Unassociated Document
U.S.
SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
one)
x
|
Quarterly
Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934
|
For
the
Quarterly Period Ended September 30, 2008
or
o
|
Transition
Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934
|
Commission
File Number 000-50491
China
Fire & Security Group, Inc.
(Name
of
small business issuer in its charter)
Florida
|
|
65-1193022
|
(State
or other jurisdiction
of
incorporation or organization)
|
|
(I.R.S.
Employer
Identification
No.)
|
|
|
|
B-2508
TYG Center, C2
Dongsanhuanbeilu,
Chaoyang
District, Beijing 100027,
People’s
Republic of China
|
|
100027
|
(Address
of principal executive offices)
|
|
(Zip
Code)
|
Issuer’s
telephone number: (86-10) 8441 7400.
Check
whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the Registrant was required to file such reports),
and
(2) has been subject to such filing requirements for the past 90
days. Yes x
No
o
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. (Check one):
Large
accelerated filer o
|
|
Accelerated
filer o
|
|
|
|
Non-accelerated
filer o
|
|
|
(Do
not check if smaller reporting company)
|
|
Smaller
reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act) Yes o
No
x
As
of
November 12, 2008, the Registrant had 27,586,593 shares of common stock
outstanding.
China
Fire & Security Group, Inc.
Table
of
Contents
|
|
|
|
Page
|
PART
I -
|
|
FINANCIAL
INFORMATION
|
|
|
|
|
|
|
|
Item
1.
|
|
Financial
Statements (unaudited):
|
|
|
|
|
|
|
|
|
|
Consolidated
Balance Sheets as of September 30, 2008 and December 31,
2007
|
|
3
|
|
|
|
|
|
|
|
Consolidated
Statements of Income and Other Comprehensive Income
|
|
|
|
|
For
the Three and Nine Months Ended September 30, 2008 and
2007
|
|
4
|
|
|
|
|
|
|
|
Consolidated
Statements of Stockholders' Equity
|
|
5
|
|
|
|
|
|
|
|
Consolidated
Statements of Cash Flows
|
|
|
|
|
For
the Nine Months Ended September 30, 2008 and 2007
|
|
6
|
|
|
|
|
|
|
|
Notes
to Consolidated Financial Statements
|
|
7
|
|
|
|
|
|
Item
2.
|
|
Management's
Discussion and Analysis or Plan of Operation
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|
30
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|
|
|
|
|
Item
3.
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|
Quantitative
and Qualitative Disclosures About Market Risk
|
|
37
|
|
|
|
|
|
Item
4.
|
|
Controls
and Procedures
|
|
37
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|
|
|
|
|
PART II -
|
|
OTHER
INFORMATION
|
|
|
|
|
|
|
|
Item
1.
|
|
Legal
Proceedings
|
|
37
|
|
|
|
|
|
Item
1A.
|
|
Risk
Factors
|
|
37
|
|
|
|
|
|
Item
2.
|
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
|
37
|
|
|
|
|
|
Item
3.
|
|
Defaults
Upon Senior Securities
|
|
37
|
|
|
|
|
|
Item
4.
|
|
Submission
of Matters to a Vote of Security Holders.
|
|
37
|
|
|
|
|
|
Item
5.
|
|
Other
Information
|
|
37
|
|
|
|
|
|
Item
6.
|
|
Exhibits
|
|
37
|
Item
1. Financial Statements
|
|
|
|
|
|
|
|
CONSOLIDATED
BALANCE SHEETS
|
|
AS
OF SEPTEMBER 30, 2008 AND DECEMBER 31, 2007
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
September
30,
|
|
December
31,
|
|
|
|
2008
|
|
2007
|
|
CURRENT
ASSETS:
|
|
(Unaudited)
|
|
|
|
Cash
|
|
$
|
21,805,340
|
|
$
|
17,110,449
|
|
Restricted
cash
|
|
|
5,177,631
|
|
|
3,829,927
|
|
Accounts
receivable, net of allowance for doubtful accounts of $3,188,660
and
|
|
|
|
|
|
|
|
$2,483,359
as of September 30, 2008 and December 31, 2007,
respectively
|
|
|
19,159,300
|
|
|
16,525,161
|
|
Notes
receivable
|
|
|
5,139,588
|
|
|
3,315,811
|
|
Other
receivables
|
|
|
1,291,967
|
|
|
748,195
|
|
Other
receivable - related party
|
|
|
329,884
|
|
|
-
|
|
Inventories
|
|
|
7,752,813
|
|
|
4,048,283
|
|
Costs
and estimated earnings in excess of billings
|
|
|
28,786,789
|
|
|
13,068,036
|
|
Employee
advances
|
|
|
1,147,653
|
|
|
1,307,433
|
|
Employee
advances - officers and directors
|
|
|
36,910
|
|
|
18,682
|
|
Prepayments
and deferred expenses
|
|
|
3,562,333
|
|
|
2,218,391
|
|
Total
current assets
|
|
|
94,190,208
|
|
|
62,190,368
|
|
|
|
|
|
|
|
|
|
PLANT
AND EQUIPMENT, net
|
|
|
8,372,761
|
|
|
6,568,250
|
|
|
|
|
|
|
|
|
|
OTHER
ASSETS:
|
|
|
|
|
|
|
|
Restricted
cash - non current
|
|
|
990,616
|
|
|
-
|
|
Accounts
receivable - retention
|
|
|
831,043
|
|
|
193,029
|
|
Deferred
expenses - non current
|
|
|
-
|
|
|
21,234
|
|
Advances
on building and equipment purchases
|
|
|
156,709
|
|
|
366,317
|
|
Investment
in joint ventures
|
|
|
1,166,782
|
|
|
1,156,294
|
|
Intangible
assets, net of accumulated amortization
|
|
|
1,133,601
|
|
|
1,150,935
|
|
Total
other assets
|
|
|
4,278,751
|
|
|
2,887,809
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
106,841,720
|
|
$
|
71,646,427
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
7,515,936
|
|
$
|
6,327,182
|
|
Customer
deposits
|
|
|
16,168,355
|
|
|
4,757,179
|
|
Billings
in excess of costs and estimated earnings
|
|
|
3,363,588
|
|
|
4,882,217
|
|
Other
payables
|
|
|
1,338,031
|
|
|
168,868
|
|
Accrued
liabilities
|
|
|
5,346,951
|
|
|
4,214,530
|
|
Taxes
payable
|
|
|
1,454,849
|
|
|
1,088,335
|
|
Total
current liabilities
|
|
|
35,187,710
|
|
|
21,438,311
|
|
|
|
|
|
|
|
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS'
EQUITY:
|
|
|
|
|
|
|
|
Common
stock, $0.001 par value, 65,000,000 shares authorized,
|
|
|
|
|
|
|
|
27,586,593
and 27,556,893 shares
issued and outstanding as of
|
|
|
|
|
|
|
|
September
30, 2008 and December 31, 2007, respectively
|
|
|
27,586
|
|
|
27,556
|
|
Additional
paid-in-capital
|
|
|
19,353,835
|
|
|
19,317,287
|
|
Statutory
reserves
|
|
|
5,067,061
|
|
|
5,067,061
|
|
Retained
earnings
|
|
|
40,102,939
|
|
|
22,228,095
|
|
Accumulated
other comprehensive income
|
|
|
7,102,589
|
|
|
3,568,117
|
|
Total
shareholders' equity
|
|
|
71,654,010
|
|
|
50,208,116
|
|
|
|
|
|
|
|
|
|
Total
liabilities and shareholders' equity
|
|
$
|
106,841,720
|
|
$
|
71,646,427
|
|
The
accompanying notes are an integral part of these consolidated
statements.
|
|
|
|
|
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
|
|
FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND
2007
|
|
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended September 30,
|
|
Nine
Months Ended September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
$
|
15,173,858
|
|
$
|
6,105,899
|
|
$
|
41,060,246
|
|
$
|
23,270,285
|
|
Products
|
|
|
978,806
|
|
|
5,188,117
|
|
|
5,393,942
|
|
|
8,827,922
|
|
Maintenance
services
|
|
|
590,603
|
|
|
302,954
|
|
|
1,639,429
|
|
|
545,410
|
|
Total
revenues
|
|
|
16,743,267
|
|
|
11,596,970
|
|
|
48,093,617
|
|
|
32,643,617
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
|
6,459,973
|
|
|
2,539,812
|
|
|
18,001,928
|
|
|
10,564,382
|
|
Products
|
|
|
117,258
|
|
|
2,065,515
|
|
|
1,176,638
|
|
|
3,705,298
|
|
Maintenance
services
|
|
|
301,605
|
|
|
124,211
|
|
|
821,932
|
|
|
181,085
|
|
Total
cost of revenues
|
|
|
6,878,836
|
|
|
4,729,538
|
|
|
20,000,498
|
|
|
14,450,765
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
9,864,431
|
|
|
6,867,432
|
|
|
28,093,119
|
|
|
18,192,852
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
and marketing
|
|
|
1,582,557
|
|
|
1,205,360
|
|
|
4,592,598
|
|
|
3,058,663
|
|
General
and administrative
|
|
|
1,268,864
|
|
|
1,297,037
|
|
|
4,021,984
|
|
|
3,390,596
|
|
Depreciation
and amortization
|
|
|
123,829
|
|
|
128,394
|
|
|
445,779
|
|
|
387,933
|
|
Research
and development
|
|
|
762,382
|
|
|
139,205
|
|
|
1,656,983
|
|
|
457,126
|
|
Total
operating expense
|
|
|
3,737,632
|
|
|
2,769,996
|
|
|
10,717,344
|
|
|
7,294,318
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
FROM OPERATIONS
|
|
|
6,126,799
|
|
|
4,097,436
|
|
|
17,375,775
|
|
|
10,898,534
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
280,094
|
|
|
249,537
|
|
|
501,737
|
|
|
577,535
|
|
Other
expense
|
|
|
(3,675
|
)
|
|
(1,400
|
)
|
|
(89,063
|
)
|
|
(7,817
|
)
|
Interest
income
|
|
|
48,010
|
|
|
46,462
|
|
|
139,754
|
|
|
90,632
|
|
Change
in fair value of derivative instruments
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
1,205,791
|
|
Total
other income
|
|
|
324,429
|
|
|
294,599
|
|
|
552,428
|
|
|
1,866,141
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
BEFORE PROVISION FOR INCOME TAXES
|
|
|
6,451,228
|
|
|
4,392,035
|
|
|
17,928,203
|
|
|
12,764,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PROVISION
(CREDIT) FOR INCOME TAXES
|
|
|
(6,736
|
)
|
|
-
|
|
|
53,359
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
|
6,457,964
|
|
|
4,392,035
|
|
|
17,874,844
|
|
|
12,764,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
COMPREHENSIVE INCOME:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
173,873
|
|
|
540,152
|
|
|
3,534,472
|
|
|
1,350,486
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME
|
|
$
|
6,631,837
|
|
$
|
4,932,187
|
|
$
|
21,409,316
|
|
$
|
14,115,161
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BASIC
EARNINGS PER SHARE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares
|
|
|
27,572,112
|
|
|
27,026,221
|
|
|
27,562,087
|
|
|
26,649,859
|
|
Earnings
per share
|
|
$
|
0.23
|
|
$
|
0.16
|
|
$
|
0.65
|
|
$
|
0.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DILUTED
EARNINGS PER SHARE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares
|
|
|
28,259,171
|
|
|
27,825,442
|
|
|
28,205,583
|
|
|
27,436,695
|
|
Earnings
per share
|
|
$
|
0.23
|
|
$
|
0.16
|
|
$
|
0.63
|
|
$
|
0.47
|
|
The
accompanying notes are an integral part of these consolidated
statements.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
Retained
Earnings
|
|
other
|
|
|
|
|
|
Common
Stock
|
|
Additional
|
|
Statutory
|
|
|
|
comprehensive
|
|
|
|
|
|
Shares
|
|
Par
value
|
|
paid-in-capital
|
|
reserves
|
|
Unrestricted
|
|
|
|
Total
|
|
BALANCE,
December 31, 2006
|
|
|
26,461,678
|
|
$
|
26,462
|
|
$
|
13,393,171
|
|
$
|
4,030,627
|
|
$
|
6,462,893
|
|
$
|
1,065,522
|
|
$
|
24,978,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,764,675
|
|
|
|
|
|
12,764,675
|
|
Warrants
reclassified from liabilities
|
|
|
|
|
|
|
|
|
1,475,020
|
|
|
|
|
|
|
|
|
|
|
|
1,475,020
|
|
Issuance
of common stock
|
|
|
876,985
|
|
|
877
|
|
|
3,638,768
|
|
|
|
|
|
|
|
|
|
|
|
3,639,645
|
|
Warrants
exercised
|
|
|
90,147
|
|
|
90
|
|
|
(90
|
)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Warrants
issued for services
|
|
|
|
|
|
|
|
|
94,274
|
|
|
|
|
|
|
|
|
|
|
|
94,274
|
|
Options
issued to employees
|
|
|
|
|
|
|
|
|
159,288
|
|
|
|
|
|
|
|
|
|
|
|
159,288
|
|
Adjustment
to statutory reserves
|
|
|
|
|
|
|
|
|
|
|
|
(605,000
|
)
|
|
605,000
|
|
|
|
|
|
-
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,350,486
|
|
|
1,350,486
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE,
September 30, 2007 (Unaudited)
|
|
|
27,428,810
|
|
$
|
27,429
|
|
$
|
18,760,431
|
|
$
|
3,425,627
|
|
$
|
19,832,568
|
|
$
|
2,416,008
|
|
$
|
44,462,063
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,036,961
|
|
|
|
|
|
4,036,961
|
|
Issuance
of common stock
|
|
|
107,695
|
|
|
106
|
|
|
525,446
|
|
|
|
|
|
|
|
|
|
|
|
525,552
|
|
Warrants
exercised
|
|
|
20,388
|
|
|
21
|
|
|
(21
|
)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Options
issued to employees
|
|
|
|
|
|
|
|
|
31,431
|
|
|
|
|
|
|
|
|
|
|
|
31,431
|
|
Adjustment
to statutory reserves
|
|
|
|
|
|
|
|
|
|
|
|
1,641,434
|
|
|
(1,641,434
|
)
|
|
|
|
|
-
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,152,109
|
|
|
1,152,109
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE,
December 31, 2007
|
|
|
27,556,893
|
|
$
|
27,556
|
|
$
|
19,317,287
|
|
$
|
5,067,061
|
|
$
|
22,228,095
|
|
$
|
3,568,117
|
|
$
|
50,208,116
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,874,844
|
|
|
|
|
|
17,874,844
|
|
Options
issued to employees
|
|
|
|
|
|
|
|
|
36,578
|
|
|
|
|
|
|
|
|
|
|
|
36,578
|
|
Warrants
exercised
|
|
|
29,700
|
|
|
30
|
|
|
(30
|
)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,534,472
|
|
|
3,534,472
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE,
September 30, 2008 (Unaudited)
|
|
|
27,586,593
|
|
$
|
27,586
|
|
$
|
19,353,835
|
|
$
|
5,067,061
|
|
$
|
40,102,939
|
|
$
|
7,102,589
|
|
$
|
71,654,010
|
|
The
accompanying notes are an integral part of these consolidated
statements.
