655     1,794,555     1,786,201  

Stock-based compensation

  -     3,130,000     1,453,110  

Loss on disposal of property and equipment, net

  578,265     339,601     62,803  

Loss on write-off of land use rights

  -     232,938     -  

Provision for obsolete inventories

  4,627,598     378,619     183,714  

Change in fair value of contingent consideration

  (1,481,756 )   (325,132 )   (1,108,759 )

Change in deferred income tax

  (1,694,374 )   110,200     (1,268,670 )

Impairment of long-term investment

  1,002,755     855,176     233,211  

Imputed interest on shareholder’s loan

  166,667     187,500     -  

Changes in operating assets and liabilities, net of effects of business acquisitions

                 

Increase in restricted cash

  (2,772,004 )   (743,913 )   (5,856,949 )

Increase in accounts receivable

  (4,538,402 )   (27,889,936 )   (24,850,334 )

Decrease (increase) in advances to suppliers

  3,973,915     (2,044,930 )   3,001,469  

(Increase) decrease in other receivables and prepaid expenses

  (8,944,900 )   11,758,974     (13,366,450 )

Increase in inventories

  (6,171,310 )   (8,943,882 )   (1,219,083 )

Increase in accounts payable and bills payable

  7,101,150     3,761,608     11,068,019  

(Decrease) increase in advances from customers

  (1,329,076 )   3,324,359     1,416,715  

(Decrease) increase in amounts due to related parties

  (401,392 )   457,735     132,774  

Increase(decrease) in other payables and accrued expenses and other liabilities

  1,245,553     (6,673,381 )   1,149,194  

(Decrease) increase in income tax payable

  (275,586 )   398,667     1,687,973  

Net cash provided by operating activities

  16,341,327     26,949,537     11,477,783  

 

                 

INVESTING ACTIVITIES

                 

Cash acquired in HPC acquisition

  -     -     2,508,394  

Consideration paid for acquisition of HPC

  -     -     (8,000,000 )

Purchase of land use rights

  -     (232,938 )   -  

Proceeds from sale of short-term investments

  -     -     5,864,400  

Refund of investment in former Joint Venture

  -     -     4,398,300  

Proceeds from sale of property and equipment

  -     142,049     78,238  

Deposit for purchase of land use rights

  -     (25,310,974 )   -  

Investment in Tianditu

  -     (1,183,520 )   -  

Purchases of property and equipment

  (16,776,095 )   (29,860,881 )   (16,872,380 )

Capitalized and purchased software development costs

  (1,850,595 )   (1,466,554 )   (1,215,649 )

Deposit for software purchase

  -     (2,958,800 )   (1,425,577 )

Net cash used in investing activities

  (18,626,690 )   (60,871,618 )   (14,664,274 )
                   
FINANCING ACTIVITIES                  
Borrowings under short-term loans   87,474,985     52,361,076     19,952,949  
Borrowings from shareholder’s loan   -     6,035,580     -  
Borrowings under long-term loans   -     8,491,756     -  
Repayment of short-term loans   (87,299,684 )   (35,938,146 )   (12,475,839 )
Repayment of shareholder’s loan   -     (1,035,580 )   -  
Repayment of long-term loans   (1,769,920 )   (2,477,995 )   (351,984 )
Increase in restricted cash in relation to bank borrowings   (1,048,220 )   (1,483,976 )   -  
Repurchase of common stock   (684,046 )   -     (11,468 )
Capital injection to Geo by minority shareholders   -     1,744,213     -  
Capital injection to Zhongtian by minority shareholders   1,157,551              
Issued common stock   -     9,383,440     -  
Net cash (used in) provided by financing activities   (2,169,334 )   37,080,368     7,113,658  
                   
Effect of exchange rate changes on cash and cash equivalents   307,474     1,529,937     (13,786 )
                   
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS   (4,147,223 )   4,688,224     3,913,381  
CASH AND CASH EQUIVALENTS, BEGINNING   18,166,857     13,478,633     9,565,252  
CASH AND CASH EQUIVALENTS, ENDING $  14,019,634   $  18,166,857   $  13,478,633  
                   
Supplemental disclosure of cash flow information:                  
Cash paid during the year                  
                   Income taxes $  2,708,313   $  7,360,151   $  3,464,474  
                   Interest $  2,725,058   $  1,331,258   $  379,101  

-F- 9 -



Supplemental disclosure of significant non-cash transactions:

On November 11, 2009, 550,965 shares of common stock were issued for the equity portion of the purchase price of approximately $8.46 million of Huipu.

In 2009, upon achievement of earn out targets by ISS, Bocom and Zhongtian, approximately 452,582 previously issued shares became no longer returnable and resulted in additional equity purchase consideration and goodwill of approximately $5,58 million

In 2010, upon achievement of earn out target by Zhongtian, 177,582 previously issued shares became no longer returnable and resulted in additional equity purchase consideration and goodwill of $1.85 million. Huipu achieved earn out target in 2010 and 165,289 shares was issued for equity portion of purchase price of Huipu.

On February 8, 2011, the Company granted eligible employees a total of 125,000 shares of the Company’s common stock under the China Information Technology, Inc. Equity Incentive Plan as compensation. The fair value of these shares of approximately $1.1 million, based on the quoted market price, was accrued as of December 31, 2010 as the compensation was for services provided in 2010.

On May 3, 2011, upon achievement of earn out targets by Huipu, the Company issued 165,289 shares of the Company’s common stock in connection with the acquisition of Huipu.

On August 16, 2011, the Company issued a total of 925,926 shares of the Company’s common stock at a conversion price of $5.4 per share as repayment of shareholder’s loan of $5.0 million.

On August 30, 2011, the Company settled the remaining potential earn out for 2011 and 2012 with Huipu’s former shareholder and issued 344,354 shares of the Company’s common stock in connection with the acquisition of Huipu .

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

-F- 10 -


CHINA INFORMATION TECHNOLOGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

1. ORGANIZATION AND PRINCIPAL ACTIVITIES

China Information Technology Inc (the “Company” or “ CNIT ”), together with its subsidiaries, is a total solutions provider of information and display technology products and services in the People’s Republic of China (“PRC”). The Company’s total solutions include specialized software, hardware, systems integration, and related services. These services are provided through the Company’s wholly-owned PRC subsidiaries, Information Security Technology (PRC) Co., Ltd ("IST"), Information Security Software (China) Co., Ltd (formerly, Information Security Development Technology Co., Ltd), or "ISS," Shenzhen Bocom Multimedia Display Technology Co., Ltd ("Bocom"), and Huipu Electronics (Shenzhen) Co., Ltd (“Huipu”), and through the Company’s variable interest entity ("VIE"), iASPEC Software Company Limited ("iASPEC"), and its subsidiaries, Wuda Geoinformatics Co., Ltd ("Geo") and Shenzhen Zhongtian Development Company Ltd (“Zhongtian”).

