UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
AMENDMENT
NO. 2 TO
FORM
10-K
(Mark
One)
x
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
fiscal year ended December 31, 2008
OR
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
transition period ______________ to ______________
Commission
file number: 001-33588
CHINA
FIRE & SECURITY GROUP, INC.
(Exact
name of registrant as specified in its charter)
Florida
|
|
65-1193022
|
(State
of incorporation)
|
|
(I.R.S.
Employer Identification No.)
|
B-2508
TYG Center, C2 Dongsanhuanbeilu,
Chaoyang
District, Beijing 100027,
People’s
Republic of China
(Address
of principal executive offices)
(86-10)
8441 7400
(Issuer’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Exchange Act:
Common
Stock, $.001 Par Value
|
|
The
Nasdaq Capital Market, LLC
|
(Title
of Class)
|
|
(Name
of each exchange on which
registered)
|
Securities
registered pursuant to Section 12(g) of the Exchange Act: None.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes ¨ No þ
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes þ No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
|
Accelerated filer x
|
Non-accelerated filer ¨
(Do not check if a smaller
reporting company)
|
Smaller reporting
company ¨
|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act):
Yes ¨ No þ
The
aggregate market value of the 12,170,527 shares of voting and non-voting
common equity stock held by non-affiliates of the registrant was $ 97,607,627 as
of June 30, 2008, the last business day of the registrant’s most recently
completed second fiscal quarter, based on the last sale price of the
registrant’s common stock on such date of $8.02 per share, as reported by The
NASDAQ Stock Market, Inc.
As
of March 13, 2009, there were 27,586,593 shares of common stock of China
Fire & Security Group, Inc. outstanding.
EXPLANATORY
NOTE
This
Amendment No. 2 to our Annual Report on Form 10-K initially filed with the
Securities and Exchange Commission (the “Commission”) on March 16, 2009 is being
filed to correct a typographical error on the date of the Report of Independent
Registered Public Accounting Firm.
TABLE
OF CONTENTS
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Page
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PART
I
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Item
1
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Business
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3 |
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Item
1A
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Risk
Factors
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13 |
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Item
1B
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Unresolved
Staff Comments
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22 |
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Item
2
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Properties
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22 |
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Item
3
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Legal
Proceedings
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22 |
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Item
4
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Submission
of Matters to a Vote of Security Holders
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22 |
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PART
II
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|
Item
5
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Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
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|
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23 |
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Item
6
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Selected
Financial Data
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|
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24 |
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Item
7
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operation
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|
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25 |
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Item
7A
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Quantitative
and Qualitative Disclosures About Market Risk
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|
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35 |
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Item
8
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Financial
Statements and Supplementary Data
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|
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35 |
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Item
9
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Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure
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36 |
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Item
9A
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Controls
and Procedures
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36 |
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Item
9B
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Other
Information
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39 |
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PART
III
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Item
10
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Directors,
Executive Officers and Corporate Governance
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39 |
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Item
11
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Executive
Compensation
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|
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43 |
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Item
12
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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|
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47 |
|
Item
13
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Certain
Relationships and Related Transactions, and Director
Independence
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|
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49 |
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Item
14
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Principal
Accounting Fees and Services
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49 |
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PART
IV
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Item
15
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Exhibits
and Financial Statement Schedules
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49 |
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PART I
Item 1.
Business
Overview
We are
engaged primarily in the design, development, manufacture and sale of a variety
of fire safety products for the industrial fire safety market and the design and
installation of industrial fire safety systems in which we primarily use our own
fire safety products. To a minor extent, we provide maintenance services for
customers of our industrial fire safety systems. Our business is primarily in
China, where we operate sales and liaison offices in more than 20 cities, but we
are expanding our business overseas by providing integrated fire safety
systems.
We market
our industrial fire safety products and systems primarily to major companies in
the iron and steel, power and petrochemical industries in China. In 2008, we
also secured significant contracts with nuclear power plants. We are further
developing our business in the transportation sector, including subways and
highway tunnels. We plan to expand our marketing efforts to secure business in
these industries.
We have
internal research and development facilities engaged primarily in furthering
fire safety technologies. We believe that our technologies allow us to offer
cost-effective and high-quality fire safety products and systems. We have
developed products for industrial fire detecting and extinguishing. We believe
that we are the leading manufacturer in China which has successfully developed a
comprehensive line of linear heat detectors.
We are
the result of a share exchange completed on October 27, 2006 between Unipro
Financial Services, Inc., a Florida corporation (“Unipro”) and the shareholders
of China Fire Protection Group, Inc., a limited liability company organized
under the laws of the British Virgin Islands (“CFPG”). The share exchange
resulted in the change of control of Unipro, with the former shareholders of
CFPG owning approximately 80.5% of the company on a fully diluted basis after
the share exchange. The directors and officers of CFPG became our directors and
officers in conjunction with the share exchange. Effective as of January 31,
2007 we changed our name to China Fire & Security Group,
Inc.
We have
twice been ranked as the leading Chinese industrial fire safety company by the
China Association for Fire Prevention based on six major factors including total
revenue, growth rate, net profit, return on assets, investment in research and
development and intellectual property. In 2008, we were also ranked as the
leading fire protection brand in China in a survey conducted by www.HC360.com. HC360
is a leading B2B electronic commerce services provider in China and
runs the largest commercial website in China's fire protection industry
(www.fire.HC360.com). Our key products include linear heat detectors
and water mist extinguishers. Our products have been used by our customers in
more than 20 provinces throughout China.
Our
Strategy:
We
plan to implement the following specific strategies to achieve our growth
goals:
1)
Strengthen and further develop our total solution business. We plan to continue
to serve our current customers and gain additional market share, and capture
business in new industries and international markets
As the
leading brand in China’s industrial fire protection industry, China Fire has a
long list of mid-to-high end customers in various industrial verticals and
specialty constructions. By fully utilizing the Company’s brand name and
influence in the marketplace, China Fire will adhere to and further develop its
business model in providing total fire protection systems to our customers. As a
result of the global financial downturn, China Fire’s primary target industries,
including iron and steel, power generation and, petrochemicals industries, have
become the recipient of favorable recovery policies from the Chinese
government. China Fire will continue to gain growth opportunities provided by
the government’s support for consolidation and technical upgrades in these
industries.
China
will issue a major amendment to the national fire law on May 1, 2009. The new
fire law will stipulate higher requirements for fire safety technologies and
products. China Fire will focus on serving the new industrial build-outs,
rebuild and upgrades, and maintenance projects to solidify its existing customer
base and to further enhance its competitive position in the market. The Company
will expand into other sectors by promoting its new technologies and products
and strengthening synergistic cooperation in the marketplace. The Company will
also pursue business opportunities in select international markets.