|
|
|
|
|
|
|
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Nine
months ended
|
|
|
|
September
30
|
|
|
|
2008
|
|
2007
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
Net
income
|
|
$
|
17,874,844
|
|
$
|
12,764,675
|
|
Adjustments
to reconcile net income to cash
|
|
|
|
|
|
|
|
provided
by operating activities:
|
|
|
|
|
|
|
|
Depreciation
|
|
|
652,290
|
|
|
409,261
|
|
Amortization
|
|
|
56,224
|
|
|
35,539
|
|
Provision
for doubtful accounts
|
|
|
527,870
|
|
|
465,482
|
|
Gain
on disposal of equipment
|
|
|
(32,828
|
)
|
|
(9,136
|
)
|
Stock
compensation to employees
|
|
|
36,579
|
|
|
159,288
|
|
Warrants
issued for services
|
|
|
-
|
|
|
94,274
|
|
Change
in fair value of derivative instruments
|
|
|
-
|
|
|
(1,205,791
|
)
|
Change
in operating assets and liabilities
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(2,635,095
|
)
|
|
(3,389,580
|
)
|
Notes
receivable
|
|
|
(1,569,203
|
)
|
|
(337,052
|
)
|
Other
receivables
|
|
|
(483,680
|
)
|
|
(458,743
|
)
|
Other
receivables - related party
|
|
|
(323,278
|
)
|
|
-
|
|
Inventories
|
|
|
(3,364,122
|
)
|
|
26,023
|
|
Costs
and estimated earnings in excess of billings
|
|
|
(14,544,590
|
)
|
|
(2,145,503
|
)
|
Employee
advances
|
|
|
262,093
|
|
|
(814,369
|
)
|
Advances
to officers and directors
|
|
|
(36,171
|
)
|
|
(10,130
|
)
|
Prepayments
and deferred expenses
|
|
|
(1,149,078
|
)
|
|
(1,090,443
|
)
|
Accounts
payable
|
|
|
754,464
|
|
|
617,376
|
|
Customer
deposits
|
|
|
10,869,806
|
|
|
2,070,561
|
|
Billings
in excess of costs and estimated earnings
|
|
|
(1,809,272
|
)
|
|
(4,684,877
|
)
|
Other
payables
|
|
|
1,134,642
|
|
|
156,501
|
|
Accrued
liabilities
|
|
|
838,157
|
|
|
586,981
|
|
Taxes
payable
|
|
|
287,605
|
|
|
(3,407
|
)
|
Net
cash provided by operating activities
|
|
|
7,347,257
|
|
|
3,236,930
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
Purchase
of plant and equipment
|
|
|
(1,637,531
|
)
|
|
(971,743
|
)
|
Advances
on building and equipment purchase
|
|
|
(156,709
|
)
|
|
(2,345,809
|
)
|
Proceeds
from sale of equipment
|
|
|
67,839
|
|
|
19,646
|
|
Purchase
of intangible assets
|
|
|
-
|
|
|
(608,782
|
)
|
Payments
for investment in Hubei Sureland Changjiang Fire Safety Technology
Co.,
Ltd.
|
|
|
-
|
|
|
(148,930
|
)
|
Payments
for investment in King Galaxy Investments Limited
|
|
|
-
|
|
|
(1,000,000
|
)
|
Proceeds
from sale of investment in Tianjin Fire Safety Equipment Co.,
Ltd.
|
|
|
-
|
|
|
510,829
|
|
Proceeds
from sale of Beijing Zhong Xiao Fire Safety Technology Co.,
Ltd
|
|
|
-
|
|
|
1,060,535
|
|
Net
cash used in investing activities
|
|
|
(1,726,401
|
)
|
|
(3,484,254
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Change
in restricted cash
|
|
|
(2,039,634
|
)
|
|
841,349
|
|
Payments
to Beijing Zhong Xiao Fire Safety Technology Co., Ltd.
|
|
|
-
|
|
|
(2,447,101
|
)
|
Proceeds
from Beijing Zhong Xiao Fire Safety Technology Co., Ltd
|
|
|
-
|
|
|
1,353,955
|
|
Proceeds
from issuance of common stock
|
|
|
-
|
|
|
3,639,645
|
|
Net
cash (used in) provided by financing activities
|
|
|
(2,039,634
|
)
|
|
3,387,848
|
|
|
|
|
|
|
|
|
|
EFFECT
OF EXCHANGE RATE CHANGES ON CASH
|
|
|
1,113,669
|
|
|
412,282
|
|
|
|
|
|
|
|
|
|
INCREASE
IN CASH
|
|
|
4,694,891
|
|
|
3,552,806
|
|
CASH,
beginning of period
|
|
|
17,110,449
|
|
|
9,426,091
|
|
|
|
|
|
|
|
|
|
CASH,
end of period
|
|
$
|
21,805,340
|
|
$
|
12,978,897
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
Income
taxes paid
|
|
$
|
36,473
|
|
$
|
-
|
|
Interest
paid
|
|
$
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
NON-CASH
TRANSACTIONS INVESTING AND FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
Reclassification
of warrant liability to paid-in capital
|
|
|
|
|
|
|
|
upon
modification of warrants agreement
|
|
$
|
-
|
|
$
|
1,475,020
|
|
Reclassification
of advances on building and equipment purchase
|
|
|
|
|
|
|
|
to
plant and equipment upon receipt of purchase
|
|
$
|
390,898
|
|
$
|
-
|
|
The
accompanying notes are an integral part of these consolidated
statements.
CHINA
FIRE & SECURITY GROUP,
INC. AND
SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Note
1 - Background
China
Fire & Security Group Inc. (the
“Company”), is a Florida corporation. The Company, through its subsidiaries, is
engaged in the design, development, manufacturing and sales of fire protection
products and services for industrial customers in China.
Note
2 - Summary of significant accounting policies
The
reporting entity
The
consolidated financial statements of China Fire & Security Group Inc. and
subsidiaries reflect the activities of the parent and the following
subsidiaries:
Subsidiaries
|
|
Incorporated
in
|
|
Ownership
Percentage
|
China
Fire Protection Group Inc (“CFPG”)
|
|
British
Virgin Islands
|
|
100%
|
Sureland
Industrial Fire Safety Limited (“Sureland Industrial”)
|
|
People’s
Republic of China
|
|
100%
|
Sureland
Industrial Fire Equipment Co. Ltd (“Sureland Equipment”)
|
|
People’s
Republic of China
|
|
100%
|
Tianxiao
Fire Safety Equipment Co., Ltd. (“Tianxiao Equipment”)
|
|
People’s
Republic of China
|
|
100%
|
Beijing
Hua An Times Fire Safety Technology Co., Ltd. (“Beijing Hua
An”)
|
|
People’s
Republic of China
|
|
100%
|
Basis
of presentation
The
accompanying consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America.
All material intercompany transactions and balances have been eliminated in
consolidation.
Management
has
included
all normal recurring adjustments considered necessary to give a fair
presentation of operating results for the periods presented. Interim results
are
not necessarily indicative of results for a full year. The information included
in this Form 10-Q should be read in conjunction with information included
in the 2007 annual report filed on Form 10-KSB.
Use
of
estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles of the United States of America requires management to
make estimates and assumptions that affect the amounts reported in the combined
financial statements and accompanying notes. Management believes that the
estimates utilized in preparing its financial statements are reasonable and
prudent. Actual results could differ from these estimates.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Certain
of the Company’s accounting policies require higher degrees of judgment than
others in their application. These include the recognition of revenue and
earnings from system contracting projects under the percentage of completion
method, determining the fair value of stock based compensation and the allowance
of doubtful accounts. Management evaluates all of its estimates and judgments
on
an on-going basis.
Revenue
recognition
Revenue
is recognized when it is probable that the economic benefits will flow to the
Company as follows:
|
1.
|
Revenue
from system contracting projects are recognized using the
percentage-of-completion method of accounting and, therefore, take
into
account the costs, estimated earnings and revenue to date on contracts
not
yet completed. Revenue recognized is that percentage of the total
contract
price that cost expended to date bears to anticipated final total
cost,
based on current estimates of costs to complete. Contract costs include
all direct material and labor costs and those indirect costs related
to
contract performance, such as indirect labor, supplies, tools, repairs,
and depreciation costs. Selling, general, and administrative costs
are
charged to expense as incurred. At the time a loss on a contract
becomes
known, the entire amount of the estimated ultimate loss is recognized
in
the consolidated financial statements. Claims for additional contract
costs are recognized upon a signed change order from the customer
or in
accordance with paragraphs 62 and 65 of the AICPA’S Statement of Position
("SOP") 81-1, "Accounting for Performance of Construction - Type
and
Certain Production - Type Contracts" ("SOP
81-1").
|
|
2.
|
Revenue
from product sales is recognized when the goods are delivered and
title
has passed. Product sales revenue is presented net of a value-added
tax
(VAT). All of the Company’s products that are sold in the People’s
Republic of China (“PRC”) are subject to a Chinese value-added tax at a
rate of 17% of the gross sales price. This VAT may be offset by VAT
paid
by the Company on raw materials and other materials included in the
cost
of producing their finished
product.
|
|
3.
|
Revenue
from the rendering of Maintenance Services is recognized over the
service
period on a straight line basis.
|
In
accordance with SFAS 48, “Revenue Recognition when Right of Return Exists,”
revenue is recorded net of an estimate of markdowns, price concessions and
warranty costs. Such reserve is based on management’s evaluation of historical
experience, current industry trends and estimated costs.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Shipping
and handling
Costs
related to shipping and handlings are included in cost of revenue
pursuant
to EITF 00-10 “Accounting for Shipping and Handling Fees and
Costs.”
Foreign
currency translation
The
reporting currency of the Company is the US dollar. The Company uses their
local
currency, Renminbi (RMB), as their functional currency. Results of operations
and cash flow are translated at average exchange rates during the period, and
assets and liabilities are translated at the unified exchange
rate as quoted by the People’s Bank of China
at the
end of the period. Translation adjustments resulting from this process are
included in accumulated other comprehensive income in the statement of
shareholders’ equity.