On April 2, 2007, China Public Security Technology, Inc. ("CPST") entered into an Agreement and Plan of Merger (the "Merger Agreement") with CNIT, a Nevada corporation and wholly-owned subsidiary of CPST. Pursuant to the Merger Agreement, CPST agreed to merge with and into CNIT, with CNIT being the surviving entity (the "Reincorporation Merger"). The Reincorporation Merger became effective on April 7, 2008. The Reincorporation Merger was effected by an exchange of shares of CPST into shares of CNIT on a one-for-one basis. As a result of the Reincorporation Merger, CPST became domiciled in Nevada and its name was changed to China Information Technology, Inc. All assets, liabilities, contracts and obligations of CPST became the assets, liabilities, contracts and obligations of CNIT. References to the Company are to CNIT as successor to CPST and its subsidiaries.

Management Service Agreement

Pursuant to the terms of a July 2007 management service agreement (“MSA”), as amended, iASPEC granted IST a ten-year, exclusive, royalty-free, transferable worldwide license to use and install certain iASPEC software, along with copies of source and object codes relating to such software. In addition, IST licensed back to iASPEC a royalty-free, limited, non-exclusive license to the software, without right of sub-license, for the sole purpose of permitting iASPEC to carry out its business as presently conducted. IST has the right to designate two Chinese citizens to serve as senior managers of iASPEC, to serve as a majority on iASPEC’s Board of Directors, and to assist in managing the business and operations of iASPEC. In addition, both iASPEC and IST will require the affirmative vote of a majority of the Company’s Board of Directors, including at least one non-insider director, for certain material actions, as defined, with respect to iASPEC.

In connection with the MSA, IST also entered into an immediately exercisable purchase option agreement (“Option Agreement”) with iASPEC and its shareholders, pursuant to which the iASPEC shareholder granted the Company or its designee(s) an exclusive, irrevocable option to purchase, from time to time, all or a part of iASPEC’s shares or iASPEC’s assets from the iASPEC shareholder for $1,800,000 in the aggregate. The option may not be exercised if the exercise would violate any applicable laws and regulations in the PRC or cause any license or permit held by, and necessary for the operation of iASPEC, to be cancelled or invalidated.

-F- 11 -


CHINA INFORMATION TECHNOLOGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)

Amended and Restated MSA

Pursuant to the MSA, IST will provide management and consulting services to iASPEC, under the following terms:

  • iASPEC agreed that IST will be entitled to receive ninety five percent (95%) of the Net Received Profit, as defined, of iASPEC during the term of the Agreement. iASPEC is obligated to calculate and pay the Net Received Profit due to IST no later than the last day of the first month following the end of each fiscal quarter;

  • Mr. Lin agreed to enter into a pledge agreement with IST to pledge all of his equity interests in iASPEC as security for his and iASPEC’s fulfillment of their respective obligations under the MSA, and to register the pledge agreement with the local AIC (Administration for Industry and Commerce);

  • Mr. Lin confirmed his status as the sole iASPEC shareholder and his assumption of all of the obligations of the iASPEC shareholder under the agreement, including a confirmation of his continuing obligation under a written guaranty, executed by the then iASPEC shareholders;

  • Based on iASPEC’s needs for its development and operation, IST has the right, from time to time, at its sole discretion, to provide iASPEC with capital support

  • IST agreed that it will not interfere in any business of iASPEC covered by iASPEC’s PRC State Secret related Computer Information System Integration Certificate, including but not limited to, seeking access to relevant documents regarding such business; provided, however, that iASPEC agreed that it will cooperate with the requests of the Company as necessary to comply with the Company’s reporting obligations to the Securities and Exchange Commission.

The substance of the MSA and the Option Agreement is to:

  • Allow the Company to utilize the business licenses, contacts, permits and other resources of iASPEC in order for the Company to be able to expand its operations and business model;

  • Provide the Company with effective control over all of iASPEC’s operations;

  • Allow the shareholders of iASPEC an opportunity to monetize a portion of their investment through the $1.8 million purchase option.

As a result of the MSA and the Option Agreement, iASPEC is a Variable Interest Entity (VIE) of the Company. To comply with PRC laws and regulations that restrict foreign ownership of companies that provide public security information technology and Geographic Information Systems software operating services to certain government and other customers, the Company operates the restricted aspect of its business through iASPEC.

On September 3, 2010, Geo, a majority-owned subsidiary of iASPEC increased its registered capital from RMB 60 million (approximately $8.8 million) to RMB79 million (approximately $11.7 million). The RMB19.2 million (approximately $2.8 million) increase was contributed by iASPEC, the minority shareholders of Geo and new shareholders, comprising of the management teams of both GEO and iASPEC, including Mr. Lin, the Company’s chief executive officer and the sole shareholder of iASPEC.

On August 2011, the Boards of Directors of iASPEC and the Company approved iASPEC’s less than pro rata contribution of RMB7.4 million (approximately $1.1 million), and approved the participation of the management teams of Geo and iASPEC in the capital increase as an incentive and to align their interests with the interests of Geo and iASPEC. As a result of the capital increase, the equity interest owned by iASPEC in Geo was reduced from 57% to 52.54%, and the management teams of Geo and iASPEC now hold 11.02% of the equity interests in Geo.

-F- 12 -


CHINA INFORMATION TECHNOLOGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)

On May 5, 2011, Kwong Tai International Technology Ltd. (“Kwong Tai”), our wholly-owned subsidiary, and iASPEC entered into an equity transfer agreement, pursuant to which Kwong Tai agreed to transfer 100% of equity interests in Zhongtian, also our wholly-owned PRC subsidiary, to iASPEC, for a purchase price of RMB20.2 million (approximately $3.1 million), and resulted in approximately $1 million of Zhongtian's equity being reclassified to non-controlling interest. The Purchase Price is equal to the PRC registered capital of Zhongtian.