2)
Strengthen technological innovation and intellectual property protection and
influence the enhancement of new product standards and fire codes
China
Fire continues to invest in technological innovation and will deliver new
products with leading technologies and strong potential market demand. The
Company will increase its focus the registration of intellectual property rights
and increase its efforts crackdown on infringing products. China Fire will also
continue to proactively participate in the development of various industry
standards and code enhancements in light of its leading fire safety
technologies. The Company plans to continue to gain additional market share as a
result of its superior product offering and competitive pricing.
3)
Continue to selectively explore strategic M&A targets to enhance our
competitive advantages and financial results
To
supplement its organic growth and strengthen its leadership position in the
industry, China Fire expects to grow through mergers and acquisitions. We will
be very selective and value business synergies by acquiring fire protection
companies with strong market presence in certain industrial verticals, companies
with strong marketing channels and companies that possess recurring maintenance
services business. All acquisitions will be accretive to earnings.
Our
Industry
The
Industrial Fire Safety Industry
The fire
safety industry can be generally divided into three major segments: residential,
commercial and industrial. The industrial fire safety business requires greater
technical expertise than the residential or commercial fire safety businesses
due to the hazardous conditions of the industrial environment. Designers must
consider a myriad of complex technologies, safety factors, as well as, unique
fire hazard risks associated with various areas of production. Designers
must also contend with adverse environmental problems such as humidity, dust and
electro-magnetic interference to develop solutions to analyze and mitigate the
spread of fire and chain reactions that are more likely to occur in the
automated industrial production environment.
Along
with China’s modernization drive, its economy has witnessed significant growth
in the past three decades, which brought about a rapid growth in its
manufacturing capacity. Moreover, due to its investment environment and cheap
labor, China has attracted many manufacturers from developed countries. The
increasing industrial capacity of China has caused, and is anticipated to
continue to cause, a high level of demand for industrial fire safety products
and services. According to a study published by China’s Building
Mechanical & Electrical Engineering Magazine, China’s total revenues
from industrial fire safety products and services in 2006 was approximately $1
billion and the annual growth rate for the following five years was expected to
be more than 11%.
Due to
the increased loss of lives and properties as a result of fires, the Chinese
government began to attach increasing importance to industrial fire safety in
the 1990’s. The government enacted various laws and issued regulations on fire
safety of which the most important included the Fire Safety Law of 1998 and the
Safe Production Law of 2002. These laws, while expressing the government’s
increased emphasis on fire safety, can be vague and are not themselves
responsible for the increase in demand. More important to the demand for
products and services are fire codes for various industrial sectors. In April
2007, China’s Ministry of Construction published a fire code entitled “Code of
Design on Fire Protection and Prevention for Iron and Steel Metallurgy
Enterprises”, which became effective on January 1st, 2008.
This fire code is applicable to all new build-out of plants, expansion and
renovation of existing facilities in any iron and steel company.
The
products used by the fire safety industry have historically been foreign
products, which have been superior in technology and quality. In recent years,
Chinese products have improved in terms of technology and quality and are being
increasingly accepted. The competitive price of Chinese products has also become
a competitive advantage.
The
industry for the design, manufacture and installation of fire safety systems is
fragmented with no dominant players. As a result, we believe that there is an
opportunity for consolidation and expansion so that major players can
emerge.
Our
Leadership Position in the Industry
We began
in 1995 as the first Chinese company specializing in industrial fire safety. We
believe that we have established ourselves as the recognized leader in the
industrial fire safety business in China based on the following competitive
advantages:
l
|
A
long list of mid-to-high end loyal customers in various
industries
|
China
Fire has been issued the top level certificates for both System Contracting and
Engineering from the Ministry of Construction of China. China Fire was ranked
No. 1 in the survey of System
Contracting Enterprises undertaken by China Fire Association in 2001.
Leveraging on its own products with proprietary technologies and comprehensive
design experience, China Fire has superior capabilities and expertise in
providing total fire protection systems to industrial customers. China Fire has
been serving a long list of mid-to-high end loyal customers in various
industries including iron and steel, petrochemical, power, nuclear power, and
transportation. We have been receiving repeat business from these customers when
they build new projects or rebuild their existing plants.
l
|
Technology
leadership with several high valued proprietary intellectual
properties.
|
China
Fire has developed a series of proprietary technologies for industrial fire
safety products including Linear Heat Detectors (LHD) which have been awarded
dozens of patents worldwide. These technologies have enabled the Company to
become one of the chief editors for relevant national fire product standards.
Leading technologies, proprietary patent protection and our influence over fire
safety standard have contributed to China Fire’s unique market leading position
with sustainable advantages.
l
|
Lead
and influence the enhancement of various national fire codes and product
standards.
|
China
Fire is an editorial member for the national Codes of Fire Protection Standards
for Metallurgy, Iron & Steel Enterprises, and for the “Linear Heat Detector” and
participated in various other fire codes at the national and provincial level.
These enhancements have improved fire safety standard in China and created
larger market demand for many products including our proprietary products which
have better price with better reliability.
l
|
Specialized
research and development centers and manufacturing bases for fire
detection products and fire suppression
products
|
China
Fire has a specialized research and development center and manufacturing base
for fire detection products in Beijing and another research and development
center and manufacturing base for fire suppression products in Tianjin.
Recognized by the government as high-tech enterprise, China Fire has ample
manufacturing capacity to support its future business growth in specialized fire
detection and suppression products.
l
|
Experienced
management team with established track record for sustained
growth
|
China
Fire has a strong management team which consists of experts in technology, sales
and marketing as well as general management. The core team has both domestic
experience and international vision with strong track record for achieving
sustained business and financial growth over the last 5 years.
Our
Products and Services
Our major
customers are in the iron and steel (contributing approximately 81% of
revenues), traditional power generation (contributing approximately 9% of
revenues) and petrochemical (contributing approximately 4% of revenues)
industries. Our revenues are mainly from three sources: Total Solutions, Product
Sales, and Maintenance Services. In 2008, revenues from total solutions
accounted for approximately 83% of total revenues and the sale of products
integrated by us accounted for approximately 14% of total revenues, while
maintenance services accounted for approximately 3% of total
revenues.
Total
Solutions
We design
and install total fire protection systems for our clients. A fire protection
system consists of three major components: fire detectors, fire alarm control
and network supervisory systems, and fire extinguishing systems. In most cases,
we design and install all three components. The price of systems varies with the
size and complexity of the installation, ranging from $10,000 to $32 million. In
2008, we designed and installed more than 177 systems. The design and
installation of a system can take one month to three years, depending on the
complexity of the system. Approximately 11% of the systems take less than one
year to complete, while approximately 89% of the systems require more than one
year. Revenues from total solutions typically can be broken down as follows:
50-65% of revenues from products manufactured by us; 25-40% of revenues from
products manufactured by third parties; and 10% of revenues from services (the
design and installation). The price of our own products incorporated into the
total solution systems we design and install is similar to that sold directly to
our customers. The markup for third party products is approximately
20-30%.