Translation
adjustments amounted to $7,102,589
and $3,568,117 as of September
30, 2008
and
December 31, 2007, respectively. Asset and liability accounts at September
30,
2008 were translated at 6.84 RMB to $1.00 as compared to 7.29 RMB at December
31, 2007. Equity accounts were stated at their historical rate. The average
translation rates applied to income statements accounts for the nine months
ended September 30, 2008 and 2007 were 6.97 RMB and 7.65 RMB, respectively.
Cash
flows are also translated at average translation rates for the period,
therefore, amounts reported on the statement of cash flows will not necessarily
agree with changes in the corresponding balances on the balance sheet.
Transaction
gains and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in
the
results of operations as incurred. Historically, the Company has not entered
any
currency trading or hedging transactions, although there is no assurance that
the Company will not enter into such transactions in the future.
Plant
and equipment
Plant
and
equipment are stated at cost less accumulated depreciation. Depreciation is
computed using the straight-line method over the estimated useful lives of
the
assets with 5% residual value. For the three months ended September 30, 2008
and
2007, depreciation expense amounted to $ 325,742 and $140,393
respectively. Depreciation
expense amounted to $652,290 and $409,261 for the nine months ended September
30, 2008 and 2007, respectively.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Estimated
useful lives of the assets are as follows:
|
|
Useful
Life
|
|
Buildings
and improvements
|
|
|
40
years
|
|
Transportation
equipment
|
|
|
5
years
|
|
Machinery
|
|
|
10
years
|
|
Office
equipment
|
|
|
5
years
|
|
Furniture
|
|
|
5
years
|
|
Construction
in progress represents the costs incurred in connection with the construction
of
buildings or additions to the Company’s plant facilities. No depreciation is
provided for construction in progress until such time as the assets are
completed and placed into service.
The
cost
and related accumulated depreciation of assets sold or otherwise retired are
eliminated from the accounts and any gain or loss is included in the statements
of income. Maintenance, repairs and minor renewals are charged directly to
expense as incurred. Major additions and betterment to buildings and equipment
are capitalized.
Long-term
assets of the Company are reviewed periodically or more often if circumstances
dictate, to determine whether their carrying value has become impaired. The
Company considers assets to be impaired if the carrying value exceeds the future
projected cash flows from related operations. The Company evaluates the periods
of depreciation and amortization to determine whether subsequent events and
circumstances warrant revised estimates of useful lives. As of September 30,
2008, the Company expects these assets to be fully recoverable.
Plant
and
equipment consist of the following:
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
Buildings
and improvements
|
|
$
|
5,418,087
|
|
$
|
5,077,373
|
|
Transportation
equipment
|
|
|
2,553,048
|
|
|
1,985,701
|
|
Machinery
|
|
|
1,193,576
|
|
|
970,500
|
|
Office
equipment
|
|
|
1,223,402
|
|
|
1,047,350
|
|
Furniture
|
|
|
38,386
|
|
|
35,972
|
|
Construction
in progress
|
|
|
971,356
|
|
|
-
|
|
Total
|
|
|
11,397,855
|
|
|
9,116,896
|
|
Less
accumulated depreciation
|
|
|
(3,025,094
|
)
|
|
(2,548,646
|
)
|
Plant
and equipment, net
|
|
$
|
8,372,761
|
|
$
|
6,568,250
|
|
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Concentration
of risk
Cash
includes cash on hand and demand deposits in accounts maintained with
state owned
banks within the People’s Republic of China and Hong Kong. The Company maintains
balances at financial institutions which, from time to time, may exceed Hong
Kong Deposit Protection Board insured limits for the banks located in Hong
Kong.
Balances at financial institutions or state owned banks within the PRC are
not
covered by insurance. As of September 30, 2008 and December 31, 2007, the
Company had deposits (including restricted cash balances) totaling to
$27,973,587 and $20,940,016, that are not covered by insurance, respectively.
The Company has not experienced any losses in such accounts and believes it
is
not exposed to any risks on its cash in bank accounts.
The
Company's operations are carried out in the PRC. Accordingly, the Company's
business, financial condition and results of operations may be influenced by
the
political, economic and legal environments in the PRC, and by the general state
of the PRC's economy. The Company's operations in the PRC are subject to
specific considerations and significant risks not typically associated with
companies in the North America and Western Europe. These include risks
associated with, among others, the political, economic and legal environments
and foreign currency exchange. The Company's results may be adversely affected
by changes in governmental policies with respect to laws and regulations,
anti-inflationary measures, currency conversion and remittance abroad, and
rates
and methods of taxation, among other things.
The
Company has one major customer who represents approximately 34% and 21% of
the
Company’s sales for both the three months
and nine
months ended September 30, 2008.
Accounts receivable from this customer was $0 as of September 30, 2008. The
Company had one major customer who represents approximately 23% of the Company’s
sales for the nine months ended September 30, 2007. Accounts receivable from
this customer was $0 as of September 30, 2007.
Cash
and cash equivalents
The
Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents. Cash equivalents are carried at
cost, which approximates at
its
market value.
Restricted
cash
Restricted
cash represents cash required to be deposited in
a
separate bank account subject to withdrawal restrictions by its system
contracting projects and product sales customers to guarantee its contracts
will
be performed. The deposit cannot be drawn or transferred by the Company until
the restriction period has expired. The amounts are $6,168,247 and $3,829,927
as
of September 30, 2008 and December 31, 2007, respectively.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
Restricted
cash
|
|
|
|
|
|
|
|
Products
sales
|
|
$
|
1,279,427
|
|
$
|
102,355
|
|
System
contracting projects
|
|
|
4,888,820
|
|
|
3,727,572
|
|
Total
restricted cash
|
|
|
6,168,247
|
|
$
|
3,829,927
|
|
Restricted
cash - non current
|
|
|
(990,616
|
)
|
|
-
|
|
Restricted
cash - current
|
|
$
|
5,177,631
|
|
|
3,829,927
|
|
Inventories
Inventories
are stated at the lower of cost or market, using weighted average method.
Inventories consisted of the following at:
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
Raw
materials
|
|
$
|
1,153,522
|
|
$
|
310,255
|
|
Finished
goods
|
|
|
4,816,764
|
|
|
2,617,638
|
|
Work
in progress
|
|
|
1,782,527
|
|
|
1,120,390
|
|
Total
|
|
$
|
7,752,813
|
|
$
|
4,048,283
|
|
Raw
materials consist primarily of materials used in production. Finished goods
consist primarily of equipment used in product sales and system contracting
projects. The costs of finished goods include direct costs of raw materials
as
well as direct labor used in production. Indirect production costs such as
utilities and indirect labor related to production such as assembling, shipping
and handling costs are also included in the cost of inventory. The Company
reviews its inventories periodically to determine if any reserves are necessary
for potential obsolescence. As of September 30, 2008 and December 31, 2007
the
Company determined no reserves are necessary.
Accounts
receivable
Accounts
receivable represents amounts due from customers for products sales, maintenance
services and system contracting projects. Overdue balances are reviewed
regularly by senior management. Reserves are recorded when collection of amounts
due are in doubt.
Accounts
receivable consists of the following:
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
Accounts
receivable:
|
|
|
|
|
|
System
contracting projects
|
|
$
|
12,640,635
|
|
$
|
10,296,762
|
|
Maintenance
services
|
|
|
2,287,425
|
|
|
670,357
|
|
Products
sales
|
|
|
8,250,943
|
|
|
8,234,430
|
|
Total
accounts receivable
|
|
|
23,179,003
|
|
|
19,201,549
|
|
Allowance
for bad debts
|
|
|
(3,188,660
|
)
|
|
(2,483,359
|
)
|
Accounts
receivable, net
|
|
|
19,990,343
|
|
|
16,718,190
|
|
Accounts
receivable - non-current retentions
|
|
|
(831,043
|
)
|
|
(193,029
|
)
|
Accounts
receivable - current
|
|
$
|
19,159,300
|
|
$
|
16,525,161
|
|
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
The
activity in the allowance for doubtful accounts for trade accounts
receivable
for the
nine months ended September
30, 2008
and the
year ended December 31, 2007 is as follows:
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
Beginning
allowance for doubtful accounts
|
|
$
|
2,483,359
|
|
$
|
1,252,947
|
|
Additional
charged to bad debt expense
|
|
|
527,870
|
|
|
1,111,051
|
|
Write-off
charged against the allowance
|
|
|
-
|
|
|
(12,700
|
)
|
Foreign
currency translation adjustment
|
|
|
177,431
|
|
|
132,061
|
|
Ending
allowance for doubtful accounts
|
|
$
|
3,188,660
|
|
$
|
$2,483,359
|
|
Retentions
held by customers of system contracting projects included in the Company’s
accounts receivable as following:
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
Retentions
|
|
|
|
|
|
|
|
Current
|
|
$
|
2,158,523
|
|
$
|
2,829,250
|
|
Non-current
|
|
|
831,043
|
|
|
193,029
|
|
Total
retentions
|
|
$
|
2,989,566
|
|
$
|
3,022,279
|
|
These
balances represent portions of billings made by the Company but held for payment
by the customer pending satisfactory completion of the project. Retention
payments are generally collected within one year of the completion of the
project.
Costs
and estimated earnings in excess of billings
The
current asset, “Costs and estimated earnings in excess of billings” on
contracts, represents revenues recognized in excess of amounts
billed.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
Contract
costs incurred plus recognized
|
|
|
|
|
|
|
|
profits
less recognized losses to date
|
|
$
|
71,961,987
|
|
$
|
50,877,880
|
|
Less:
progress billings
|
|
|
43,175,198
|
|
|
37,809,844
|
|
Costs
and estimated earnings in excess of billings
|
|
$
|
28,786,789
|
|
$
|
13,068,036
|
|
Billings
in excess of costs and estimated earnings
The
current liability, “Billings in excess of costs and estimated earnings” on
contracts, represents billings in excess of revenues recognized.
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
Progress
billings
|
|
$
|
22,331,319
|
|
$
|
15,713,786
|
|
Less:
contracts costs incurred plus recognized
|
|
|
|
|
|
|
|
profits
less recognized losses to date
|
|
|
18,967,731
|
|
|
10,831,569
|
|
Billings
in excess of costs and estimated
|
|
|
|
|
|
|
|
earnings
|
|
$
|
3,363,588
|
|
$
|
4,882,217
|
|
Research
and development
Research
and development expenses include salaries, consultant fees, supplies and
materials, as well as costs related to other overhead such as depreciation,
facilities, utilities and other departmental expenses. The costs we incur with
respect to internally developed technology and engineering services are included
in research and development expenses as incurred as they do not directly relate
to any particular licensee, license agreement or licenses fee.
Warranties
Generally,
the
Company’s products are not covered by specific warranty terms. However, it is
the Company’s policy to replace parts if they become defective within one year
after deployment at no additional charge. Historically, failure of product
parts
due to materials or workmanship is rare. Therefore, at September 30, 2008 and
December 31, 2007, the Company made no provision for warranty claims for our
products. Management continuously evaluates the potential warranty obligation.
Management will record the expenses related to the warranty obligation when
the
estimated amount become material at the time revenue is recorded.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Fair
value of financial instruments
On
January 1, 2008, the Company adopted SFAS 157, Fair Value Measurements, which
defines fair value, establishes a three-level valuation hierarchy for
disclosures of fair value measurement and enhances disclosures requirements
for
fair value measures. The carrying amounts reported in the balance sheets for
current assets and current liabilities qualify as financial instruments and
are
a reasonable estimate of fair value because of the short period of time between
the origination of such instruments and their expected realization and their
current market rate of interest. The three levels are defined as
follow:
|
·
|
Level
1 inputs to the valuation methodology are quoted prices (unadjusted)
for
identical assets or liabilities in active
markets.
|
|
·
|
Level
2 inputs to the valuation methodology include quoted prices for similar
assets and liabilities in active markets, and inputs that are observable
for the assets or liability, either directly or indirectly, for
substantially the full term of the financial
instruments.
|
|
·
|
Level
3 inputs to the valuation methodology are unobservable and significant
to
the fair value.
|
The
Company invested $166,782 to Hubei Shou An Changjiang Fire Protection Co.,
Ltd
for 19% ownership and invested $1,000,000 to King Galaxy Investments Limited
for
5% ownership. Total investment as of September 30, 2008 amounted to $1,166,782.
Since there is no quoted or observable market price for the fair value of
similar long term in joint venture, the Company then used the level 3 inputs
for
its valuation methodology. The determination of the fair value was based on
the
cost of the capital contribution to the joint ventures.
The
Company did not identify any other assets and liabilities that are required
to
be presented on the balance sheet at fair value in accordance with SFAS No.
157.
Intangible
assets
Land
use
rights - All land in the People’s Republic of China is owned by the government.