On December 29, 2011, Zhongtian, increased its registered capital from RMB33.2 million (approximately $5.2 million) to RMB40.7 million (approximately $6.4 million). The RMB7.5 million(approximately $1.2 million) was contributed by new shareholders, comprising the management teams of Zhongtian, including Mr. Jianghuai Lin, the Company’s chief executive officer. As a result of the capital increase, the equity interest owned by iASPEC in Zhongtian was reduced from 100% to 81.65%, and the management team of Zhongtian now holds 18.35% of the equity interest in Zhongtian.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of Consolidation

The consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles. The consolidated financial statements include the accounts of the Company, its subsidiaries and its VIE for which the Company is the primary beneficiary. All significant intercompany accounts and transactions have been eliminated in consolidation.

(b) Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ from those estimates.

(c) Economic and Political Risks

The majority of the Company’s operations are conducted in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy. The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation.

(d) Cash and Cash Equivalents

The Company considers all highly liquid investments purchased and cash deposits with financial institutions with original maturities of three months or less to be cash equivalents.

The Company maintains its cash accounts at credit worthy financial institutions and closely monitors the movements of its cash positions. At December 31, 2011 and 2010, approximately $14.02 million and $18.17 million, respectively was held in bank accounts in the PRC.

(e) Restricted Cash

Restricted cash as of December 31, 2011 consists of security deposits in bank accounts in the PRC that serve as collateral for the Company’s revolving working capital facility, which are included in short-term loans, bills payable, as well as letter of credit facilities.

-F- 13 -


CHINA INFORMATION TECHNOLOGY, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

(f) Accounts Receivable, Bills Receivable and Concentration of Risk

The Company evaluates the creditworthiness of each customer before accepting them and continuously monitors their recoverability. If there are any indicators that the customer may not make payment, then we may consider making provision for impairment for that particular customer. At the same time, we may cease further sales or services to such customer. The following are some of the factors that we consider in determining whether to discontinue sales or revenue recognition:

  •  
  • the customer fails to comply with its payment schedule;
  •  
  • the customer is in serious financial difficulty;
  •  
  • a significant dispute with the customer has occurred regarding job progress or other matters;
  •  
  • the customer breaches any of the contractual obligations;
  •  
  • the customer appears to be financially distressed due to economic or legal factors;
  •  
  • the business between the customer and the Company is not active; and
  •  
  • other objective evidence which indicates impairment of the accounts receivable.

    We consider the following factors when determining whether to permit a longer payment period or provide other concessions to customers:

  •  
  • the customer’s past payment history;
  •  

  • the customer’s general risk profile, including factors such as the customer’s size, age, and public or private status;
  •  
  • macroeconomic conditions that may affect a customer’s ability to pay; and
  •  
  • the relative importance of the customer relationship to our business.

    Bills receivable represent bank undertakings that essentially guarantee payment of amounts thereunder. The undertakings are provided by banks upon receipt of collateral deposits from the Company’s customers or debtors. Bills receivable can be sold at a discount before maturity, which is typically within three months.

    Accounts receivable include $72.23 million and $67.62 million of unbilled accounts receivable at December 31, 2011 and 2010, respectively. Unbilled accounts receivable consist of estimated future billings for work performed but not yet invoiced to the customer. Unbilled accounts receivable are generally invoiced upon the completion of work orders, which is estimated to be within one year.

    The Company’s top five customers accounted for 19% of accounts receivable as of December 31, 2011, of which no single customer accounted for greater than 10% or more of accounts receivable. The Company’s top five customers accounted for 16% of accounts receivable as of December 31, 2010, of which no single customer accounted for greater than 10% or more of accounts receivable.

    For the years ended December 31, 2011, 2010 and 2009, no single customer accounted for 10% or more of total revenue. The allowance for doubtful accounts at December 31, 2011 and 2010, totaled $9.37 million and $6.07 million respectively, representing management’s best estimate. The following table describes the movement in the allowance for doubtful accounts during the year ended December 31, 2011:

    Balance at January 1, 2011 $  6,072,644  
    Increase in allowance for doubtful accounts   6,169,941  
    Amounts recovered during current period   (3,145,063 )
    Foreign exchange difference   275,804  
    Balance at December 31, 2011 $  9,373,326  

    (g) Advances to Suppliers

    Advances to suppliers represents cash deposits for the purchase of inventory items from suppliers.

    -F- 14 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    (h) Advances from Customers

    Advances from customers represents cash received from customers as advance payments for the purchase of the Company’s products.

    (i) Fair Value of Financial Instruments and Fair Value Accounting

    Fair Value of Financial Instruments

    Management has estimated that the carrying amounts of non-related party financial instruments approximate fair values for all periods presented due to their short-term maturities. The carrying amount of debt approximates fair value because of its variable interest rate. The fair value of the amount due from (to) related parties is not practicable to estimate due to the related party nature of the underlying transactions.

    Fair Value Accounting

    Financial Accounting Standards Board (FASB) Accounting Standards Codifications (ASC) 820-10 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). As required by FASB ASC 820-10, assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The three levels of the fair value hierarchy under FASB ASC 820-10 are described below:

    Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
    Level 2 Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
    Level 3 Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).

    As of December 31, 2010, the contingent consideration for the Company’s acquisition of Huipu was measured at fair values using level 3 inputs. In 2011 the contingent consideration of $1.48 million was settled.

    (j) Inventories

    Inventories are valued at the lower of cost or market. Market is the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated costs necessary to make the sale.

    The Company performs an analysis of slow-moving or obsolete inventory periodically and any necessary valuation reserves, which could potentially be significant, are included in the period in which the evaluations are completed. As of December 31, 2011, the inventory impairment was mainly from raw materials, and results in a new cost basis for accounting purposes.

    For the years ended December 31, 2011 and 2010, approximately 43%, 40%, respectively of total inventory purchases were from five unrelated suppliers. Two suppliers accounted for 25% of total inventory purchases in 2011 and no other suppliers accounted for greater than 10% of total inventory purchases. One supplier accounted for 10.6% of total inventory purchases in 2010 and no other suppliers accounted for greater than 10% of total inventory purchases.

    (k) Long-term Investments

    Long-term investments are carried at cost. If a decline in the fair value of a cost method investment is determined to be other than temporary, an impairment charge is recorded and the fair value becomes the new cost basis of the investment. Management evaluates all cost method investments for impairment; however, the fair value of the cost method investments is not required to be determined unless impairment indicators are present. When impairment indicators exist, discounted cash flow analyses are generally used to estimate the fair value. (Level 3)

    -F- 15 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    (l) Property, plant and equipment

    Property, plant and equipment are stated at cost less accumulated amortization and depreciation. Amortization and depreciation is provided over the assets’ estimated useful lives, using the straight-line method. Estimated useful lives of property, plant and equipment are as follows:

    Office buildings 20-50 years
    Plant and machinery 3-20 years
    Electronics equipment, furniture and fixtures 3-5 years
    Motor vehicles 5 years
    Purchased software 3-10 years

    Maintenance and repairs costs are expensed as incurred, whereas significant renewals and betterments are capitalized.