We
maintain long-term relationships with the majority of our customers. In 2008,
the top-five projects for total solution systems that we implemented for our
customers (based on its revenue recognized and the percentage contribution) were
as follows:
Top-Five
Customers of Our Total Solutions in 2008
Name
|
Industry
|
|
Amount
of Revenues
($1,000)
|
|
|
Percentage
of Total Solution
Revenues
|
|
Capital
Iron & Steel (Caofeidian Project)
|
Iron
and Steel
|
|
|
17,570
|
|
|
|
30.8
|
%
|
Anshan
Iron & Steel (Bayuquan Project)
|
Iron
and Steel
|
|
|
2,965
|
|
|
|
5.2
|
%
|
Datang
Power (Tashan Project)
|
Power
|
|
|
2,629
|
|
|
|
4.6
|
%
|
Wuhan
Iron & Steel (CSP Project)
|
Iron
and Steel
|
|
|
2,468
|
|
|
|
4.3
|
%
|
Xinyu
Iron & Steel
|
Iron
and Steel
|
|
|
2,102
|
|
|
|
3.7
|
%
|
Total
|
|
|
|
|
|
|
|
48.6
|
%
|
Products
Depending
on the requirements of our clients, we provide integrated fire protection
products. By selling products we manufacture and incorporating products
outsourced from third parties we provide a complete system for our clients. Such
revenues do not include the sale of our products in connection with our total
solution business, the design and installation of fire protection systems. We
manufacture the following products, which can be divided into three categories
according their functions:
·
|
Fire
Detectors. The products
include:
|
|
Linear
Heat Fire Detectors
|
|
Multi-Frequency
Infrared Flame Detectors
|
|
|
|
Long
Range Infrared Combustible Gas
Detectors
|
|
Fixed
Point Combustible Gas
Detectors
|
|
Fire
Alarm Control and Network Supervisory Systems. The products
include:
|
·
|
Fire
Control Room Display System
|
|
Fire
Safety Monitoring Center
System
|
|
Remote
Customer Service System
|
|
Fire
Extinguishing Systems. The products
include:
|
|
Water
Mist Fire-Extinguishing
System
|
|
Anti-False-Spray
Water Spray Fire-Extinguishing
System
|
|
Gas-Based
Fire-Extinguishing System
|
|
Foam-Based
Fire-Extinguishing System
|
|
Portable
and Transportable Fire
Extinguishers
|
We focus
on the production and sales of our proprietary products, which are associated
with our technologies and intellectual properties. The sales of our proprietary
products, which include our liner heat detectors and water mist
fire-extinguishing systems, contribute a higher gross margin than the products
outsourced from the third parties.
Recently
we have developed new products, including fixed point combustible gas detectors
and foam-based fire extinguishing systems. The development of these new products
will enhance our product offerings and strengthen our competitive
position.
We
have established quality assurance systems throughout the company and achieved
ISO9001:2000 certification since 2001. ISO9001:2000 refers to a quality
management system which demonstrates the company’s ability to consistently
provide products that meet applicable regulatory requirements and aim to enhance
customer satisfaction. We believe these certifications are recognition of our
commitment to and efforts in implementing and maintaining a quality management
system in the design, manufacturing and sales of our fire safety
products.
The
tables below list our top-five Products Sales customers as of December 31,
2008. The amounts and percentages do not include the sales of our products as
part of total solutions:
Top-Five
Customers of Our Product Sales in 2008
Name
|
Industry
|
|
Sales in
USD ($1,000)
|
|
|
Percentage of
Total Product
Sales
|
|
Xian
System Sensor Electronics
|
OEM
|
|
|
2,169
|
|
|
|
22.43
|
%
|
Petrochina
|
Petrochemical
|
|
|
1,631
|
|
|
|
16.86
|
%
|
Tianjin
Tiantie Company
|
Iron
and Steel
|
|
|
1,062
|
|
|
|
10.97
|
%
|
Datang
Chongqing Power Company
|
Power
|
|
|
522
|
|
|
|
5.40
|
%
|
Anshan
Iron & Steel
|
Iron
and Steel
|
|
|
323
|
|
|
|
3.35
|
%
|
Total
|
|
|
|
|
|
|
|
59.01
|
%
|
Our
Intellectual Property
We have
developed our own technologies for our products and services. We own 76 patents
and have 37 pending applications in China and internationally. These patents are
related to fire detecting, system control, and fire extinguishing technologies
as listed in the table below.
Our
Intellectual Properties
Product
|
|
Patents
Issued
|
|
|
Patents
Pending
|
|
Linear
Heat Fire Detectors
|
|
|
50
|
|
|
|
30
|
|
Infrared
Flame Detectors
|
|
|
1
|
|
|
|
|
|
Water
Mist Nozzles
|
|
|
15
|
|
|
|
3
|
|
Remote
System Control Device
|
|
0
|
|
|
|
1
|
|
Fire
Alarm Control Device
|
|
|
|
|
|
|
2
|
|
Foamed-Based
Fire Extinguishing Device
|
|
|
4
|
|
|
|
|
|
Others
|
|
|
6
|
|
|
|
1
|
|
Total
|
|
|
76
|
|
|
|
37
|
|
We own
six copyrights for software used for detecting assembly and control modules. We
have developed proprietary software to provide localized and network-based fire
detection and monitoring solutions. We believe that we are the first company in
China to provide customers with remote system monitoring services based on our
network-based solutions. From our centralized monitoring center, we can detect
any status change (major alarm, critical alarm, fire alarm, etc.) of the major
components of each system, upload information, and take appropriate actions if
needed. We have been granted copyrights for such software by China’s State
Bureau of Copyrights.
We have
thirteen registered trademarks for our products and services approved by the
State Administration for Industry and Commerce of China,. In
addition, we currently own three internet domain names “www.sureland.com.cn”,
“www.sureland.com.” and www.chinafiresecurity.com.
Our
Research and Development Efforts
We
currently have approximately 34 members on our research and development team.
Most of our R&D staff have been working in the field of fire safety products
for over five years. Research and development costs were $2,102,976 and $672,379
during the year ended December 31, 2008 and 2007, respectively.
Our
research and development activities involve improving upon existing products,
developing new products, designing better and more efficient fire safety
systems, and developing new applications for such products and systems. We are
currently developing new technologies for anti-explosive gas bottles, alternate
foam storage and mix device and high-pressure water mist systems. We plan to
conduct R&D to develop infrared flame detectors and industrial fire
protection monitoring and control systems in the future. Our R&D activities
also involve further developing and improving our core manufacturing
technologies so that we can expand our product lines and reduce overall costs.