However, the government grants the user “land use rights”. The Company acquired
land use rights in 2001 and the land use rights expire in 2051. The costs of
these rights are being amortized over
fifty years
using
the straight-line method
Technology
rights - In May 2007, the Company acquired two technology rights to manufacture
fire protection products for and the costs of these rights are being amortized
over
ten years
using
the straight-line method
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
Land
use rights
|
|
$
|
768,689
|
|
$
|
720,445
|
|
Technology
rights
|
|
|
608,745
|
|
|
608,745
|
|
Accumulated
amortization
|
|
|
(243,833
|
)
|
|
(178,255
|
)
|
Balance
|
|
$
|
1,133,601
|
|
$
|
1,150,935
|
|
Amortization
expense amounted to $18,816 and $18,658 for the three months ended September
30,
2008 and 2007, respectively. Amortization expense amounted to $56,224 and
$35,539 for the nine months ended September 30, 2008 and 2007,
respectively.
Intangible
assets of the Company are reviewed annually to determine whether their carrying
value has become impaired. The Company considers assets to be impaired if the
carrying value exceeds the future projected cash flows from related operations.
The Company also evaluates the periods of amortization to determine whether
subsequent events and circumstances warrant revised estimates of useful lives.
As of September 30, 2008, the Company expects these assets to be fully
recoverable.
Income
taxes
The
Company adopted Statement of Financial Accounting Standards No. 109, “Accounting
for Income Taxes” (SFAS 109). SFAS 109 requires the recognition of deferred
income tax liabilities and assets for the expected future tax consequences
of
temporary differences between income tax basis and financial reporting basis
of
assets and liabilities. Provision for income taxes consist of taxes currently
due plus deferred taxes. There are no deferred tax amounts at June 30, 2008
and
December 31, 2007.
The
Company adopted FASB Interpretation 48, “Accounting for Uncertainty in Income
Taxes” (“FIN 48”), as of January 1, 2007. A tax position is recognized as a
benefit only if it is “more likely than not” that the tax position would be
sustained in a tax examination, with a tax examination being presumed to occur.
The amount recognized is the largest amount of tax benefit that is greater
than
50% likely of being realized on examination. For tax positions not meeting
the
“more likely than not” test, no tax benefit is recorded. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting
in
interim periods, disclosures, and transition. The adoption had no affect on
the
Company’s financial statements.
The
Company’s operations are subject to income and transaction taxes in the United
States and in the PRC jurisdictions. Significant estimates and judgments are
required in determining the Company’s worldwide provision for income taxes. Some
of these estimates are based on interpretations of existing tax laws or
regulations. The ultimate amount of tax liability may be uncertain as a
result.
The
Company does not anticipate any events which could cause change to these
uncertainties.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
The
charge for taxation is based on the results for the year as adjusted for items,
which are non-assessable or disallowed. It is calculated using tax rates that
have been enacted or substantively enacted by the balance sheet
date.
Deferred
tax is accounted for using the balance sheet liability method in respect of
temporary differences arising from differences between the carrying amount
of
assets and liabilities in the financial statements and the corresponding tax
basis used in the computation of assessable tax profit.
In
principal, deferred tax liabilities are recognized for all taxable temporary
differences, and deferred tax assets are recognized to the extent that it is
probably that taxable profit will be available against which deductible
temporary differences can be utilized. Deferred tax is calculated using tax
rates that are expected to apply to the period when the asset is realized or
the
liability is settled. Deferred tax is charged or credited in the income
statement, except when it is related to items credited or charged directly
to
equity, in which case the deferred tax is also dealt with in equity. Deferred
tax assets and liabilities are offset when they relate to income taxes levied
by
the same taxation authority and the Company intends to settle its current tax
assets and liabilities on a net basis.
Beginning
January 1, 2008, the new Enterprise Income Tax (“EIT”) law replaced the existing
laws for Domestic Enterprises (“DES”) and Foreign Invested Enterprises (“FIEs”).
Value
Added Tax
Enterprises
or individuals who sell products, engage in repair and maintenance or import
and
export goods in the PRC are subject to a value added tax in accordance with
Chinese laws. The value added tax standard rate is 17% of the gross sales price.
A credit is available whereby VAT paid on the purchases of semi-finished
products or raw materials used in the contract and production of the Company’s
finished products can be used to offset the VAT due on sales of the finished
product.
VAT
on
sales and VAT on purchases amounted to $1,573,500 and $1,195,867 for the three
months ended September 30, 2008, and $1,687,472 and $971,409 for the three
months ended September 30, 2007 respectively. VAT on sales and VAT on purchases
amounted to $4,291,620 and $3,266,583 for the nine months ended September 30,
2008, and $4,313,715 and $3,397,843 for the nine months ended September 30,
2007
respectively. Sales and purchases are recorded net of VAT collected and paid
as
the Company acts as an agent for the government. VAT taxes are not impacted
by
the income tax holiday.
Stock
based
compensation
The
Company adopted Statement of Financial Accounting Standards No. 123R “Accounting
for Stock-Based Compensation” (“SFAS 123R”) at the beginning of 2006, which
defines a fair-value-based method of accounting for stock based employee
compensation and transactions in which an entity issues its equity instruments
to acquire goods and services from non-employees. Stock compensation for stock
granted to non-employees has been determined in accordance with SFAS 123R and
the Emerging Issues Task Force consensus Issue No. 96-18, "Accounting for Equity
Instruments that are issued to Other than Employees for Acquiring, or in
Conjunction with Selling Goods or Services" ("EITF 96-18"), as the fair value
of
the consideration received or the fair value of equity instruments issued,
whichever is more reliably measured.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Recently
issued accounting pronouncements
In
February 2007, the FASB SFAS 159, The Fair Value Option for Financial Assets
and
Financial Liabilities—including an amendment of FASB Statement No. 115. FAS 159
permits companies to choose to measure many financial instruments and certain
other items at fair value that are
not currently required to be measured at fair value. The objective of FAS 159
is
to provide opportunities to mitigate volatility in reported earnings caused
by measuring
related assets and liabilities differently without having to apply hedge
accounting provisions. FAS 159 also establishes presentation and
disclosure requirements
designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities. SFAS No.
159
is effective as of the beginning of an entity’s first fiscal year that begins
after November 15, 2007. The Company adopted SFAS No. 159 on January 1, 2008.
The Company chose not to elect the option to measure the fair value of eligible
financial assets and liabilities.
In
June 2007, the
FASB
issued FASB Staff Position No. EITF 07-3, “Accounting for Nonrefundable Advance
Payments for Goods or Services Received for use in Future Research and
Development Activities” (“FSP EITF 07-3”), which addresses whether nonrefundable
advance payments for goods or services that used or rendered for research and
development activities should be expensed when the advance payment is made
or
when the research and development activity has been performed. FSP EITF 07-3
will be effective for an entity’s financial statements issued for fiscal years
beginning after than December 15, 2007. The adoption of FSP EITF 07-3 did not
impact our consolidated financial statements.
In
December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in
Consolidated Financial Statements - an amendment of Accounting Research Bulletin
No. 51”, which establishes accounting and reporting standards for ownership
interests in subsidiaries held by parties other than the parent, the amount
of
consolidated net income attributable to the parent and to the noncontrolling
interest, changes in a parent’s ownership interest and the valuation of retained
non-controlling equity investments when a subsidiary is deconsolidated. The
Statement also establishes reporting requirements that provide sufficient
disclosures that clearly identify and distinguish between the interests of
the
parent and the interests of the non-controlling owners. SFAS 160 is effective
for fiscal years beginning after December 15, 2008. The Company has not
determined the effect that the application of SFAS 160 will have on its
consolidated financial statements.
In
December 2007, SFAS 141(R), Business Combinations, was issued. SFAS 141R
replaces SFAS No. 141, Business Combinations. SFAS 141R retains the fundamental
requirements in SFAS 141 that the acquisition method of accounting (which SFAS
141 called the purchase method) be used for all business combinations and for
an
acquirer to be identified for each business combination. SFAS 141R requires
an
acquirer to recognize the assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree at the acquisition date, measured at
their fair values as of that date, with limited exceptions. This replaces SFAS
141’s cost-allocation process, which required the cost of an acquisition to be
allocated to the individual assets acquired and liabilities assumed based on
their estimated fair values. SFAS 141R also requires the acquirer in a business
combination achieved in stages (sometimes referred to as a step acquisition)
to
recognize the identifiable assets and liabilities, as well as the noncontrolling
interest in the acquiree, at the full amounts of their fair values (or other
amounts determined in accordance with SFAS 141R). SFAS 141R applies
prospectively to business combinations for which the acquisition date is on
or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. An entity may not apply it before that date. The Company
is
currently evaluating the impact that adopting SFAS 141R will have on its
financial statements.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
In
March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities - An Amendment of SFAS No. 133” (“SFAS
161”). Effective on January 1, 2009, SFAS 161 seeks to improve financial
reporting for derivative instruments and hedging activities by requiring
enhanced disclosures regarding the impact on financial position, financial
performance, and cash flows. To achieve this increased transparency, SFAS 161
requires (1) the disclosure of the fair value of derivative instruments and
gains and losses in a tabular format; (2) the disclosure of derivative
features that are credit risk-related; and (3) cross-referencing within the
footnotes. The Company is in the process of evaluating the new disclosure
requirements under SFAS 161.
In
May
2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted
Accounting Principles" ("SFAS 162"). FAS 162 is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in preparing financial statements that are
presented in conformity with U.S. GAAP for nongovernmental entities. SFAS 162
is
effective 60 days following the SEC's approval of the Public Company Accounting
Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly
in
Conformity with Generally Accepted Accounting Principles." The Company is in
the
process of evaluating the impact of adoption of this statement on the results
of
operations, financial position or cash flows.
In
June
2008, the FASB issued EITF 07-5 “Determining whether an Instrument (or Embedded
Feature) is indexed to an Entity’s Own Stock”. This Issue is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years. Early application is not
permitted. Paragraph 11(a) of SFAS 133 “Accounting for Derivatives and Hedging
Activities” specifies that a contract that would otherwise meet the definition
of a derivative but is both (a) indexed to the Company’s own stock and
(b) classified in stockholders’ equity in the statement of financial
position would not be considered a derivative financial instrument. EITF 07-5
provides a new two-step model to be applied in determining whether a financial
instrument or an embedded feature is indexed to an issuer’s own stock and thus
able to qualify for the SFAS 133 paragraph 11(a) scope exception. This
standard will triggered liability accounting on all options and warrants
exercisable at strike prices denominated in any currency other than the
functional currency of the operating entity in China (Renminbi). The
Company is currently evaluating the impact of the adoption of EITF 07-5 on
the
Company’s consolidated financial statements.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
In
June
2008, FASB issued EITF 08-4, “Transition Guidance for Conforming Changes to
Issue No. 98-5”. The objective of EITF 08-4 is to provide transition
guidance for conforming changes made to EITF 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios”, that result from EITF 00-27 “Application of Issue No. 98-5
to Certain Convertible Instruments”, and SFAS 150, “Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity”. This
Issue is effective for financial statements issued for fiscal years ending
after
December 15, 2008. Early application is not permitted. Management is
currently evaluating the impact of adoption of EITF 08-4 on the accounting
for
the convertible notes and related warrants transactions.
On
October 10, 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active,” which clarifies
the application of SFAS 157 in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of a
financial asset when the market for that financial asset is not active. FSP
157-3 became effective on October 10, 2008, and its adoption did not have a
material impact on our financial position or results for the quarter ended
September 30, 2008.
Reclassifications
Certain
prior period amounts have been reclassified to conform to the current period
presentation. These reclassifications have no effect on net income or cash
flows.
Note
3 - Earnings per share
The
Company reports earnings per share in accordance with the provisions of SFAS
128, “Earnings per Share.” SFAS 128 requires presentation of basic and diluted
earnings per share in conjunction with the disclosure of the methodology used
in
computing such earnings per share. Basic earnings per share is computed by
dividing income available to common stockholders by the weighted average common
shares outstanding during the period. Diluted earnings per share takes into
account the potential dilution that could occur if securities or other contracts
to issue common stock were exercised and converted into common
stock.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
The
following is a reconciliation of the basic and diluted earnings per share
computation:
|
|
For
the three months ended September 30,
|
|
For
the nine months ended September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
Net
income for earnings per share
|
|
$
|
6,457,964
|
|
$
|
4,392,035
|
|
$
|
17,874,844
|
|
$
|
12,764,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares used in basic computation
|
|
|
27,572,112
|
|
|
27,026,221
|
|
|
27,562,087
|
|
|
26,649,859
|
|
Diluted
effect of stock options and warrants
|
|
|
687,059
|
|
|
799,221
|
|
|
643,496
|
|
|
786,836
|
|
Weighted
average shares used in diluted computation
|
|
|
28,259,171
|
|
|
27,825,442
|
|
|
28,205,583
|
|
|
27,436,695
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.23
|
|
$
|
0.16
|
|
$
|
0.65
|
|
$
|
0.48
|
|
Diluted
|
|
$
|
0.23
|
|
$
|
0.16
|
|
$
|
0.63
|
|
$
|
0.47
|
|
For
the
three and nine months ended September 30, 2008 and 2007, all options and
warrants have been included in the calculation of diluted earnings per share.