    (m) Land use rights

    All land in the PRC is owned by the PRC government. The government in the PRC, according to the PRC law, may sell the right to use the land for a specified period of time. Thus, all of the Company’s land purchases in the PRC are considered to be leasehold land under operating lease arrangement and are stated at cost less accumulated amortization and any recognized impairment loss. The cost of the land use right is amortized on a straight-line basis over the beneficial period of 46 years.

    (n) Intangible assets

    Intangible assets represent technology and customer base intangible assets acquired in connection with business acquisitions, and software development costs capitalized by the Company’s subsidiaries.

    Intangible assets are amortized using the straight-line method over the following estimated useful lives:

    Software development costs 2-5 years
    Technology 10-20 years
    Trademarks 20 years
    Customer Base 2 years

    (o) Goodwill

    ASC 350-30-50, “Goodwill and Other Intangible Assets”, requires the testing of goodwill and indefinite-lived intangible assets for impairment at least annually. The Company tests goodwill for impairment in the fourth quarter each year.

    Under applicable accounting guidance, the goodwill impairment analysis is a two-step test. The first step of the goodwill impairment test involves comparing the fair value of each reporting unit with its carrying amount including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its fair value, the second step must be performed to measure potential impairment.

    The second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated possible impairment. If the implied fair value of goodwill exceeds the goodwill assigned to the reporting unit, there is no impairment. If the goodwill assigned to a reporting unit exceeds the implied fair value of goodwill, an impairment charge is recorded for the excess.

    -F- 16 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    (p) Long-Lived Assets

    Long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology or other industry changes. Determination of recoverability of assets to be held and used is determined by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets held for disposal, if any, are reported at the lower of the carrying amount or fair value less costs to sell.

    (q) Revenue Recognition

    The Company generates its revenues primarily from three sources, (1) hardware sales, (2) software sales, and (3) system integration services. The Company’s revenue recognition policies are in accordance with SEC Staff Accounting Bulletin No. 104, "Revenue Recognition" and FASB ASC No.605-35 "Construction-Type and Production-Type Contracts" ("FASB ASC 605-35").

    Revenues from hardware products are recognized only when persuasive evidence of an arrangement exists, delivery has occurred and upon receipt of customers’ acceptance, the price to the customer is fixed or determinable in accordance with the contract, and collectability is reasonably assured.

    Software revenues are generated from fixed-price contracts which include the development of software products, and services to customize such software to meet customers’ needs. Generally, when the services are determined to be essential to the functionality of the delivered software, revenue is recognized using the percentage of completion method of accounting in accordance with FASB ASC 605-35. The percentage of completion for each contract is estimated based on the ratio of direct labor hours incurred to total estimated direct labor hours. The Company provides post contract support (PCS), which includes telephone technical support that is not essential to the functionality of the software. Although vendor-specific objective evidence does not exist for PCS, because (1) the PCS fees are included in the total contract amount, (2) the PCS service period is for less than one year, (3) the estimated cost of providing PCS is not significant, and (4) unspecified upgrades enhancements offered are minimal and infrequent; the Company recognizes PCS revenue after delivery and customer acceptance.

    System integration revenues are generated from fixed-price contracts which provide for software development and hardware integration, which involves more than minor modifications to the functionality of the software and hardware products. Accordingly, system integration revenues are accounted for in accordance with FASB ASC 605-35, using the percentage of completion method of accounting. The percentage of completion for each contract is estimated based on the ratio of costs incurred to total estimated costs.

    Contract periods are usually less than six months, and typical contract periods for PCS are 12 months.

    System integration projects are billed in accordance with contract terms, which typically require partial payment at the signing of the contract, at delivery and customer acceptance dates, with the remainder due within a stated period of time not exceeding 12 months. Occasionally, the Company enters into contracts which allow a percentage of the total contract price to be paid one to three years after completion of the system integration project. Revenues on these extended payments are recognized upon completion of the terms specified in the contract and when collectability is reasonably assured.

    No rights of return are allowed except for non-conforming products, which have been insignificant based on historical experiences. If non-conforming products are returned due to software issues, the Company will provide upgrades or additional customization to suit customers’ needs. In cases where non-conformity is a result of integrated hardware, the Company returns the hardware to the original vendor for replacement.

    -F- 17 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    (q) Revenue Recognition (continued)

    Unbilled accounts receivable consist of estimated future billings for work performed but not yet invoiced to the customer. Unbilled accounts receivable are generally invoiced within one year of completion of the work performed. Changes in estimates for revenues, costs and profits are recognized in the period in which they are determinable. When the Company’s estimates indicate that the entire contract will be performed at a loss, a provision for the entire loss is recorded in the current accounting period.

    (r) Treasury Stock

    The Company repurchases its common stock from time to time in the open market and holds such shares as treasury stock. The Company applies the “cost method” and presents the cost to repurchase such shares as a reduction in shareholders’ equity. During the year ended December 31, 2011 and 2009, the Company has repurchased a net total of 357,627 and 3,000 shares of common stock. No shares were repurchased in 2010.

    (s) Stock-based compensation

    The Company applies ASC No. 718, “Compensation — Stock Compensation” (formerly the SFAS No. 123 (revised 2004) “Share-based Payment”), which requires that share-based payment transactions with employees, such as share options, be measured based on the grant-date fair value of the equity instrument issued and recognized as compensation expense over the requisite service period, with a corresponding addition to equity. Under this method, compensation cost related to employee share options or similar equity instruments is measured at the grant date based on the fair value of the award and is recognized over the period during which an employee is required to provide service in exchange for the award, which generally is the vesting period.

    During the years ended December 31, 2010 and 2009, the Company recognized $3.13 million and $1.45 million, respectively of compensation expenses under the Plan. There was no compensation expense recorded in the year ended December 31, 2011.

    (t) Foreign Currency Translation

    The functional currency of the US and British Virgin Islands (“BVI”) companies is the United States dollars. The functional currency of the Company’s Hong Kong subsidiaries is the Hong Kong dollars.

    The functional currency of the Company’s wholly-owned PRC subsidiaries and its VIE is the Chinese Renminbi Yuan, (“RMB”). RMB is not freely convertible into foreign currencies. The Company’s PRC subsidiaries’ and their VIE’s financial statements are maintained in the functional currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet date. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transactions. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income for the respective periods.