We have entered into joint research and development agreements with some
universities whereby we have exclusive ownership to any technology developed.
These efforts have led to the successful development of numerous peripheral
products for our fire safety systems. For example, we have enhanced
our network based fire protection system monitoring software through a joint
development program between the Company and Wuhan Iron and Steel University. In
2008, we established a Fire Safety Research Center with Wuhan Technology
University.
To
enhance our R&D capabilities, we completed the construction of a new R&D
center in 2006, consisting of a 1,800 square meter building with new R&D
equipment. The total spending for the construction and equipment was
approximately $1 million. The center is devoted to our research and development
efforts and for the development of integrated manufacturing practice and
processes. The center is a base for training research and technical personnel
and for developing additional proprietary technologies.
Our
Marketing Efforts
Currently,
we have established our position as the leading Chinese supplier of fire safety
products and services in the iron and steel, power, and petrochemical
industries. We have installed 70% of the large systems in the steel industry.
Our business plan is to maintain our leadership and expand our market share in
the iron and steel, power and petrochemical markets, while targeting several new
market segments which we believe offer expansionopportunities for us,
including transportation (highways, subways and railways) and nuclear power
generation. We also have installed fire safety systems for the warehouses of
distilleries and cigarette factories.
Our
marketing efforts have made us one of the leading suppliers of fire safety
products and services in China. All of our products and services are marketed
and sold through government agencies which are responsible for certain
industries and the research and design institutes under those agencies which
design and plan new manufacturing facilities in several industries.
Under Chinese laws and regulations, a company which plans to install
fire safety systems must apply to the relevant government agency for the
approval of the project. Due to our relationship with these agencies, we are
able to receive information about projects under consideration in
advance and prepare for the bidding accordingly. Our relationship with the
research and design institutes under those agencies better position us for
receiving subcontract assignments for fire safety systems when they design a new
plant or facility. We also market and sell our products and services directly to
manufacturers in local markets. Our primary method
of promoting our products is direct marketing supplemented with
indirect marketing. Almost all of our contracts are procured through an open
bidding or invitation only bidding process. Contracts secured without
bidding usually provides us with higher margins.
Our
linear heat detectors and water/mist extinguishers have received the UL
certification. We have entered into an agreement with Xi’an System Sensor
Electronics Co., Ltd., a China subsidiary of Honeywell, for OEM manufacturing of
linear heat detectors for Honeywell. We have also signed an OEM agreement with a
multinational company under confidential terms.
We are
actively expanding our marketing network into other parts of China. We have
established sales offices and liaison offices in more than 20 locations. Mainly
through internal growth, we project an increase in the number of sales and
liaison offices.
Our sales
team has approximately 101 members. To expand distribution channels and increase
our market share, we regularly attend industrial exhibitions organized by local
and national industrial associations. We run advertisements in major industry
journals, magazines and catalogues. We also run advertisements on industry
websites including www.china-fire.com
and www.fire.hc360.com .
Material
and Parts Supply
We only
manufacture products that provide high margins while subcontracting those
products with low margins. Given the importance to our business of key materials
and parts, the purchasing and management of these important functions are top
priorities to us. We carefully manage our purchasing efforts and have
established company policies involving materials and parts procurement. The cost
of materials for our own products is approximately 80-90% of the total
production cost.
Supplier
Management System
We have
adopted measures to reduce risks in materials and parts supply, including 1)
obtaining better services and higher quality, 2) diversifying suppliers and
supply sources, and 3) seeking long-term contracts with
suppliers.
Purchasing
Procedures
Our
production department collaborates with our quality and procurement department
to produce a list of qualified suppliers that is based on quality, price,
technical competency and capacity. Purchasing transactions are sometimes
conducted in accordance with a procedure for bidding invitations. Potential
suppliers are evaluated on their proposed terms, technical specifications,
price, payment terms and timing for delivery. After validation of the various
suppliers’ service stable supply capabilities, we acquire the needed materials
and parts from the supplier offering the best terms. Our procurement department
establishes an oversight process by appointing individuals to conduct periodic
market research of key price points. There is a standard procedure for
conducting said bidding process and accepting the bids to insure that the all
purchasing procedures are being strictly adhered to. We enter into long-term
contracts with certain suppliers to lock in prices and send purchase orders for
each delivery when necessary.
Major
Suppliers
The
tables below list our top five suppliers as of December 31,
2008
Major
Suppliers of Materials and Parts for Our Own Products
Item
|
Suppliers
|
|
Amount
Purchased
in 2007
($1,000)
|
|
|
Percentage
of Total
Purchase for
Our Own
Products
|
|
Stainless
steel pipe and brass bar
|
Beijing
Kehai Wanda Company
|
|
|
584
|
|
|
|
12.45
|
%
|
Accessories
|
Sanhe
Hangjian Machining Plant
|
|
|
388
|
|
|
|
8.27
|
%
|
Cabinets
|
Hebei
Qingxian Fangzheng
|
|
|
369
|
|
|
|
7.87
|
%
|
Sprinkling
Valve
|
Beijing
Jinxinglin Metal Material Company
|
|
|
298
|
|
|
|
6.35
|
%
|
Circuit
board and electronic components
|
Beijing
Tianlike Commercial Ltd.
|
|
|
292
|
|
|
|
6.22
|
%
|
Total
|
|
|
|
|
|
|
|
41.16
|
%
|
Major
Suppliers for Third Party Products of Our Fire Safety Systems
Item
|
Suppliers
|
|
Amount
Purchased
in 2007
($1,000)
|
|
|
Percentage
of Total
Purchase
for Third Party
Products
|
|
Stainless
steel pipes
|
Beijing
guangyuan longfa Company
|
|
|
1,068
|
|
|
|
10.55
|
%
|
Fire
safety pump
|
Shanghai
Pudong Tezhong Fire Safety Company
|
|
|
801
|
|
|
|
7.92
|
%
|
Electronic
components
|
Honeywell
Shanghai Company
|
|
|
686
|
|
|
|
6.78
|
%
|
Fire
detecting devices
|
Xian
System Sensor Electronics
|
|
|
468
|
|
|
|
4.63
|
%
|
Fire
detecting devices
|
Haiwan
Safety Company
|
|
|
438
|
|
|
|
4.32
|
%
|
Total
|
|
|
|
|
|
|
|
34.2
|
%
|
Our
Competition
The fire
safety market in China is intensively competitive and includes thousands of
companies in China. We compete primarily in providing total fire safety
solutions including engineering and installations to end customers. We also
compete in the market for providing fire safety products.