Note
4 - Notes receivable
Notes
receivable represents trade accounts receivable due from various customers
where
the customers’ bank has guaranteed the payment of the receivable. This amount is
non-interest bearing and is normally paid within three to six months. The
Company has the ability to submit their request for payment to the customer’s
bank earlier than the scheduled payment date. However, the Company will incur
an
interest charge and a processing fee when they submit the payment request early.
The Company‘s notes receivable totaled $5,139,588 and $3,315,811 as of September
30, 2008 and December 31, 2007, respectively.
Note
5 - Other receivable from related party
The
Company has other receivable from Hubei Shou An Changjiang Fire Protection
Co.,
Ltd. (“Hubi Shou An”), which the Company has 19% interest in. Receivable due
from Hubei Shou An was $329,884 and $0 as of September 30, 2008 and December
31,
2007, respectively. This balance was for the operating cash flow in Hubei Shou
An and expected to be repaid by December 31, 2008 in cash.
Note
6 - Prepayments and deferred expenses
Prepayments
and deferred expenses are monies deposited with or advanced to subcontractors
to
perform services on System Contracting Projects. Some subcontractors require
a
certain amount of money to be deposited as a guarantee payment in order for
them
start performing the services. Prepayments and deferred expenses also include
monies deposited or advanced to vendors on future inventory purchases to ensure
timely delivery. The total outstanding amount was $3,562,333 and $2,218,391
as
of September 30, 2008 and December 31, 2007, respectively.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Note
7 - Investment in joint ventures
During
the second quarter of 2007, the Company invested $166,782 (RMB 1,140,000) for
a
19% interest in Hubei Shou An Changjiang Fire Protection Co., Ltd., located
in
China Hubei, PRC. Investment is recorded under cost method.
During
the third quarter of 2007, the Company invested $1,000,000 for a 5% interest
in
King Galaxy Investments Limited. King Galaxy through its wholly owned
subsidiary, China Alliance Security Holdings Company Limited owns 100% of Wan
Sent (China) Technology Co., Ltd. (“Wan Sent”), an emerging Chinese fire
emergency remote-monitoring system provider based in Beijing, PRC. The
investment has been recorded under the cost accounting method.
Note
8 - Customer deposits
Customer
deposits represent amounts advanced by customers on products orders and
maintenance services deposits and system contracting projects deposits. The
product or service normally is shipped or performed within six months after
receipt of the advance payment and the related sale is recognized in accordance
with the Company’s revenue recognition policy. Customer deposits also represent
amounts advanced by customers on system contracting projects deposits. The
advance payment will apply to the invoices when the Company billed our customer
based on the progression of the projects. As of September 30, 2008 and December
31, 2007, customer deposits amounted to $16,168,355 and $4,757,179,
respectively.
Note
9 - Accrued liabilities
Accrued
liabilities represent subcontractors’ expenses incurred as of balance sheet date
for system contracting projects. As of September 30, 2008 and December 31,
2007,
accrued liabilities amounted to $5,346,951 and $4,214,530,
respectively.
Note
10 - Income taxes
Prior
to
January 1, 2008, under the Income Tax Laws of PRC, the Company’s subsidiaries
are generally subject to an income tax at an effective rate of 25% on income
reported in the statutory financial statements after appropriate tax
adjustments, unless the enterprise is located in a specially designated region
where it allows enterprises a three-year income tax exemption and a 50% income
tax reduction for the following three years or the enterprise is a manufacturing
related joint venture with a foreign enterprise or a wholly owned subsidiary
of
a foreign enterprise, where it allows enterprises a two-year income tax
exemption and a 50% income tax reduction for the following three
years.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Under
the
Income Tax Laws of Beijing State Administration Taxation of PRC, any
enterprise
with manufacturing operations in the City of Beijing who is a wholly owned
subsidiary of a foreign enterprise is subject to income tax rate of
24%.
The
Company’s subsidiaries are paying the following tax rate for the three months
and nine months ended September 30, 2007.
Subsidiaries
|
|
Percentage
of exemption
|
|
Effective
income tax rate
|
Sureland
Industrial
|
|
100%
|
|
0%
|
Sureland
Equipment
|
|
100%
|
|
0%
|
Beijing
Hua
|
|
100%
|
|
0%
|
Tianxiao
Equipment
|
|
0%
|
|
33%
|
Beginning
from January 1, 2008, the new Enterprise Income Tax (“EIT”) law will replace the
existing income tax laws for Domestic Enterprises (“DES”) and Foreign Invested
Enterprises (“FIEs”).
The
key
changes are:
a.
|
The
new standard EIT rate of 25% will replace the 33% rate currently
applicable to both DES and FIEs, except for High Tech companies who
pays a
reduced rate of 15%;
|
b.
|
Companies
established before March 16, 2007 will continue to enjoy tax holiday
treatment approved by local government for a grace period of the
next 5
years or until the tax holiday term is completed, whichever is sooner.
|
The
Company’s subsidiaries are paying the following tax rate for the three months
and nine months ended September 30, 2008.
Subsidiaries
|
|
Percentage
of exemption
|
|
Effective
income tax rate
|
Sureland
Industrial
|
|
100%
|
|
0%
|
Sureland
Equipment
|
|
50%
|
|
12.5%
|
Beijing
Hua
|
|
100%
|
|
0%
|
Tianxiao
Equipment
|
|
0%
|
|
25%
|
The
credit for income taxes for the three months ended September 30, 2008 and 2007
amounted to $6,737 and $0, respectively. The provision for income taxes amounted
to $53,359 and $0 for the nine months ended September 30, 2008 and 2007,
respectively.
The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the three months and nine months ended September 30:
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Three
months ended)
|
|
(Three
months ended)
|
|
(Nine
months ended)
|
|
(Nine
months ended)
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
U.S.
Statutory rates
|
|
|
34.0
|
%
|
|
34.0
|
%
|
|
34.0
|
%
|
|
34.0
|
%
|
Foreign
income not recognized in USA
|
|
|
(34.0
|
)
|
|
(34.0
|
)
|
|
(34.0
|
)
|
|
(34.0
|
)
|
China
income taxes
|
|
|
25.0
|
|
|
33.0
|
|
|
25.0
|
|
|
(33.0
|
)
|
China
income tax exemption
|
|
|
(25.0
|
)
|
|
(33.0
|
)
|
|
(24.7
|
)
|
|
(33.0
|
)
|
Total
provision (credit) for income taxes
|
|
|
(0.0
|
)%
|
|
0.0
|
%
|
|
0.3
|
%
|
|
0.0
|
%
|
The
estimated tax savings for the three months ended September 30, 2008 and 2007
amounted to $1,414,294 and $1,638,589, respectively. The net effect on basic
earnings per share if the income tax had been applied would decrease basic
earnings per share for the three months ended September
30, 2008 and 2007
by $0.05
and $0.06, respectively. The estimated tax savings for the nine months ended
September 30, 2008 and 2007 amounted to $4,611,290 and $4,124,617, respectively.
The net effect on basic earnings per share if the income tax had been applied
would decrease basic earnings per share for the nine months ended September
30,
2008 and 2007 by $0.17 and $0.15, respectively.
China
Fire & Security Group,
Inc. was incorporated in the United States and has incurred net operating losses
of $0 for income tax purposes for the nine months ended September 30, 2008.
The
net operating loss carry forwards for United States income taxes amounted to
$1,004,414 may be available to reduce future years’ taxable income. These carry
forwards will expire, if not utilized, beginning in 2025 and continue through
2027. Management believes that the realization of the benefits from these losses
appears uncertain due to the Company’s limited operating history and continuing
losses for United States income tax purposes. Accordingly, the Company has
provided a 100% valuation allowance on the deferred tax asset benefit to reduce
the asset to zero. The accumulated valuation allowance as of September 30,
2008
amounted to $341,501 will review this valuation allowance periodically and
make
adjustments as warranted.
Taxes
payable
Taxes
payable consisted of the following:
|
|
September
30, 2008
(Unaudited)
|
|
December
31, 2007
|
|
VAT
taxes payable
|
|
$
|
-
|
|
$
|
71,367
|
|
Income
taxes payable
|
|
|
22,877
|
|
|
5,915
|
|
Sales
taxes
|
|
|
1,401,580
|
|
|
979,999
|
|
Other
taxes payable
|
|
|
30,392
|
|
|
31,054
|
|
Total
|
|
$
|
1,454,849
|
|
$
|
1,088,335
|
|
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Note
11 - Retirement plan
The
Company
and its
subsidiaries are required to participate in a central pension scheme operated
by
the local municipal government. The Company is required to contribute 20% of
its
payroll costs to the central pension scheme in 2008 and 2007. The contributions
are charged to the income statement of the Company as they become payable in
accordance with the rules of the scheme.
The aggregate contributions of the Company to retirement benefit schemes
amounted to $54,879 and $58,460 for
the
three months ended September 30, 2008 and 2007,
respectively. The aggregate contributions of the Company to retirement benefit
schemes amounted to $179,806 and $134,147 for
the
nine months ended September 30, 2008 and 2007,
respectively.
Note
12 - Statutory reserves
The
laws and regulations of the People’s Republic of China require that before an
enterprise distributes profits to its partners, it must first satisfy all tax
liabilities, provide for losses in previous years, and make allocations, in
proportions determined at the discretion of the board of directors, after the
statutory reserve. The statutory reserves include surplus reserve
fund
and the enterprise fund. These
statutory reserves represent restricted retained earnings.
Surplus
reserve fund
The
Company is required to transfer 10% of its net income, as determined in
accordance with the PRC accounting rules and regulations, to a statutory surplus
reserve fund until such reserve balance reaches 50% of the Company’s registered
capital.
The
transfer to this reserve must be made before distribution of any dividend to
shareholders. For the nine months ended September 30, 2008 and 2007, the Company
did not make any contribution to this fund. The surplus reserve fund is
non-distributable other than during liquidation and can be used to fund previous
years’ losses, if any, and may be utilized for business expansion or converted
into share capital by issuing new shares to existing shareholders in proportion
to their shareholding or by increasing the par value of the shares currently
held by them, provided that the remaining reserve balance after such issue
is
not less than 25% of the registered capital.
On
May
17, 2007, the Beijing Shunyi District Business Administration approved the
Company to increase registered capital from RMB 50,000,000 to RMB 100,000,000.
$605,000 or RMB 5,000,000 was approved by the Beijing Shunyi District Business
Administration to be transferred out from this surplus reserve fund as an
increase of registered capital.
Enterprise
fund
The
enterprise fund may be used to acquire plant and equipment or to increase the
working capital to expend on production and operation of the business. No
minimum contribution is required and the Company did not make any contribution
to this fund for the nine months ended September 30, 2008 and
2007.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
Note
13 - Shareholders’ equity
On
January 30, 2008, the Company’s 2008 Omnibus Long-term Incentive Plan was
adopted and approved by shareholders. Pursuant to the 2008 Omnibus Long-term
Incentive Plan, the Company reserved 2,000,000 shares of our common stock for
issuance.
On
March
12, 2008, the Company’s
Board of
Directors authorized the repurchase of up to $10 million of the Company's
outstanding common stock.
Warrants
On
April
26, 2007, the Company amended its Series A Warrants and Series B Warrants issued
to certain investors on October 27 and December 5, 2006 pursuant to the
Securities Purchase Agreement in connection with a private placement (the
“Amendment”). The Amendment eliminates the right of the warrant holders to be
paid in cash in the event of a merger or other types of reorganization. The
warrants no longer need to be accounted for as derivative instrument
liabilities. The fair value of the warrants were transferred to equity on
the signing date and no further accounting (i.e., no mark-to-market) is required
going forward. As of December 31, 2006 the fair value of the derivative
instrument totaled $2,680,811. At April 26, 2007, the Company determined the
fair value of the warrants was $1,475,020 using the Cox-Ross-Rubinstein binomial
model with the following assumptions: volatility 25%; risk free interest rate
4.59%; dividend yield of 0% and expected term of 4.5 years. On April 26, 2007,
the fair value of the warrants was transferred to additional paid-in capital.
In
2007,
a total of 492,340 series A warrants exercised at $3.58 and 492,340 series
B
warrants exercised at $4.88 for a total of 984,680 shares of common stock.
The
Company received a total of $4,165,197 from various warrant holders.
In
2007,
a total of 179,626 warrants were converted into 110,535 shares of common stock
by the warrants holders using the cashless exercise options.