    For financial reporting purposes, the financial statements of the Company have been translated into United States dollars. Assets and liabilities are translated at exchange rates at the balance sheet dates, revenue and expenses are translated at average exchange rates, and equity is translated at historical exchange rates. Any resulting translation adjustments are not included in determining net income but are included in other comprehensive income, a component of equity.

    The exchange rates adopted are as follows:

      December 31,   December 31,
      2011   2010
    Year end exchange rate 6.3532   6.5920
    Average yearly exchange rate 6.4533   6.7595

    The average yearly exchange rate adopted for the year ended December 31, 2009 was 6.8208.

    No representation is made that the RMB amounts could have been, or could be, converted into United States dollars at the rates used in translation.

    -F- 18 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    (u) Accounting for Computer Software to be Sold, Leased or Otherwise Marketed

    The Company accounts for software development costs in accordance with FASB ACS 985-20-Cost of Software to be Sold, Leased, or Marketed. Costs related to establishing the technological feasibility of a software product are expensed as incurred as a part of research and development expenses. Costs that are incurred to produce the finished products after technological feasibility is established are capitalized and amortized over the estimated economic life of 2 to 5 years. The Company performs periodic reviews to ensure that unamortized program costs remain recoverable from future revenue. During the years ended December 31, 2011, 2010 and 2009, $1.85 million, $1.47 million and $1.08 million, respectively was capitalized. At December 31, 2011, 2010 and 2009, unamortized capitalized software costs were approximately $3.38 million, $1.87 million, and $1.24 million, respectively.

    (v) Subsidy Income

    Subsidy income mainly represents income received from the local governmental agency in China for development and designated activities. We have no continuing obligation under the subsidy provision.

    (w) Income Taxes

    Income taxes are provided on an asset and liability approach for financial accounting and reporting of income taxes. Deferred income taxes are recognized for all significant temporary differences at enacted rates and classified as current or non-current based upon the classification of the related asset or liability in the financial statements. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion, or all of, the deferred tax asset will not be realized. The Company classifies interest and/or penalties related to unrecognized tax benefits, if any, as a component of income tax expense.

    The Company applies the provisions of ASC No. 740 “Income Taxes” (“ASC 740”), which clarifies the accounting for uncertainty in income taxes recognized by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC 740 also provides accounting guidance on de-recognition, classification, interest and penalties, and disclosure.

    (x) Segment reporting

    Segment information is consistent with how management reviews the businesses, makes investing and resource allocation decisions and assesses operating performance. Transfers and sales between reportable segments, if any, are recorded at cost.

    In connection with the changes in the Company’s business portfolio and realignment of management, management conducted a review of its operating business segments during the first quarter of 2011. The review resulted in changing the segment reporting from four to two new segments, Information Technology (“IT”), and Display Technology (“DT”).

    The Company’s new segment reporting, which has been used for all periods presented, follows the organizational structure as reflected in its internal management reporting systems, which are the basis for assessing the financial performance of the business segments and for allocating resources to the business segments.

    The Company reports financial and operating information in the following two segments:

    -F- 19 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    (x) Segment reporting (continued)

    (a)

    IT includes revenues from products and services surrounding the Company’s variety of software core competencies currently primarily in Geographic Information Systems, Digital Public Security Technologies and Hospital Information Systems. IT segment revenues are generated from the sales of software and system integration services, as well as hardware other than display products.

       
    (b)

    DT includes revenues from products and services surrounding the Company’s display technology core competencies currently primarily in Geographic Information Systems, Digital Public Security Technologies, Education and Media Solutions and consumer products. DT segment revenues are generated from sales of hardware and total solutions of hardware integrated with proprietary software and content, as well as services.

    (y) Sales, use and other value added tax

    Revenue is recorded net of applicable sales, use and value added tax.

    (z) Recently Issued Accounting Guidance

    In September 2011, the FASB issued ASU 2011-08—Intangibles—Goodwill and Other (Topic 350) - Testing Goodwill for Impairment. ASU 2011-08 provides an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is not less than its carrying amount, then performing the two-step impairment test is not required. ASU 2011-08 is effective for fiscal year 2013. Early adoption is permitted.. The adoption of ASU 2011-08 is not expected to have a material impact on our consolidated financial statements.

    3. VARIABLE INTEREST ENTITY

    The Company is the primary beneficiary of iASPEC, pursuant to the MSA, and iASPEC qualifies as a variable interest entity of the Company. Accordingly, the assets and liabilities and revenues and expenses of iASPEC have been included in the accompanying consolidated financial statements. In the opinion of management, (i) the ownership structure of the Company, and the VIEs are in compliance with existing PRC laws and regulations; (ii) the contractual arrangements with the VIEs and its shareholder are valid and binding, and will not result in any violation of PRC laws or regulations currently in effect; and (iii) the Company’s business operations are in compliance with existing PRC laws and regulations in all material respects.

    However, there are substantial uncertainties regarding the interpretation and application of current and future PRC laws and regulations. Accordingly, the Company cannot be assured that PRC regulatory authorities will not ultimately take a contrary view to its opinion. If the current ownership structure of the Company and its contractual arrangements with VIEs are found to be in violation of any existing or future PRC laws and regulations, the Company may be required to restructure its ownership structure and operations in the PRC to comply with the changing and new PRC laws and regulations. In the opinion of management, the likelihood of loss in respect of the Company’s current ownership structure or the contractual arrangements with VIEs is remote based on current facts and circumstances.

    In order to facilitate iASPEC’s expansion and also to provide financing for iASPEC to complete the acquisition of Geo, the Company advanced RMB38 million (approximately $5.4 million) to iASPEC in two installments on in2007 and 2008, to increase iASPEC’s registered capital. In order to comply with PRC laws and regulations, the advance was made to Mr. Lin, iASPEC’s then majority shareholder, who, upon the authority and direction of the Board of Directors, forwarded the funds to iASPEC . The Company has recorded the advance of these funds as an interest-free loan to iASPEC, which was eliminated against additional capital of iASPEC in consolidation. The increase in iASPEC’s registered capital does not affect IST’s exclusive option to purchase iASPEC’s assets and shares under the MSA

    . -F- 20 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    3. VARIABLE INTEREST ENTITY (CONTINUED)

    For the years ended December 31, 2011, 2010 and 2009, $660,781 ($385,099 from iASPEC and $275,682 from Geo), and $1,071,626 ($893,316 from iASPEC and $178,310 from Geo), $43,076 ($180,000 from iASPEC and a loss $136,924 from Geo) respectively have been attributed to non-controlling interest in the consolidated statements of income of the Company.