The
market for the design and installation of fire safety systems includes numerous
small and mostly regional competitors. Consequently, we believe that
our leading position in the industry has enabled us to win a high percentage of
our bids (e.g., around 60-70% of bids in the iron and steel industry). We
compete on design, technology, track record, price, quality of products,
expertise and capability to complete the job in time. We believe that the fact
that we use our own products also adds to our competitive
positioning. While these factors play a less significant role in
bidding for smaller jobs, we have twice been recognized as the industry leader
by the China Association of Fire Prevention based on numerous significant
factors including total revenue and profit. As an aside, due to their
disadvantage in labor costs and the requirement of Chinese certificates, foreign
competitors normally do not engage in system integration.
We
compete with both foreign competitors and local manufacturers for our products.
Foreign-made products have historically had an advantage over Chinese-made
products because of superior technology and quality. We believe that the demand
for foreign products has begun to decline because of improvements in Chinese
technology and as the technology and quality gaps narrow, the price advantage
that Chinese-made products typically have has increased demand for Chinese-made
products. We have developed numerous patented products with technological lead
over our competitors Our China-based competitors tend to focus on low-end and
technologically less sophisticated products that have lower quality and are not
suitable for large projects. Most of the China-based companies have lower
operating expenses and often compete with lower pricing.
Although
currently successfully in providing total fire safety solutions to our
customers, there is no assurance that we will continue to be able to do so in
the future. We have been successful in the iron and steel, power and
petrochemical industries. But as we move into new industrial sectors, our lack
of proprietary products that may be required by those industries may limit our
market acceptance.
Our
Employees
As of
December 31, 2008, we employed 625 full-time employees. Approximately 14% of our
employees are management personnel, 5% are R&D staff members and 16% are
sales staff members. Approximately 54% of our employees have college degrees or
higher.
Under
Chinese law, our employees have formed labor unions that protect employees’
rights, aim to assist in the fulfillment of our economic objectives, encourage
employee participation in management decisions and assist in mediating
disputes. We believe that we maintain a satisfactory working
relationship with our employees and have not experienced any significant labor
disputes or any difficulty in recruiting staff for our operations.
As
required by applicable Chinese law, we have entered into employment
contracts with all of our employees. We have also entered into confidentiality
agreements with all of our employees under which our employees are prohibited
from disclosing confidential information of the Company or using it for purposes
other than the benefit of the Company. Directors, officers, mid-level managers
and certain key employees in sales and R&D are required to sign a
non-compete agreement that prohibits them from competing with the Company while
they are employees of the Company and within two years after their employment
with the Company is terminated.
Our
employees in China participate in a state
pension arrangement organized by Chinese municipal and provincial
governments. We are required to contribute to this arrangement at the
rate of 20% of the average monthly salary. In addition, we are required by
Chinese law to cover employees in China with other types of social insurances.
Our total contribution may amount to 30% of the average monthly salary. We have
purchased social insurances for all of our employees. In the event that any
current employee, or former employee, files a complaint with the Chinese
government, we may be required to purchase insurance for said employee, and we
may be subject to administrative fines. We believe that such fines, if imposed,
are immaterial.
Item
1A. Risk Factors
Cautionary
Statement Regarding Future Results, Forward-Looking Information And Certain
Important Factors
In this
report we make, and from time to time we will otherwise make, written and oral
statements regarding our business and its prospects, such as projections of
future performance, statements of management’s plans and objectives, forecasts
of market trends, and other matters that are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. Statements containing
the words or phrases “will likely result,” “are expected to,” “will continue,”
“is anticipated,” “estimates,” “projects,” “believes,” “expects,” “anticipates,”
“intends,” “target,” “goal,” “plans,” “objective,” “should” or similar
expressions identify forward-looking statements, which may appear in documents,
reports, filings with the Securities and Exchange Commission, news releases,
written or oral presentations made by officers or other representatives made by
us to analysts, stockholders, investors, news organizations and others, and
discussions with management and other of our representatives. For such
statements, we claim the protection of the safe harbor for forward-looking
statements contained in the Private Securities Litigation Reform Act of
1995.
Our
future results, including results related to forward-looking statements, involve
a number of risks and uncertainties. No assurance can be given that the results
reflected in any forward-looking statements will be achieved. Any
forward-looking statement speaks only as of the date on which such statement is
made. Our forward-looking statements are based upon assumptions that are
sometimes based upon estimates, data, communications and other information from
suppliers, government agencies and other sources that may be subject to
revision. Except as required by law, we do not undertake any obligation to
update or keep current either (i) any forward-looking statement to reflect
events or circumstances arising after the date of such statement, or
(ii) the important factors that could cause our future results to differ
materially from historical results or trends, results anticipated or planned by
us, or which are reflected from time to time in any forward-looking
statement.
In
addition to other matters identified or described by us from time to time in
filings with the SEC, there are several important factors that could cause our
future results to differ materially from historical results or trends, results
anticipated or planned by us, or results that are reflected from time to time in
any forward-looking statement. Some of these important factors include the risk
factors below.
An
investment in our common stock is speculative and involves a high degree of
risk. You should carefully consider the risks described below and the other
information in this Form 10-K before purchasing any of our common stock. If any
of the events described in the risk factors below actually occur, our business,
financial condition or results of operations could suffer significantly. In such
case, the value of your investment could decline and you may lose all or part of
the money you paid to buy our common stock.
Risks
Related To Our Business
Disruptions in the capital and credit
markets related to the current national and worldwide financial crisis, which
may continue indefinitely or intensify, could adversely affect our results of
operations, cash flows and financial condition, or those of our customers and
suppliers.
The
current disruptions in the capital and credit markets may continue indefinitely
or intensify, and adversely impact our results of operations, cash flows and
financial condition, or those of our customers and suppliers. These disruptions
could adversely affect our ability to draw on our bank revolving credit
facility, which is dependent on the ability of the banks that are parties to the
facility to meet their funding commitments. Those banks may not be able to meet
their funding commitments to us if they experience shortages of capital and
liquidity. Disruptions in the capital and credit markets as a result of
uncertainty, changing or increased regulation, reduced alternatives or failures
of significant financial institutions could adversely affect our access to
liquidity needed to conduct or expand our businesses or conduct acquisitions or
make other discretionary investments, as well as our ability to effectively
hedge our currency or interest rate. Such disruptions may also adversely impact
the capital needs of our customers and suppliers, which, in turn, could
adversely affect our results of operations, cash flows and financial
condition.
Our products and
services have relied on a few industries. We may not be able to increase the
market for our products and services in other industries. Presently, our
products and services are mainly sold to the iron and steel, power and
petrochemical industries. Our products and services, therefore, depend heavily
on a limited number of industries. Our growth potential may be limited if we
cannot expand the market for our products and services. Although we have
increased our research and development to expand the range of application of our
products and services, there is no assurance that we will succeed in our
effort.