On
February 1, 2007, CFPG issued 50,000 warrants to Hayden Communication, the
Company’s investor relations consultant, as part of its compensation. These
warrants meet the conditions for equity classification pursuant to FAS 133
and
EITF 00-19. Therefore, the warrants were classified as equity and accounted
as
compensation expenses. The warrants vest one year from the grant date. The
Company used the Black Scholes model to value the options at the time they
were
issued, based on the exercise price of $4.25 and expiration dates of the
instruments and using a risk-free rate of 4.84% and the volatility at 50% that
was estimated by analyzing the trading history of the Company’s stock. At that
market price, the 50,000 warrants had a fair value of approximately $94,274.
The
service that the investor relation consultant provides started from the second
quarter of 2007; the related compensation expense is recognized on a
straight-line basis over the total service period and has been fully expensed
in
2007.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
On
June
23, 2008, a total of 5,000 warrants were converted into 3,634 shares of common
stock by the warrants holders using the cashless exercise options.
On
August
21, 2008, a total of 40,000 warrants were converted into 26,066 shares of common
stock by the warrants holders using the cashless exercise options..
The
Company’s warrant activity is as follows:
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
Weighted
|
|
Remaining
|
|
|
|
Warrants
|
|
Warrants
|
|
Average
Exercise
|
|
Contractual
|
|
|
|
Outstanding
|
|
Exercisable
|
|
Price
|
|
Life
|
|
Outstanding,
December 31, 2006
|
|
|
1,169,306
|
|
|
1,169,306
|
|
$
|
4.23
|
|
|
4.58
|
|
Granted
|
|
|
50,000
|
|
|
|
|
$
|
4.25
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(1,164,306
|
)
|
|
(1,164,306
|
)
|
$
|
4.23
|
|
|
|
|
Outstanding,
December 31, 2007
|
|
|
55,000
|
|
|
5,000
|
|
$
|
4.19
|
|
|
4.08
|
|
Granted
|
|
|
|
|
|
50,000
|
|
$
|
4.25
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(45,000
|
)
|
|
(45,000
|
)
|
$
|
4.24
|
|
|
|
|
Outstanding,
September 30, 2008 (Unaudited)
|
|
|
10,000
|
|
|
10,000
|
|
$
|
4.25
|
|
|
3.33
|
|
Note
14 - Options issued to employees
On
April
20, 2007, CFPG issued 9,500 options to the Company’s four independent directors
as part of their compensation. The options will vest immediately after one
year
from the issuance date. The fair value of these warrants was determined to
be
$19,428 using the Black Sholes model with the following assumptions: volatility
45%; risk free interest rate 4.57%; dividend yield of 0% and expected term
of 5
years. Options were vested immediately at exercise price of $4.51 per share
which was the close price of the Company’s stock on April 19, 2007. Because the
services that the independent directors are to provide started from the second
quarter of 2007 and will last for one year, the related compensation expense
is
recognized on a straight-line basis over the total service period.
On
July
1, 2007, CFPG issued 20,000 options to Mr. Yuan, Xiaoyuan, who joined the
Company as Chief Accounting Officer on the same day. The options will vest
evenly each quarter over the following four years, starting from the third
quarter of 2007. The Company used the Black Sholes model to value the options
at
the time they were issued, based on the exercise price of $6.70, which was
the
close price of the Company’s stock on June 30, 2007 and expiration dates of the
instruments and using a risk-free rate of 4.84% and the volatility of 40% that
was estimated by analyzing the trading history of the Company’s stock. At that
market price, the 20,000 employee options had a fair value of $57,178. Because
the options will vest each quarter over the following four years, the related
compensation expense is recognized on a straight-line basis over the total
vesting period.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
The
total
compensation expense recognized for the three months ended September 30, 2008
and 2007 was $3,574 and $89,568, respectively, and for the nine months ended
September 30, 2008 and 2007 was $36,578 and $253,562, respectively.
The
Company has stock options as follows:
|
|
|
|
Weighted
|
|
|
|
|
|
Options
|
|
Average
Exercise
|
|
Aggregate
|
|
|
|
Outstanding
|
|
Price
|
|
Intrinsic
Value
|
|
Outstanding,
December 31, 2006
|
|
|
750,000
|
|
$
|
1.25
|
|
$
|
2,250,000
|
|
Granted
|
|
|
29,500
|
|
$
|
5.99
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
779,500
|
|
$
|
1.43
|
|
$
|
8,925,615
|
|
Outstanding,
December 31, 2007
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
September 30, 2008 (Unaudited)
|
|
|
779,500
|
|
$
|
1.43
|
|
$
|
7,078,340
|
|
Following
is a summary of the status of options outstanding at September 30,
2008:
Outstanding
Options
|
|
Exercisable
Options
|
|
Number
of Options
|
|
Exercise
Price
|
|
Average
Remaining Contractual Life
|
|
Number
of Options
|
|
Exercise
Price
|
|
Average
Remaining Contractual Life
|
|
750,000
|
|
|
1.25
|
|
|
2.75
|
|
|
750,000
|
|
|
1.25
|
|
|
2.75
|
|
9,500
|
|
|
4.51
|
|
|
3.58
|
|
|
9,500
|
|
|
4.51
|
|
|
3.58
|
|
20,000
|
|
|
6.70
|
|
|
3.75
|
|
|
6,250
|
|
|
6.70
|
|
|
3.75
|
|
Note
15 - Restructuring
of subsidiaries
On
April
2, 2007, the Company evaluated the operations of its subsidiary, Beijing Zhong
Xiao Fire Safety Technology Co., Ltd. (“Beijing Zhong Xiao”) and noted
efficiencies could be obtained by consolidating the operations of Beijing Zhong
Xiao into Sureland Equipment.
Beijing
Zhong Xiao was a subsidiary of Sureland Industrial established in the PRC as
a
limited liability company on March 18, 2003. On April 3, 2007, Sureland
Industrial signed an agreement to transfer 100% ownership in Beijing Zhong
Xiao
to Gong Gang Qiang, a Chinese individual, for consideration price equal to
the
net assets of Beijing Zhong Xiao as of March 31, 2007.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES
TO
CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
After
the
restructuring of Beijing Zhong Xiao, the Company still has a significant
continuing involvement in the historical operations of the manufacturing of
fire
safety and protection products through Sureland Equipment, which results in
the
Company failing the test in paragraph 42 of FAS 144 “Accounting for the
Impairment or Disposal of Long-Lived Assets”. The failure of this test therefore
does not require the classification of the disposal of Beijing Zhong Xiao
as
a
discontinued operation.
Item
2. Management's Discussion and Analysis or Plan of
Operation
The
following discussion and analysis provides information which the management
of
China Fire & Security Group, Inc., (the "Company" or "CFSG") believes to be
relevant to an assessment and understanding of the Company's results of
operations and financial condition. This discussion should be read together
with
the Company's financial statements and the notes to financial statements, which
are included in this report.
Overview
We
are engaged in the design, development, manufacturing and sale of fire
protection products and services for large industrial consumers in China. We
have developed a proprietary product line that addresses all aspects of
industrial fire safety from fire detection to fire system control and
extinguishing. The Company is the first in China to leverage high technology
for
fire protection and safety to clients such as iron and steel companies, power
plants, petrochemical plants, as well as, special purpose construction in
China.
Reorganization
We
were organized as a Florida corporation on June 17, 2003.
On
September 1, 2006, we entered into a share exchange agreement, pursuant to
which
we acquired all of the outstanding capital shares of China Fire Protection
Group
Inc. in exchange for a controlling interest in our common shares. The
transaction was completed on Oct 27, 2006.
China
Fire Protection Group was organized on June 2, 2006 for the purpose of acquiring
all of the capital shares of Sureland Industrial Fire Safety Limited (Sureland
Industrial), a Chinese corporation, and, Sureland Industrial Fire Equipment
Co.,
Ltd. (Sureland Equipment), a Chinese corporation, which collectively engage
in
the design, development, manufacturing and sale of fire protection products
and
services for large industrial consumers in China. As a result of the
transactions described above, both Sureland Industrial Fire Safety Limited
and
Sureland Industrial Fire Equipment Co., Ltd became wholly-owned subsidiaries
of
China Fire Protection Group Limited, and China Fire Protection Group Limited
is
a wholly-owned subsidiary of Unipro.
On
February 9, 2007, Unipro changed its name to China Fire & Security Group,
Inc. (CFSG) and started trading on OTC Bulletin Board under its new ticker
symbol CFSG. On July 16, 2007, China Fire & Security Group, Inc. began
trading on Nasdaq Capital Market and retained the ticker symbol
CFSG.
CFSG
owns, through its wholly owned subsidiary China Fire Protection Group, Inc.,
Sureland Industrial and Sureland Equipment (jointly “Sureland”). Sureland is
engaged primarily in the design, development, manufacture and sale in China
of a
variety of fire safety products for the industrial fire safety market and of
design and installation of industrial fire safety systems in which it uses
its
own fire safety products. To a minor extent, it provides maintenance services
for customers of its industrial fire safety systems. Its business is primarily
in China, but it has recently begun contract manufacturing products for the
export market and it has begun to provide a fire safety system for a Chinese
company operating abroad.
Sureland
markets its industrial fire safety products and systems primarily to major
companies in the iron and steel, power and petrochemical industries in China.
It
has also completed projects for highway and railway tunnels, wine distilleries,
tobacco warehouses and a nuclear reactor. It is developing its business in
the
transportation, wine and tobacco, vessels, nuclear energy, and public space
markets. Its products can be readily adapted for use on vessels and in
exhibition halls and theatres. It plans to expand its marketing efforts to
secure business in these industries.
By
September 30, 2008, Sureland operates more than 30 sales and liaison offices
in
China.
Sureland
has been ranked as the leading Chinese industrial fire safety company two times
by the China Association for Fire Prevention based on six major factors
including total revenue, growth rate, net profit, return on assets, investment
in research and development and intellectual property. Its key products include
linear heat detectors and water mist extinguishers, whose sales volumes are
the
largest in China. Its products have been used by its customers in more than
20
provinces throughout China.
Critical
Accounting Policies and Estimates
While
our significant accounting policies are more fully described in Note 2 to our
consolidated financial statements appearing at the end of this quarterly report,
we believe that the following accounting policies are the most critical to
aid
you in fully understanding and evaluating our reported financial
results.
Revenue
recognition
Revenue
is recognized when it is probable that the economic benefits will flow to the
Company as follows:
1.
|
Revenue
from system contracting projects are recognized using the
percentage-of-completion method of accounting and, therefore, take
into
account the costs, estimated earnings and revenue to date on contracts
not
yet completed. Revenue recognized is that percentage of the total
contract
price that cost expended to date bears to anticipated final total
cost,
based on current estimates of costs to complete. Contract costs include
all direct material and labor costs and those indirect costs related
to
contract performance, such as indirect labor, supplies, tools, repairs,
and depreciation costs. Selling, general, and administrative costs
are
charged to expense as incurred. At the time a loss on a contract
becomes
known, the entire amount of the estimated ultimate loss is recognized
in
the consolidated financial statements. Claims for additional contract
costs are recognized upon a signed change order from the customer
or in
accordance with paragraphs 62 and 65 of AICPA Statement of Position
81-1,
"Accounting for Performance of Construction - Type and Certain Production
- Type Contracts" ("SOP 81-1")
|
2.
|
Revenue
from product sales is recognized when the goods are delivered and
title
has passed. Product sales revenue represents the invoiced value of
goods,
net of a value-added tax (VAT). All of the Company’s products that are
sold in the PRC are subject to a Chinese value-added tax at a rate
of 17
percent of the gross sales price. This VAT may be offset by VAT paid
by
the Company on raw materials and other materials included in the
cost of
producing their finished product.
|
|
Revenue
from the rendering of Maintenance Services is recognized when such
services are provided.
|
4.
|
Provision
is made for foreseeable losses as soon as they are anticipated
by
management.
|
5.
|
Where
contract costs incurred to date plus recognized profits less
recognized
losses exceed progress billings, the surplus is treated as
an amount due
from contract consumers. Where progress billings exceed contract
costs
incurred to date plus recognized profits less recognized losses,
the
surplus is treated as an amount due to contract
customers.
|
Almost
all the Company’s products (fire detecting products, fire alarm control device,
and water mist/sprinkler systems) are sold via system contracting projects
or as
part of the integrated products sales. The composition of these three types
of
products varies significantly from project to project, both in quantity and
in
dollar amounts. Although the Company could provide a breakdown of sales
contribution for our own products for each project, it is almost impossible
to
provide revenues for each of our products when the revenue from each project
is
recognized based on percentage of completion. More importantly, the revenues
from the Company’s own products do not accurately reflect our overall financial
performance. The Company is a system contracting projects provider rather than
product vendors who sell their own products directly or through channels.