    At December 31, 2011, the consolidation of iASPEC, Geo and Zhongtian resulted in an increase in assets of approximately $92.63 million, an increase in liabilities (consisting primarily of accounts payable and short-term bank loans) of approximately $30.74 million, and an increase in non-controlling interest of approximately $21.67 million, and for the years ended December 31, 2011 and 2010 the consolidation resulted in an increase in net income attributable to the Company of approximately $7.32 million and $16.97 million, respectively.

    4. EARNINGS PER SHARE

    Basic earnings per share are computed by dividing income available to common shareholders by the weighted-average number of common stock outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, or resulted in the issuance of common stock that shared in the earnings of the entity. For purposes of the computation of net income per share, shares issued in connection with acquisitions that are returnable are considered contingently returnable shares under FASB ASC 260, although classified as issued and outstanding, are not included in the basic weighted average number of shares until all necessary conditions are met that no longer cause the shares to be contingently returnable. These contingently returnable shares are included in the diluted weighted average number of shares as of the beginning of the period in which the conditions were satisfied (or as of the date of the agreement, if later).

    On March 1, 2012, the Company announced that it has filed a Certificate of Change pursuant to Section 78.209 of the Nevada Revised Statutes with the Nevada Secretary of State to effect a one (1)-for-two (2) reverse stock split of the authorized and issued and outstanding Common Stock, par value $0.01 per share, of the Company. The reverse stock split was effective at the market opening on March 2, 2012, at which time the Company’s Common Stock will begin trading on the NASDAQ Stock Market on a split-adjusted basis. All references in this report to share and per share data have been adjusted, including historical data which have been retroactively adjusted, to give effect to the reverse stock split unless specified otherwise. Components of basic and diluted earnings per share were as follows for the years ended December 31, 2011, 2010 and 2009:

        2011     2010     2009  
                       
    Net income attributable to the Company $  7,909,398   $  34,402,004   $  30,094,569  
    Weighted average outstanding shares of common stock   26,737,638     25,907,217     24,338,196  
    Effect of dilutive securities                  
       Warrants   -     -     -  
       Contingently issuable shares   227,368     165,289     -  
                       
    Earnings per share:                  
    Basic $  0.30   $  1.33   $  1.24  
                       
    Diluted $  0.29   $  1.32   $  1.24  

    Warrants for the purchase of 200,000 shares were not included in 2011, 2010, or 2009as their effect would have been anti-dilutive.

    -F- 21 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    5. GOODWILL AND CONTINGENT CONSIDERATION FROM BUSINESS ACQUISITIONS

    Goodwill by segment as at December 31, 2011 and 2010 is as follows:

            Foreign      
    December 31, exchange rate December 31,
        2010     adjustment     2011  
    IT Segment $  25,941,242   $  1,038,952   $  26,980,194  
    DT Segment   25,977,033     1,026,460     27,003,493  
    Total $  51,918,275   $  2,065,412   $  53,983,687  

    On October 14, 2009, the Company, through CPSH, acquired 100% of the equity interests of Topwell Treasure Ltd.("Topwell"), a Hong Kong limited company, and its wholly-owned Chinese subsidiary, Huipu Electronics (Shenzhen) Co., Ltd. ("Huipu"), for an aggregate purchase price of $16 million pursuant to a Share Purchase Agreement, dated August 28, 2009. Huipu is a leading developer and manufacturer of customized LCD/LED multi-screen display systems in China and the holder of numerous technology patents, trademarks, certifications and licenses. As a result of the acquisition, the Company is expected to penetrate to those markets with the integrated system of the software and LCD/LED multi-screen display.

    The total acquisition date fair value of the consideration transferred was estimated at $22.06 million, which included the initial payments totaling approximately $8 million in cash, 550,965 shares of the Company’s common stock valued at $15.36 per share, representing the closing market price of the Company’s shares at acquisition date, and the estimated fair value of acquisition-related contingent consideration to be paid to Huipu’s shareholders totaling approximately $5.6 million.

    The fair value estimate of the contingent consideration was based on weighted probability (level 3 input) of achievement of After Tax Net Income targets (ATNI) in 2010, 2011 and 2012, which could have resulted in the issuance of up to 550,965 additional shares of the Company’s common stock. Actual achievement of ATNI below $3.2 million would have reduced the liability to zero and achievement of ATNI of $6.8 million or more would have increased the liability to $6.8 million. Changes in fair value of the acquisition-related contingent consideration were recorded in the statement of operations and financial position in the period of change. Gains of $1.48 million, $0.33 million and $1.1 million of other income, net in 2011, 2010 and 2009, respectively. On August 30, 2011, the Company waived the requirement of the remaining potential earn out for 2011 and 2012 with Huipu’s former shareholder, therefore, as at December 31, 2011, the fair value of contingent consideration is zero. The following table represents the fair value movement changes in 2011:

    Contingent consideration:      
    Fair value as at December 31, 2010: $  4,168,258  
    Less: common stock issued upon achieved earn out target for 2010:   (1,722,312 )
    Less: fair value changes during the year 2011:   (1,481,756 )
    Less: common stock issued upon amendment of the earn out clause in 2011:   (964,190 )
    Fair value as at December 31, 2011: $  -  

    6. RELATED PARTY BALANCES AND TRANSACTIONS

    As of December 31, 2011 and 2010, amounts due from (to) related parties consist of:

        December 31,     December 31,  
        2011     2010  
    Due from related companies            
                                 - Xiamen Yili Geo Information Technology Co., Ltd. $  22,823   $  137,289  
                                 - Shenzhen Kewen Information Technology Co., Ltd.   -     193,587  
      $  22,823   $  330,876  

    -F- 22 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    6. RELATED PARTY BALANCES AND TRANSACTIONS (CONTINUED)

    Due to related companies            
                             - Shenzhen Information Security Investment and Development Co., Ltd. $ -   $ 697,820  
                             - Wuhan Geo Navigation and Communication Technology Co., Ltd.   593,617     596,046  
      $  593,617   $  1,293,866  
                 
    Due to related party, long-term portion            
                             - Shareholder $  12,624   $  5,014,949  

    Due from related companies, current portion

    Approximately 8% of Xiamen Yili Geo Information Technology Co., Ltd. (“Yili”) is owned by Geo. The balance consists of accounts receivable from sales.