Price increases
of raw materials such as copper and steel could increase the cost of our
products and reduce our profit margin. Copper is the major material for
our linear heat detectors and stainless steel is the major material for our fire
extinguishing nozzles. In the last two years, the prices of copper and steel
have fluctuated substantially as have other raw materials. Although we have
managed to minimize the impact of such fluctuation in the past by passing the
cost increase on to our customers, there is no assurance that we will be able to
do so in the future. If the price for copper and steel increases more
significantly and we cannot increase our selling price, our profit
margin could decrease significantly.
We may not be
able to secure financing needed for future operating needs on acceptable terms,
or on any terms at all. From time to time, we may seek additional
financing to provide the capital required to maintain or expand our design and
production facilities, research and development initiatives and equipment and/or
working capital, as well as repay outstanding loans if cash flow from operations
is insufficient to do so. We cannot predict with certainty the timing or amount
of any such capital requirements. If such financing is not available on
satisfactory terms, we may be unable to expand our business or to develop new
business as the rate desired, and our operating results may suffer. If we are
able to incur debt, we may be subject to certain restrictions imposed by the
terms of the debt and the repayment of such debt may limit our cash flow and our
ability to grow. If we are unable to incur debt, we may be forced to issue
additional equity, which could have a dilutive effect of the then current
holders of equity.
Our strategic
alliances may not achieve their objectives. Currently, we have agreements
with two multinational companies to supply our linear heat detectors. We are
negotiating with another company to enter into a similar agreement. The
strategic alliances are intended to enhance or complement our technology or work
in conjunction with our technology, increase our manufacturing capacity, provide
additional components or materials, and develop, introduce and distribute
products using our technology and know-how. If these alliances do not achieve
their objectives or parties to our strategic alliances do not perform as
contemplated, our growth may be adversely affected.
Expansion of our
business may put added pressure on our management and operational infrastructure
impeding our ability to meet any increased demand for our products and services
and possibly hurting our operating results. Our business plan is to
significantly grow our operations to meet anticipated growth in demand for our
products and services products. Our planned growth includes the increase of our
line of products and expansion of sales in our exiting markets as well as entry
into new markets over the next few years. Growth in our business may place a
significant strain on our personnel, management, financial systems and other
resources. The evolution of our business also presents numerous risks and
challenges, including:
|
·
|
the continued acceptance of our
products and services by the iron and steel, power and petrochemical
industries;
|
|
·
|
our ability to successfully and
rapidly expand sales to potential customers in response to potentially
increasing demand;
|
|
·
|
the costs associated with such
growth, which are difficult to quantify, but could be
significant;
|
|
·
|
rapid technological change;
and
|
|
·
|
the highly competitive nature of
the industrial fire safety
industry.
|
If we are
successful in obtaining rapid market growth of our products and service, we will
be required to deliver large volumes of quality products and services to
customers on a timely basis at a reasonable cost. Meeting any such increased
demands will require us to expand our manufacturing facilities, to increase our
ability to purchase raw materials, to increase the size of our work force, to
expand our quality control capabilities and to increase the scale upon which we
provide our products and services. Such demands would require more capital and
working capital than we currently have available and we may be unable to meet
the needs of our customers.
Our business
depends on our ability to protect our intellectual property effectively. If any
of our patents are not protected, or any of our trade secrets are divulged, we
may lose our competitive edge. The success of our business depends in
substantial measure on the legal protection of the patents and other proprietary
rights in the technology we hold. We hold issued patents and pending patent
applications in China related to technologies important to our business.
Monitoring infringement of intellectual property rights is difficult, and we
cannot be certain that the steps we have taken will prevent unauthorized use of
our intellectual property and know-how in China where, in comparison to the
Untied States, the laws may be difficult to enforce to fully protect our
proprietary rights. The validity and breadth of claims in patents and trade
secrets involve complex legal and factual questions and, therefore, the extent
of their enforceability and protection is highly uncertain. Issued patents or
patents based on pending patent applications or any future patent applications
or trade secrets may not exclude competitors or may not provide a competitive
advantage to us. In addition, patents issued or licensed to us may not be held
valid if subsequently challenged and others may claim rights in or ownership of
such patents. Furthermore, we cannot assure you that our competitors have not
developed or will not develop similar products, will not duplicate our products,
or will not design around any patents issued to or licensed by us.
We claim
proprietary rights in various unpatented technologies, know-how, trade secrets
and trademarks relating to products and manufacturing processes. We protect our
proprietary rights in our products and operations through contractual
obligations, including nondisclosure agreements. If these contractual measures
fail to protect our proprietary rights, any advantage those proprietary rights
provided to us would be negated. Some of our products are based on formulas. The
formulas are maintained as trade secrets and are revealed only to a small number
of technical and management personnel. The trade secrets provide us a
competitive edge in the linear heat technology and to the best of our knowledge,
no other manufacturers have successfully developed such technology. If any of
the trade secrets are divulged, we could lose our competitive edge in the linear
heat technology and others.
We receive a
significant portion of our revenues from a small number of customers. Our
business will be harmed if our customers reduce their orders from us. A
significant amount of our revenues are derived from only a small number of
customers mainly in the iron and steel, power and petrochemical industries. One
customer individually accounted for more than 20% of our revenues for the fiscal
year ended December 31, 2008 in the aggregate, our five largest customers of our
total solutions and products businesses accounted for approximately 49% and 59% of our
revenues from these segments in fiscal 2008. Dependence on a few customers could
make it difficult to negotiate attractive prices for our products and could
expose us to the risk of substantial losses if a single dominant customer stops
purchasing our products. If we lose any customers and are unable to replace them
with other customers that purchase a similar amount of our products and
services, our revenues and net income would decline considerably.
We extend
relatively long payment terms for accounts receivable. If any of our
customers fails to pay us, our revenues may be affected as a result. Our
standard practice is to charge our customers 10%-30% of the contract amount up
front and collect the balance according to a schedule based on the progress of a
project. However, many of our customers are state-owned enterprises and may be
slow in their payment process. As a result of the size of many of our contracts,
their delayed payments adversely affect our cash flow and our ability to fund
our operations out of our operating cash flow. In addition, although we attempt
to establish appropriate reserves for our receivables, those reserves may not
prove to be adequate in view of actual levels of bad debts. The failure of our
customers to pay us in a timely manner could negatively affect our working
capital, which could, in turn, adversely affect our cash flow. Although, on
occasion payments have been delayed, no customer has failed to pay us however,
there is no assurance that they will be able to pay in the
future.