Therefore, it is not practical to separately disclose the revenues from external
customers for each of our products.
Foreign
currency translation
The
reporting currency of the Company is the US dollar. The Company uses their
local
currency, Renminbi (RMB), as their functional currency. Results of operations
and cash flow are translated at average exchange rates during the period, and
assets and liabilities are translated at the unified exchange rate as quoted
by
the People’s Bank of China at the end of the period. Translation adjustments
resulting from this process are included in accumulated other comprehensive
income in the statement of shareholders’ equity. Transaction gains and losses
that arise from exchange rate fluctuations on transactions denominated in a
currency other than the functional currency are included in the results of
operations as incurred. Historically, the Company has not entered any currency
trading or hedging, although there is no assurance that the Company will not
enter into such activities in the future.
Plant
and equipment are stated at cost less accumulated depreciation. Depreciation
is
computed using the straight-line method over the estimated useful lives of
the
assets with 5 percent residual value.
Use
of estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles of the United States of America requires management to
make estimates and assumptions that affect the amounts reported in the combined
financial statements and accompanying notes. Management believes that the
estimates utilized in preparing its financial statements are reasonable and
prudent. Actual results could differ from these estimates.
Certain
of the Company’s accounting policies require higher degrees of judgment than
others in their application. These include the recognition of revenue and
earnings from system contracting projects under the percentage of completion
method and the allowance of doubtful accounts. Management evaluates all of
its
estimates and judgments on an on-going basis.
Inventories
Inventories
are stated at the lower of cost or market, using the weighted average method.
Inventories consist of raw materials, work in progress, finished goods and
consumables. Raw materials consist primarily of materials used in production.
Finished goods consist primarily of equipment used in project contracts. The
cost of finished goods included direct costs of raw materials as well as direct
labor used in production. Indirect production costs such as utilities and
indirect labor related to production such as assembling, shipping and handling
costs are also included in the cost of inventory. The Company reviews its
inventory annually for possible obsolete goods or to determine if any reserves
are necessary for potential obsolescence.
Accounts
receivable
Accounts
receivable represents the products sales, maintenance services and system
contracting projects with its customers that were on credit. The credit term
is
generally for a period of three months for major customers. Each customer has
a
maximum credit limit. The Company seeks to maintain strict control over its
outstanding receivables. Overdue balances are reviewed regularly by senior
management.
Results
of Operations
The
following is a schedule showing results of our business.
Three
Months Financial Results
Comparison
of the three months ended on September 30, 2008 and
2007:
|
|
Three
months ended
September
30,
|
|
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
Revenues
|
|
$
|
16,743,267
|
|
$
|
11,596,970
|
|
Cost
of revenues
|
|
|
6,878,836
|
|
|
4,729,538
|
|
Gross
profits
|
|
|
9,864,431
|
|
|
6,867,432
|
|
Operating
expenses
|
|
|
3,737,632
|
|
|
2,769,996
|
|
Income
from operations
|
|
|
6,126,799
|
|
|
4,097,436
|
|
Total
other income(expense)
|
|
|
324,429
|
|
|
294,599
|
|
Change
in fair value of derivative instruments
|
|
|
-
|
|
|
|
|
Income
before income taxes and minority interest
|
|
|
6,451,228
|
|
|
4,392,035
|
|
Income
taxes
|
|
|
(6,736)
|
|
|
-
|
|
Minority
interest
|
|
|
-
|
|
|
-
|
|
Net
profit (loss)
|
|
|
6,457,964
|
|
|
4,392,035
|
|
Foreign
exchange adjustment
|
|
|
173,873
|
|
|
540,152
|
|
Comprehensive
income
|
|
|
6,631,837
|
|
|
4,932,187
|
|
weighted
average number of shares-basic
|
|
|
27,572,112
|
|
|
27,026,221
|
|
weighted
average number of shares-diluted
|
|
|
28,259,171
|
|
|
27,825,442
|
|
earning
per share-basic
|
|
|
0.23
|
|
|
0.16
|
|
earning
per share-diluted
|
|
|
0.23
|
|
|
0.16
|
|
Total
revenues were approximately $16.7 million for the three months ended September
30, 2008 as compared to approximately $11.6 million for the three months ended
September 30, 2007, an increase of approximately $5.1 million or 44.4 percent.
This increase was primarily due to increase in our revenues from system
contracting projects and maintenance services during the period. The Company
recognized revenues from 163
total solution, product sales and maintenance contracts for the three months
ended September 30, 2008 as compared to 104 contracts for the three months
ended
September 30, 2007.
The
revenues from total solution contracts increased by 148.5 percent to $15.2
million which were derived from 97 contracts for the three months ended
September 30, 2008, compared to $6.1 million which were derived from 52
contracts for the same period of last year. The revenues from product sales
were
$1.0 million which were derived from 28 contracts for the three months ended
September 30, 2008, compared to $5.2 million derived from 36 contracts for
the
same period of last year. The revenues from maintenance service increased by
94.9 percent to $0.6 million which were derived from 38 contracts for the three
months ended September 30, 2008, compared to $0.3 million which were derived
from 16 contracts for the same period of last year. In particular, the three
largest customers were Capital Iron and Steel Group, Datang Tashan Power Plant
and Chengde Iron and Steel Group, which collectively contributed approximately
$8.1 million of revenues, representing 48.1 percent of total revenues for this
period..
Gross
profit for the three months ended September 30, 2008 was approximately $9.9
million compared to $6.9 million for the three months ended September 30, 2007,
an increase of approximately $3.0 million. Gross margin during this period
was
58.9 percent, compared to the gross margin of 59.2 percent for the same period
of 2007. The slightly decrease in the gross margin was mainly attributable
to
the increase in the cost of our raw materials, offset by the execution of total
solution contracts which contributed higher gross margins and a higher
percentage of revenue contribution from the sales of the Company’s
self-manufactured proprietary products which enjoy higher margins.
Operating
expenses were approximately $3.7 million for the three months ended September
30, 2008 compared to approximately $2.8 million for the three months ended
September 30, 2007. This represents an increase of approximately $1.0 million
or
34.9 percent. Compared to the same period of last year, we increased the number
of employees and the expenditure in sales incentive compensation. The increase
in operating expenses is also attributable to increased R&D expenses in new
product development and improvement in our existing product offerings including
linear heat detectors and water mist systems.
Operating
income was approximately $6.1 million for the three months ended September
30,
2008 as compared to approximately $4.1 million for the three months ended
September 30, 2007, representing an increase of 49.5 percent. The improvement
in
operating income was mainly attributable to the increased revenues during the
period. Operating margin for the three months ended September 30, 2008 was
36.6
percent, compared to the operating margin of 35.3 percent for the same period
of
2007. The improvement in our operating margin was mainly attributable to our
tighter control over general administrative expenses during the period.
Total
other income was $280,094 for the three months ended September 30, 2008,
compared to $249,537 for the three months ended September 30, 2007. The increase
in our total other income was mainly attributable to the increased tax refund
to
Beijing Hua An during the period.
Credit
for income tax was $6,736 for the three months ended September 30, 2008,
compared to no provisions for income tax for the three months ended September
30, 2007. The credit for income tax was mainly attributable to the income tax
recovery from Tianxiao Equipment during the period.
Our
net income was approximately $6.5 million for the three months ended September
30, 2008 as compared to approximately $4.4 million net income for the three
months ended September 30, 2007, representing an increase of $2.1 million or
47
percent.
Currency
translation adjustments resulting from
RMB appreciation
process amounted to $173,873 million and $540,152 million for the three months
ended September 30, 2008 and 2007, respectively.
The
comprehensive income, which adds the currency adjustment to our net income,
was
approximately $6.6 million for the three months ended September 30, 2008 as
compared to approximately $4.9 million comprehensive income for the three months
ended September 30, 2007, representing an increase of $1.7 million or 34.5
percent.
Nine
Months Financial Results
Comparison
of the nine months ended on September 30, 2008 and
2007:
|
|
Nine
months ended
September
30,
|
|
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
Revenues
|
|
$
|
48,093,617
|
|
$
|
32,643,617
|
|
Cost
of revenues
|
|
|
20,000,498
|
|
|
14,450,765
|
|
Gross
profits
|
|
|
28,093,119
|
|
|
18,192,852
|
|
Operating
expenses
|
|
|
10,717,344
|
|
|
7,294,318
|
|
Income
from operations
|
|
|
17,375,775
|
|
|
10,898,534
|
|
Total
other income(expense)
|
|
|
552,428
|
|
|
1,866,141
|
|
Change
in fair value of derivative instruments
|
|
|
-
|
|
|
1,205,791
|
|
Income
before income taxes and minority interest
|
|
|
17,928,203
|
|
|
12,764,675
|
|
Income
taxes
|
|
|
53,359
|
|
|
-
|
|
Minority
interest
|
|
|
-
|
|
|
-
|
|
Net
profit (loss)
|
|
|
17,874,844
|
|
|
12,764,675
|
|
Foreign
exchange adjustment
|
|
|
3,534,472
|
|
|
1,350,486
|
|
Comprehensive
income
|
|
|
21,409,316
|
|
|
14,115,161
|
|
weighted
average number of shares-basic
|
|
|
27,562,087
|
|
|
26,649,859
|
|
weighted
average number of shares-diluted
|
|
|
28,205,583
|
|
|
27,436,695
|
|
earning
per share-basic
|
|
|
0.65
|
|
|
0.48
|
|
earning
per share-diluted
|
|
|
0.63
|
|
|
0.47
|
|
Total
revenues were approximately $48.1 million for the nine months ended September
30, 2008 as compared to approximately $32.6 million for the nine months ended
September 30, 2007, an increase of approximately $15.5 million or 47.3 percent.
This increase was primarily due to increases in our revenues from system
contracting projects and maintenance services during the period. The Company
recognized revenues from 278 total solution, product sales and maintenance
contracts for the nine months ended September 30, 2008 as compared to 196
contracts for the nine months ended September 30, 2007.
The
revenues from total solution contracts increased by 76.4 percent to $41.1
million which were derived from 162 contracts for the nine months ended
September 30, 2008, compared to $23.3 million which were derived from 99
contracts for the same period of last year. The revenues from product sales
were
$5.4 million which were derived from 75 contracts for the nine months ended
September 30, 2008, compared to $8.9 million which were derived from 72
contracts for the same period of last year. The revenues from maintenance
service increased by 200.6 percent to $1.6 million which were derived from
41
contracts for the nine months ended September 30, 2008, compared to $0.5 million
which were derived from 25 contracts for the same period of last year. In
particular, the three largest customers were Capital Iron and Steel Group,
Datang Tashan Power Plant and Anshan Iron and Steel Group, which collectively
contributed approximately $15.9 million of the revenues, representing 33.1
percent of our total revenues for this period.
Gross
profit for the nine months ended September 30, 2008 was approximately $28.1
million, as compared to $18.2 million for the nine months ended September 30,
2007, an increase of approximately $9.9 million. Gross margin during this period
was 58.4 percent, which is higher than the gross margin of 55.7 percent for
the
same period of 2007. The increase in the gross margin was mainly attributable
to
the execution of total solution contracts which contributed higher gross margins
and a higher percentage of revenue contribution from the sales of the Company’s
self-manufactured proprietary products which enjoy higher margins.
Operating
expenses were approximately $10.7 million for the nine months ended September
30, 2008, as compared to approximately $7.3 million for the nine months ended
September 30, 2007. This represents an increase of approximately $3.4 million
or
46.9 percent. Compared to the same period of last year, we increased the number
of employees, its expenditures in sales incentive compensation and raised the
compensation for management to be in line with other US public companies. The
increase in operating expenses is also attributable to increased R&D
expenses in new product development and improvement in our existing product
offerings including linear heat detectors and water mist systems.
Operating
income was approximately $17.4 million for the nine months ended September
30,
2008 as compared to approximately $10.9 million for the nine months ended
September 30, 2007, representing an increase of 59.4 percent. The improvement
in
operating income was mainly attributable to the increased revenues and improved
gross margin during the period.
Total
other income was $552,428 for the nine months ended September 30, 2008, compared
to $1.9 million for the nine months ended September 30, 2007, which included
a
one-time non-cash gain of $1.2 million due to the change in fair value of
derivative instruments.
Provision
for income tax was $53,359 for the nine months ended September 30, 2008,
compared to no provisions for income tax for the nine months ended September
30,
2007.
Net
income was approximately $17.9 million for the nine months ended September
30,
2008 as compared to approximately $12.8 million net income for the nine months
ended September 30, 2007, representing an increase of $5.1 million or 40.0
percent. Excluding a one-time non-cash gain of $1.2 million for the change
in
fair value of derivative in the nine months ended September 30, 2007, the
non-GAAP net income for the nine months ended September 30 of 2007 was $11.6
million. Our net income for the nine months ended September 30, 2008 increased
54.3 percent in comparison to the non-GAAP net income for the nine months ended
September 30, 2007. The reason for the increase in the net income was mainly
due
to the increase in our revenues and the improvement in gross
margin.