    Shenzhen Kewen Information Technology Co., Ltd. (“Kewen”) is a private company owned by a member of the senior management of Zhongtian. The balance consists of accounts receivable balances from sales.

    Due to related companies, current portion

    Approximately 9% of Wuhan Geo Navigation and Communication Technology Co., Ltd. (“Geo Navigation”) is owned by Geo. The balance represents advances from Geo Navigation to Geo. These advances are non-interest bearing and due on demand.

    Shenzhen Information Security Investment and Development Co., Ltd., or ISID, was a company under the control of Mr. Lin and a balance of $697,820 due to ISID represented advances from ISID to the Company as of December 31, 2010. These advances are non-interest bearing and due on demand. As Mr Lin transferred control of ISID to a non-affiliated third party during the year 2011, ISID was not our related company as of December 31, 2011.

    Due to related party, long-term portion

    The balance due to shareholder represents the personal loans from Mr. Jianghuai Lin, the CEO of the Company, to the Company.

    On January 14, 2010, Mr. Lin loaned the Company a total of $5 million from the proceeds of the sale of his shares for use for general corporate purposes and working capital. In consideration of the loan from Mr. Lin, the Company’s Board of Directors approved the issuance and delivery of a one-year, non-interest bearing, convertible promissory note (“the Original Note”) to Mr. Lin, in the principal amount of $5 million. The note was due and payable on January 14, 2011, and was convertible into shares of the Company’s common stock at a conversion price of $5.88 per share (the per share closing price on the trading day prior to the delivery date of the Original Note).

    On March 25, 2010, Mr. Lin surrendered the Original Note to the Company and asked the Company to void and rescind the Original Note and issue a replacement note (the “New Note”), in the principal amount of $6,000,000, to reflect the principal amount of the Original Note as well as an additional loan of $1,000,000 made to the Company on March 25, 2010. The New Note omits the conversion feature that was contained in the Original Note and was non-interest bearing. The maturity date of the New Note was March 5, 2012 and the Company may prepay all or any part of the amounts outstanding under this Note at any time before the maturity date without the express written consent of Mr. Lin. On April 7, 2010, the Company repaid the additional loan of $1,000,000 included in the New Note. In accounting for the New Note, the Company accrues an interest expense at an interest rate of 5% per annum, which is the market interest rate for USD denominated 2-year loans in China. The imputed interests for the year ended December 31, 2011 and 2010 was $166,667 and $187,500, respectively and was recorded as a capital contribution by Mr. Lin.

    On August 16, 2011, the Company and Mr. Lin agreed to an amended and restated promissory note (the “Amended and Restated Note”) The Amended and Restated Note allowed for , the loan balance to be repaid by conversion of the balance into shares of the Company’s common stock at a conversion price of $5.4 per share. On August 16, 2011, Mr. Lin exercised this conversion right, received a total of 925,926 shares of the Company’s common stock .

    -F- 23 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    6. RELATED PARTY BALANCES AND TRANSACTIONS (CONTINUED)

    (b) Revenue - related party

    Amounts earned from Yili and Kewen during the years ended December 31, 2011, 2010 and 2009 were as follows:

        2011     2010     2009  
    Revenue $  14,334   $  630,975   $  470,422  
    Cost of sales   -     (247,892 )   (107,221 )
    Gross profit $  14,334   $  383,083   $  363,201  

    (c) Rental expenses- related party

    Rental expenses to Mr. Lin during the years ended December 31, 2011, and 2010 were $248,653, and $110,795 respectively.

    7. INVENTORIES

    As of December 31, 2011 and 2010, inventories consist of:

        2011     2010  
    Raw materials $  5,488,149   $  5,274,081  
    Work in Processes   4,102,102     227,455  
    Finished goods   4,327,818     4,700,253  
    Installations in process   8,399,191     9,730,077  
    Total $  22,317,260   $  19,931,866  

    8. LONG-TERM INVESTMENTS

    As of December 31, 2011 and 2010, long-term investments consist of:

        2011     2010  
                 
    Tianhe Navigation and Communication Technology Co., Ltd. ("Tianhe") $  1,063,661   $  2,006,802  
    Tianditu Co., Ltd (Tianditu)   1,259,200     1,213,600  
    Xiamen Yili Geo Information Technology Co., Ltd. ("Yili")   78,700     75,850  
      $  2,401,561   $  3,296,252  

    Geo holds a 20% ownership interest in Tianhe. Although Geo owns 20% of Tianhe, Geo’s management does not have the ability to exercise significant influence over operating and financial policies of Tianhe due to the following factors:

    a. The Company and Geo do not participate in the policy making, operations, or financial processes of Tianhe; b. There are no intercompany transactions between the Company or Geo and Tianhe ; c. There is no interchange of managerial personnel; d. The Company and Geo do not nominate or hold a board position at Tianhe ; and e. There is no technological or financial dependence between the Company or Geo and Tianhe .

    Management regularly evaluates the impairment of cost method investments based on performance and financial position of the investee, as well as other evidence of market value. Such evaluation includes, but is not limited to, reviewing the investee’s cash position, recent financing, projected and historical financial performance, cash flow forecasts and financing needs. As of December 31, 2010, management determined that there was an other-than-temporary impairment in the value of its investment in Tianhe and recorded an impairment loss of approximately $855,000. As of December 31, 2011, management reassessed the possible impairment of the investment in Tianhe and determined that there was an other-than-temporary impairment in the value of its investment in Tianhe and recorded an additional impairment loss of approximately $1 million. The impairment loss is recorded in "Income From Operations" within the statements of Income.

    Geo holds a 8% ownership interest in Tianditu which was set up in 2010 to provide online map service.

    -F- 24 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    9. PROPERTY, PLANT AND EQUIPMENT

    As of December 31, 2011 and 2010, property, plant and equipment consists of:

                         2011                      2010  
    Office building $  7,900,978   $  7,559,941  
    Plant and machinery   29,822,707     27,900,717  
    Electronic equipment, furniture and fixtures   10,602,803     12,045,103  
    Motor vehicles   1,100,810     1,102,159  
    Purchased software   68,460,250     48,814,198  
    Total   117,887,548     97,422,118  
                 
    Less: accumulated depreciation   (26,726,455 )   (18,073,235 )
    Net Book Value $  91,161,093   $  79,348,883  

    Depreciation expense for the years ended December 31, 2011, 2010, and 2009 was approximately $10.85 million, $7.72 million, and $4.07 million, respectively.