Our business may
be severely disrupted if we lose the services of our key executives and
employees or fail to add new senior and middle managers to our
management. Our future success is heavily dependent upon the continued
service of our key executives, particularly Mr. Brian Lin, our Chief Executive
Officer, Mr. Weishe Zhang, our Chief Technology Officer, Mr. Robert Yuan, our
Principal Accounting Officer, Mr. Weigang Li, our Vice President of Sales and
Mr. Haijun Yang, our Vice President of Operations. Our future success is also
dependent upon our ability to attract and retain qualified senior and middle
managers to our management team. If one or more of our current or future key
executives and employees are unable or unwilling to continue in their present
positions, we may not be able to easily replace them, and our business may be
severely disrupted. In addition, if any of these key executives or employees
joins a competitor or forms a competing company, we could lose customers and
suppliers and incur additional expenses to recruit and train personnel. Each of
our executive officers has entered into an employment agreement with us. We also
rely on a number of key technology staff for the operation of our Company. Given
the competitive nature of our industry, the risk of key technology staff leaving
our Company is high and could disrupt our operations.
Risks
Related To Our Industry
Our market will
open to foreign companies. China’s commitments under the WTO (World Trade
Organization) may intensify competition. In connection with its accession
to the WTO, China made many commitments including opening its markets to foreign
products and services, allowing foreign companies to conduct distribution
businesses and reducing customs duties. As a result, foreign manufacturers may
ship more industrial fire safety products into China or they may establish
manufacturing facilities and service centers in China. Competition from foreign
companies may squeeze our profit margins and our business results will suffer as
a result.
The fire
protection total solution market is fragmented and susceptible to consolidation,
which could adversely affect us. We engage in providing fire protection
total solutions that consist of the design and installation of fire
safety systems. The market is fragmented in the sense that there are many,
typically small, suppliers. The market may be subject to consolidation and, if
so, we may not be a major player. If so, our fire protection
total solution business could suffer and this business is a major source
of sales of our own products and profitability.
Our customers
will decrease their capital expenditure if China’s economy slows down. Such a
slowdown may affect our growth. Our industry is cyclical in nature and
highly dependent on economic conditions. Over the last three decades, China’s
economy has been growing at an average annual rate of 9-10%. There can be no
assurance that China’s economy will continue to grow at such pace in the future.
If the economy slows down, our customers will cut their capital expenditure and,
hence, order less of our products and services. Our growth may suffer as a
result.
High margins for
the industrial fire safety business will attract more businesses to enter this
field. Our business could suffer as a result of more competition. So far,
our business has enjoyed relatively high profit margins due to the fact that we
have concentrated in industrial fire safety. Such high margins will attract more
businesses to enter into this field. As a result, competition may intensify and
our profits may drop significantly.
If we cannot
compete successfully for market share against other industrial fire safety
products companies, we may not achieve sufficient product revenues, and our
business will suffer. The market for our products and services is
characterized by intense competition and rapid technological advances. Our
products and services compete with a multitude of products and services
developed, manufactured and marketed by others and we expect competition from
new market entrants in the future, including as a result of the WTO. Existing or
future competing products may provide better quality and technology, greater
utility or lower cost or other benefits from their intended uses than our
products, or may offer comparable performance at a lower cost. If our products
fail to capture and maintain market share, we may not achieve sufficient product
revenues, and our business could suffer.
Gross margins
could be lower in new industrial sectors. We enjoy relatively high
margins in our main markets including iron and steel, power generation and
petrochemical. As we start bidding for projects in new industrial sectors
including subways, highway tunnels, and nuclear plants, we might not be able to
sell our products at the gross margins that we enjoy in our main markets. Our
overall gross margin could be adversely affected.
Risks
Related To Doing Business in China
Changes in
China’s political or economic situation could harm us and our operational
results. Economic reforms adopted by the Chinese government have had a
positive effect on the economic development of the country, but the government
could change these economic reforms or any of the legal systems at any time.
This could either benefit or damage our operations and profitability. Some of
the things that could have this effect are:
|
·
|
level of government involvement
in the economy;
|
|
·
|
control of foreign
exchange;
|
|
·
|
methods of allocating
resources;
|
|
·
|
balance of payments
position;
|
|
·
|
international trade
restrictions;
|
|
·
|
international conflict;
and
|
The
Chinese economy differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development, or OECD, in many ways.
The economic reforms in China have been conducted under a tight grip of the
Chinese government. As a result of these differences, we may not develop in the
same way or at the same rate as might be expected if the Chinese economy were
similar to those of the OECD member countries.
Our business is
largely subject to the uncertain legal environment in China and your legal
protection could be limited. The Chinese legal system is a civil law
system based on written statutes. Unlike common law systems, it is a system in
which precedents set in earlier legal cases are not generally used. The overall
effect of legislation enacted over the past 20 years has been to enhance the
protections afforded to foreign invested enterprises in China. However, these
laws, regulations and legal requirements are relatively recent and are evolving
rapidly, and their interpretation and enforcement involve uncertainties. These
uncertainties could limit the legal protections available to foreign
shareholders, such as the right of foreign invested enterprises to hold licenses
and permits such as requisite business licenses. In addition, all of our
executive officers and our directors are residents of China and not of the U.S.,
and substantially all the assets of these persons are located outside the U.S.
As a result, it could be difficult for shareholders to effect service of process
in the U.S., or to enforce a judgment obtained in the U.S. against us or any of
these persons.
The Chinese
government exerts substantial influence over the manner in which we must conduct
our business activities. China has only recently permitted provincial and
local economic autonomy and private economic activities. The Chinese government
has exercised and continues to exercise substantial control over virtually every
sector of the Chinese economy through regulation and state ownership. Our
ability to operate in China may be harmed by changes in its laws and
regulations, including those relating to taxation, import and export tariffs,
environmental regulations, land use rights, property and other matters. We
believe that our operations in China are in material compliance with all
applicable legal and regulatory requirements. However, the central or local
governments of these jurisdictions may impose new, stricter regulations or
interpretations of existing regulations that would require additional
expenditures and efforts on our part to ensure our compliance with such
regulations or interpretations. Accordingly, government actions in the future,
including any decision not to continue to support recent economic reforms and to
return to a more centrally planned economy or regional or local variations in
the implementation of economic policies, could have a significant effect on
economic conditions in China or particular regions thereof, and could require us
to divest ourselves of any interest we then hold in Chinese
properties.
Future inflation
in China may inhibit our activity to conduct business in China. In recent
years, the Chinese economy has experienced periods of rapid expansion and high
rates of inflation. During the past ten years, the rate of inflation in China
has been as high as 20.7% and as low as -2.2%. These factors have led to the
adoption by the Chinese government, from time to time, of various corrective
measures designed to restrict the availability of credit or regulate growth and
contain inflation. While inflation has been more moderate since 1995, high
inflation may in the future cause the Chinese government to impose controls on
credit and/or prices, or to take other action, which could inhibit economic
activity in China, and thereby harm the market for our products.