Currency
translation adjustments resulting from RMB appreciation process amounted to
$3.5
million and $1.4 million for the nine months ended September 30, 2008 and 2007,
respectively.
The
comprehensive income, which adds the currency adjustment to the net income,
was
approximately $21.4 million for the nine months ended September 30, 2008 as
compared to approximately $14.1 million comprehensive income for the nine months
ended September 30, 2007, representing an increase of $7.3 million or 51.7
percent.
Liquidity
and Capital Resources
As
of September 30, 2008, we had working capital of $59.0 million including cash
and cash equivalents of $21.8 million. The following table sets forth a summary
of our cash flows for the periods indicated:
Statement
of Cash Flow
|
|
Nine
months Ended
September
30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Net
cash provided by (used in) operating activities
|
|
$
|
7,347,257
|
|
$
|
3,236,930
|
|
Net
cash (used in) investing activities
|
|
|
(1,726,401)
|
|
|
(3,484,254)
|
|
Net
cash provided by financing activities
|
|
|
(2,039,634)
|
|
|
3,387,848
|
|
Effect
of foreign currency translation on cash and cash
equivalents
|
|
|
1,113,669
|
|
|
412,282
|
|
Net
cash flow
|
|
$
|
21,805,340
|
|
$
|
12,978,897
|
|
Operating
Activities
Net
cash provided by operating activities was approximately $7.3 million for the
nine months ended September 30, 2008 as compared to $3.2 million net cash
provided in operating activities for the same period in 2007. Net cash provided
by operating activities in the nine months ended September 30, 2008 was mainly
due to the results of net income of $17.9 millions during the period, a $10.9
million increase in customer deposits and $1.1 million increase in other
payables, offset by a $2.6 million increase in account receivables, a $1.6
million increase in notes receivable, a $3.4 million increase in inventories,
a
$14.5 million increase in costs and estimated earnings in excess of billings,
a
$1.1 million decrease in prepayments and deferred expenses and a $1.8 million
decrease in billings in excess of costs and estimated earnings.
The
increase of $14.5 million in costs and estimated earnings in excess of billings
was mainly due to the increased aggregate value of projects where we have
recognized revenues more than we have billed the customers for these projects,
while the decrease of $1.8 million in billings in excess of costs and estimated
earnings was mainly due to the decreased aggregate value of projects where
we
have billed our customers less than we have recognized revenues for these
projects.
Investing
Activities
Net
cash used in investing activities in the nine months ended September 30, 2008
was $1.7 million as compared to net cash used in investing activities of $3.5
million in the same period of 2007. The cash used in investing activities in
the
nine months ended September 30, 2008 was mainly attributable to capital
expenditure in the purchase of new equipments and the improvement of office
and
manufacturing facilities.
Financing
Activities
Net
cash used by financing activities in the nine months ended September 30, 2008
totaled $2.0 million as compared to $3.4 million provided in financing
activities in the same period of 2007. The cash used by financing activities
in
the nine months ended September 30, 2008 was mainly attributable to the increase
in restricted cash during the period.
As
a result of the total cash activities, net cash increased $4.7 million from
December 31, 2007 to September 30, 2008. We believe that our currently
available working capital of $59.0 million including cash and cash equivalents
of $21.8 million should be adequate to sustain our operations at our current
level and our anticipated expansion.
Off-Balance
Sheet Arrangements
We
do not have any off-balance sheet financing arrangements.
Recently
issued accounting pronouncements
In
February 2007, the FASB SFAS 159, The Fair Value Option for Financial Assets
and
Financial Liabilities—including an amendment of FASB Statement No. 115. FAS 159
permits companies to choose to measure many financial instruments and certain
other items at fair value that are
not currently required to be measured at fair value. The objective of FAS 159
is
to provide opportunities to mitigate volatility in reported earnings caused
by measuring
related assets and liabilities differently without having to apply hedge
accounting provisions. FAS 159 also establishes presentation and
disclosure requirements
designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities. SFAS No.
159
is effective as of the beginning of an entity’s first fiscal year that begins
after November 15, 2007. The Company adopted SFAS No. 159 on January 1, 2008.
The Company chose not to elect the option to measure the fair value of eligible
financial assets and liabilities.
In
June 2007, the
FASB
issued FASB Staff Position No. EITF 07-3, “Accounting for Nonrefundable Advance
Payments for Goods or Services Received for use in Future Research and
Development Activities” (“FSP EITF 07-3”), which addresses whether nonrefundable
advance payments for goods or services that used or rendered for research and
development activities should be expensed when the advance payment is made
or
when the research and development activity has been performed. FSP EITF 07-3
will be effective for an entity’s financial statements issued for fiscal years
beginning after than December 15, 2007. The adoption of FSP EITF 07-3 did not
impact our consolidated financial statements.
In
December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in
Consolidated Financial Statements - an amendment of Accounting Research Bulletin
No. 51”, which establishes accounting and reporting standards for ownership
interests in subsidiaries held by parties other than the parent, the amount
of
consolidated net income attributable to the parent and to the noncontrolling
interest, changes in a parent’s ownership interest and the valuation of retained
non-controlling equity investments when a subsidiary is deconsolidated. The
Statement also establishes reporting requirements that provide sufficient
disclosures that clearly identify and distinguish between the interests of
the
parent and the interests of the non-controlling owners. SFAS 160 is effective
for fiscal years beginning after December 15, 2008. The Company has not
determined the effect that the application of SFAS 160 will have on its
consolidated financial statements.
In
December 2007, SFAS 141(R), Business Combinations, was issued. SFAS 141R
replaces SFAS No. 141, Business Combinations. SFAS 141R retains the fundamental
requirements in SFAS 141 that the acquisition method of accounting (which SFAS
141 called the purchase method) be used for all business combinations and for
an
acquirer to be identified for each business combination. SFAS 141R requires
an
acquirer to recognize the assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree at the acquisition date, measured at
their fair values as of that date, with limited exceptions. This replaces SFAS
141’s cost-allocation process, which required the cost of an acquisition to be
allocated to the individual assets acquired and liabilities assumed based on
their estimated fair values. SFAS 141R also requires the acquirer in a business
combination achieved in stages (sometimes referred to as a step acquisition)
to
recognize the identifiable assets and liabilities, as well as the noncontrolling
interest in the acquiree, at the full amounts of their fair values (or other
amounts determined in accordance with SFAS 141R). SFAS 141R applies
prospectively to business combinations for which the acquisition date is on
or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008. An entity may not apply it before that date. The Company
is
currently evaluating the impact that adopting SFAS 141R will have on its
financial statements.
In
March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities - An Amendment of SFAS No. 133” (“SFAS
161”). Effective on January 1, 2009, SFAS 161 seeks to improve financial
reporting for derivative instruments and hedging activities by requiring
enhanced disclosures regarding the impact on financial position, financial
performance, and cash flows. To achieve this increased transparency, SFAS 161
requires (1) the disclosure of the fair value of derivative instruments and
gains and losses in a tabular format; (2) the disclosure of derivative
features that are credit risk-related; and (3) cross-referencing within the
footnotes. The Company is in the process of evaluating the new disclosure
requirements under SFAS 161.
In
May
2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted
Accounting Principles" ("SFAS 162"). FAS 162 is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in preparing financial statements that are
presented in conformity with U.S. GAAP for nongovernmental entities. SFAS 162
is
effective 60 days following the SEC's approval of the Public Company Accounting
Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly
in
Conformity with Generally Accepted Accounting Principles." The Company is in
the
process of evaluating the impact of adoption of this statement on the results
of
operations, financial position or cash flows.
In
June
2008, the FASB issued EITF 07-5 “Determining whether an Instrument (or Embedded
Feature) is indexed to an Entity’s Own Stock”. This Issue is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years. Early application is not
permitted. Paragraph 11(a) of SFAS 133 “Accounting for Derivatives and Hedging
Activities” specifies that a contract that would otherwise meet the definition
of a derivative but is both (a) indexed to the Company’s own stock and
(b) classified in stockholders’ equity in the statement of financial
position would not be considered a derivative financial instrument. EITF 07-5
provides a new two-step model to be applied in determining whether a financial
instrument or an embedded feature is indexed to an issuer’s own stock and thus
able to qualify for the SFAS 133 paragraph 11(a) scope exception. This standard
will triggered liability accounting on all options and warrants exercisable
at
strike prices denominated in any currency other than the functional currency
of
the operating entity in China (Renminbi). The Company is currently evaluating
the impact of the adoption of EITF 07-5 on the Company’s consolidated financial
statements.
In
June
2008, FASB issued EITF 08-4, “Transition Guidance for Conforming Changes to
Issue No. 98-5”. The objective of EITF 08-4 is to provide transition
guidance for conforming changes made to EITF 98-5, “Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios”, that result from EITF 00-27 “Application of Issue No. 98-5
to Certain Convertible Instruments”, and SFAS 150, “Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity”. This
Issue is effective for financial statements issued for fiscal years ending
after
December 15, 2008. Early application is not permitted. Management is
currently evaluating the impact of adoption of EITF 08-4 on the accounting
for
the convertible notes and related warrants transactions.
On
October 10, 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active,” which clarifies
the application of SFAS 157 in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of a
financial asset when the market for that financial asset is not active. FSP
157-3 became effective on October 10, 2008, and its adoption did not have a
material impact on our financial position or results for the quarter ended
September 30, 2008.
Item
3. Quantitative and Qualitative Disclosures about Market
Risk
Not
required.
Item
4. Controls and Procedures.
a)
Evaluation
of Disclosure Controls.
Brian Lin, our Chief Executive Officer and Robert Yuan, our Chief Accounting
Officer evaluated the effectiveness of our disclosure controls and procedures
as
of the end of our second fiscal quarter 2008 pursuant to Rule 13a-15(b) of
the
Securities and Exchange Act. Disclosure controls and procedures are controls
and
other procedures that are designed to ensure that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act
is
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by us in the reports that we file under the Exchange
Act is accumulated and communicated to our management, as appropriate to allow
timely decisions regarding required disclosure. Based on their evaluations,
Mr.
Lin and Mr. Yuan concluded that our disclosure controls and procedures were
effective as of September 30, 2008.
It
should be noted that any system of controls, however well designed and operated,
can provide only reasonable, and not absolute, assurance that the objectives
of
the system are met. In addition, the design of any control system is based
in
part upon certain assumptions about the likelihood of future events. Because
of
these and other inherent limitations of control systems, there can be no
assurance that any design will succeed in achieving its stated goals under
all
potential future conditions.
(b) Changes
in internal control over financial reporting.
Other than training our staff in US GAAP accounting skills and implementing
stronger internal audit function during the last quarter, there have been no
changes in our internal control over financial reporting that occurred during
the last fiscal quarter that has materially affected, or is reasonably likely
to
materially affect, our internal control over financial reporting. Our management
team will continue to evaluate our internal control over financial reporting
in
2008 as we implement our Sarbanes Oxley testing.
PART
II - OTHER INFORMATION
Item
1. Legal Proceedings
None
Item
2. Unregistered Sales of Equity Securities and Use of Proceeds
During
the quarter ended September 30, 2008, we
issued
26,066 shares of common stock for cashless exercise of 40,000
shares
of
warrants.
Item
3. Defaults Upon Senior Securities
None
Item
4. Submission of Matters to a Vote of Security Holders.
None
Item
5. Other Information.
None
Item
6. Exhibits
The
following exhibits are hereby filed as part of this Quarterly Report on Form
10-Q.
Exhibit
Number:
|
|
Description
|
31.1
|
|
Certification
of Chief Executive Officer under Section 302 of the Sarbanes-Oxley
Act of
2002.
|
|
|
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31.2
|
|
Certification
of Principal Accounting Officer under Section 302 of the Sarbanes-Oxley
Act of 2002.
|
|
|
|
32.1
|
|
Certifications
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
Section 1350
|
|
|
|
33.2
|
|
Certification
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
Section 1350
|
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant certifies that it has duly caused this Quarterly Report
on
Form 10-Q to be signed on its behalf by the undersigned, thereunto duly
authorized, in Beijing.
|
|
|
|
CHINA
FIRE & SECURITY GROUP, INC.
|
|
|
|
Dated:
November 14, 2008
|
By:
|
/s/ Brian
Lin
|
|
Brian
Lin
|
|
Chief
Executive Officer
|
|
|
|
Dated:
November 14, 2008
|
By:
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/s/ Robert
Yuan
|
|
Robert
Yuan
|
|
Chief
Accounting Officer/Principal Accounting
Officer
|