    10. LAND USE RIGHTS AND INTANGIBLE ASSETS

    (a) Deposits for purchase of land use rights

    As of December 31, 2011, deposits for purchase of land use rights represent deposits paid for the purchases of land use rights in Dongguan City of approximately $18.88 million (RMB119.96 million), and additional land rights premiums paid for an increase in plot ratios under existing land use rights in Fuyong County of Shenzhen of approximately $8.68 million (RMB55.16 million).

    (b) Land use rights

    As of December 31, 2011 and 2010, land use rights consist of:

        2011     2010  
    Land use rights $  2,054,259   $  1,979,867  
    Less: accumulated amortization   (97,643 )                      (50,673 )
    Land use rights, net $  1,956,616   $  1,929,194  

    Amortization expense for the years ended December 31, 2011, 2010, and 2009 was approximately $44,000, $42,000 and $7,000, respectively.

    Estimated amortization for the next five years and thereafter is as follows:

    2012 $  45,066  
    2013   45,066  
    2014   45,066  
    2015   45,066  
    2016   45,066  
    Thereafter   1,731,286  
    Total $  1,956,616  

    (c) Intangible assets

    As of December 31, 2011 and December 31, 2010, intangible assets consist of:

        2011     2010  
    Software and software development costs $  9,489,011   $  7,333,720  
    Technology   7,715,591     7,436,182  
    Trademarks   4,452,846     4,291,593  
    Customer base   316,374     304,917  
    Sub-Total   21,973,822     19,366,412  
    Less: accumulated amortization   (7,593,363 )   (5,641,138 )
    Intangible assets, net $  14,380,459   $  13,725,274  

    Amortization expense for the years ended December 31, 2011, 2010 and 2009 was approximately $1.71million, $1.75 million and $1.78 million, respectively.

    -F- 25 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    10. LAND USE RIGHTS AND INTANGIBLE ASSETS (CONTINUED)

    (c) Intangible assets (continued)

    Estimated amortization expenses for the next five years and thereafter is as follows:

    2012 $  2,009,902  
    2013   1,463,774  
    2014   1,455,829  
    2015   1,453,181  
    2016   1,453,181  
    Thereafter   6,544,592  
    Total $  14,380,459  

    11. BANK LOANS

    (a) Short-term bank loans

        2011     2010  
    Secured short-term loans (1) $  39,177,186   $  33,051,066  
    Add: amounts due within one year under long-term loan contracts   1,806,271     2,275,500  
    Total short-term bank loans $  40,983,457   $  35,326,566  

    (1) Detailed information of secured short-term loan balances as of December 31, 2011 and 2010 were as follows:

     

      2011     2010  

    Collateralized by land and office buildings

    $  14,260,441   $  12,682,120  

    Secured by iASPEC’s trade receivables

      2,990,600     979,982  

    Secured by Bocom’s trade receivables and guaranteed by the Company

      1,056,182     320,432  

    Secured by Huipu’s trade receivables and guaranteed by the Company and Huipu

      2,623,691     4,740,138  

    Guaranteed by IST

      4,092,400     4,551,000  

    Secured by HPC’s trade receivables and guarnteed by IST

      4,372,404     -  

    Guaranteed by Huipu

      2,361,000     2,275,500  

    Guarnteed by the Company, CITH and Bocom

      1,030,028     -  

    Guarnteed by IASPEC

      6,390,440     -  

    Secured by Huipu’s trade receivables and guaranteed by the Company and Huipu’s formershareholder

      -     5,741,894  

    Secured by HPC’s trade receivables and guaranteed by Huipu’s formershareholder

      -     1,760,000  

    Total

    $  39,177,186   $  33,051,066  

    (b) Long-term bank loans

        2011     2010  
    Secured long-term loans $  1,915,795   $  8,138,705  
    Less: amounts due within one year under long-term loan contracts   (1,806,271 )   (2,275,500 )
    Total long-term bank loans $  109,524   $  5,863,205  

    As of December 31, 2011, the Company has borrowings from banks, expiring at various dates from January 19, 2012 to February 21, 2016, primarily used to finance working capital requirements. The bank borrowings are in the form of credit facilities. All amounts available to the Company from the banks are based on the amount of collateral pledged or the amount guaranteed by our subsidiaries. These borrowings bear interest rate at the range from 5.8% to 10% per annum. The weighted average interest rate on short term debt is approximately 7.37%, 5.41% and 5.45% for the years ended December 31, 2011, 2010 and 2009, respectively. The interest rates were above the prime interest rate declared by the People’s Bank of China with a range from 5% to 30%.

    -F- 26 -


    CHINA INFORMATION TECHNOLOGY, INC.
    NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
    FOR THE YEARS ENDED DECEMBER 31, 2011, 2010 and 2009

    12. BILLS PAYABLE

    The Company has total available bills payable facilities of $34.67 million and $19.19 million with various banks, of which $7.86 million and $2 million were unutilized as of December 31, 2011 and 2010 respectively. The funds borrowed under these facilities are generally repayable within 6 months. Bills payable are non-interest bearing and generally repaid within six months.

    13. INCOME TAXES

    Pre-tax income for the years ended December 31, 2011, 2010 and 2009 was taxable in the following jurisdictions:

        2011     2010     2009  
    PRC $  8,250,896   $  48,017,784   $  34,764,245  
    Others   1,123,432     (4,680,717 )   (739,105 )
    Total income before income taxes $  9,374,328   $  43,337,067   $  34,025,140  

    United States

    The Company was incorporated in Nevada and is subject to United States of America tax law. It is management’s intention to reinvest all the income attributable to the Company earned by its operations outside the United States of America (the “U.S.”). Accordingly, no U.S. corporate income taxes are provided in these consolidated financial statements.

    BVI

    Under the current laws of the BVI, dividends and capital gains arising from the Company’s investments in the BVI are not subject to income taxes.

    PRC

    Income tax expense consists of the following:

    2011 2010 2009
    Current taxes $  2,498,523   $  7,758,819   $  5,156,165  
    Deferred taxes   (1,694,374 )   104,618     (1,268,670 )
    Provision for income taxes $  804,149   $  7,863,437   $  3,887,495  

    The reconciliation of income taxes for income tax computed at the PRC federal statutory rate to income tax expenses is as follows:

      2011     2010     2009  
    PRC statutory tax rate   25%     25%     25%  
                       
    Computed expected income tax expense $  2,343,582   $  10,834,267   $  8,506,285  
    Tax concession   (1,544,604 )   (4,685,218 )   (4,434,779 )
    Permanent differences   (172,271 )   660,272     691,797  
    Non-deductible tax loss