Restrictions on
currency exchange may limit our ability to receive and use our revenues
effectively. The majority of our revenues will be settled in Renminbi
and, any future restrictions on currency exchanges may limit our ability to use
revenue generated in Renminbi to fund any future business activities outside
China or to make dividend or other payments in U.S. dollars. Although the
Chinese government introduced regulations in 1996 to allow greater
convertibility of the Renminbi for current account transactions, significant
restrictions still remain, including primarily the restriction that
foreign-invested enterprises may only buy, sell or remit foreign currencies
after providing valid commercial documents, at those banks in China authorized
to conduct foreign exchange business. In addition, conversion of Renminbi for
capital account items, including direct investment and loans, is subject to
governmental approval in China, and companies are required to open and maintain
separate foreign exchange accounts for capital account items. We cannot be
certain that the Chinese regulatory authorities will not impose more stringent
restrictions on the convertibility of the Renminbi.
Cessation of the
income tax reduction and exemption for our subsidiaries may have an adverse
impact on our net profits. From January 1, 2008, under Chinese new income
tax law, a company would ordinarily be subject to the PRC income tax rates of
25%. However, the law also provides tax exemption or reduction for high-tech
businesses and foreign invested enterprises (“FIE”). As a result, some of our
subsidiaries are currently enjoying a tax reduction of and/or exemption from
state and local income tax. For details, please see the income taxes section of
“Management Discussion and Analysis.” If the Chinese
government decides to change the tax law, our revenues and profit
could suffer.
A new Chinese law
may impact our ability to make acquisitions of Chinese businesses. On
August 8, 2006, six PRC regulatory agencies namely, the PRC Ministry of
Commerce, the State Assets Supervision and Administration Commission (“SASAC”),
the State Administration for Taxation, the State Administration for Industry and
Commerce, the China Securities Regulatory Commission (“CSRC”), and the State
Administration of Foreign Exchange (“SAFE”), jointly adopted the Regulations on
Mergers and Acquisitions of Domestic Enterprises by Foreign Investors (the “New
M&A Rule”), which became effective on September 8, 2006. The New
M&A Rule purports, among other things, to require offshore Special Purpose
Ventures, or SPVs, formed after the effective date, for overseas listing
purposes, through acquisitions of PRC domestic companies and controlled by PRC
companies or individuals, to obtain the approval of the CSRC prior to publicly
listing their securities on an overseas stock exchange.
The
Company intends to make acquisitions of Chinese businesses in the future. There
are uncertainties regarding the interpretation and application of the current or
future PRC laws and regulations, including the New M&A Rule and these
uncertainties could make it difficult or impossible to make acquisitions of
Chinese businesses in the future.
Foreign
Investment Policy Change. On March 16, 2007, China's parliament, the
National People's Congress, adopted the Enterprise Income Tax Law, which took
effect on January 1, 2008. The new income tax law sets unified income tax rates
for domestic and foreign companies at 25 percent and abolishes the favorable
policy for foreign invested enterprises. After January 1, 2008, newly
established foreign invested enterprises will not enjoy favorable tax treatment
permitted under prior tax laws. Some of our subsidiaries are benefiting from the
preferred tax rates for foreign companies and will follow the new tax rate when
their respective term of preferred tax rates expires. Our net income margin will
be affected at that time.
If the government
changes its policies on the value added tax rebate, our revenues and profit
could be adversely affected. Under Chinese tax law, businesses should pay
a value added tax at a 17% rate. To support the development of the software
industry, the Chinese government has instituted policies to rebate value added
tax charged for software certified by the government up to 14%. As a result, our
subsidiary Hua An Limited, is paying its value added tax at an effective rate of
3% for the software they sell. However, the Chinese government changes its
policies from time to time. If the Chinese government changes the policies
currently in place for the value added tax rebate, our revenues and our profit
could suffer.
The value of our
securities will be affected by the foreign exchange rate between U.S. dollars
and Renminbi. The value of our Common Stock will be affected by the
foreign exchange rate between U.S. dollars and Renminbi, and between those
currencies and other currencies in which our sales may be denominated. For
example, to the extent that we need to convert U.S. dollars into Renminbi for
our operational needs and should the Renminbi appreciate against the U.S. dollar
at that time, our financial position, the business of the company, and the price
of our Common Stock may be harmed. Conversely, if we decide to convert our
Renminbi into U.S. dollars for the purpose of declaring dividends on our Common
Stock or for other business purposes and the U.S. dollar appreciates against the
Renminbi, the U.S. dollar equivalent of our earnings from our subsidiaries in
China would be reduced.
Risks
Related to the Market for Our Stock
You may face
difficulties in protecting your interests, and your ability to protect your
rights through the U.S. federal courts may be limited, our operating
subsidiaries are incorporated in non-U.S. jurisdictions, we conduct
substantially all of our operations in China, and all of our officers reside
outside the United States. We conduct substantially all of our operations
in China through our wholly owned subsidiaries in China. All of our officers
reside outside the United States and some or all of the assets of those persons
are located outside of the United States. As a result, it may be difficult or
impossible for you to bring an action against us or against these individuals in
China in the event that you believe that your rights have been infringed upon
under the securities laws or otherwise. Even if you are successful in bringing
an action of this kind, the laws of the PRC may render you unable to enforce a
judgment against our assets or the assets of our directors and officers. As a
result of all of the above, our public stockholders may have more difficulty in
protecting their interests through actions against our management, directors or
major stockholders than would stockholders of a corporation doing business
entirely within the United States.
The trading
prices of many companies that have business operations only in China have been
volatile which may result in large fluctuations in the price of our Common Stock
and losses for shareholders. The stock market has experienced significant
price and volume fluctuations that have particularly affected the trading prices
of equity securities of many companies that have business operations only in
China. These fluctuations have often been unrelated or disproportionate to the
operating performance of many of these companies. Any negative change in the
public’s perception of these companies could depress our stock price regardless
of our operating results. The market price of our Common Stock has been and may
continue to be volatile. We expect our stock price to be subject to fluctuations
as a result of a variety of factors, including factors beyond our control. These
factors include:
|
·
|
actual or anticipated variations
in our quarterly operating
results;
|
|
·
|
announcements of technological
innovations or new products or services by us or our
competitors;
|
|
·
|
announcements relating to
strategic relationships or
acquisitions;
|
|
·
|
additions or terminations of
coverage of our Common Stock by securities
analysts;
|
|
·
|
statements by securities analysts
regarding us or our
industry;
|
|
·
|
conditions or trends in the
our industry; and,
|
|
·
|
changes in the economic
performance and/or market valuations of other industrial fire safety
companies.
|
The
prices at which our Common Stock trades will affect our ability to raise
capital, which may have an adverse affect on our ability to fund our
operations.
Our Common Stock
may be considered to be a “penny stock” and, as such, the market for our Common
Stock may be further limited by certain SEC rules applicable to penny
stocks. To the extent the price of our common stock remains below $5.00
per share, we have net tangible assets of $2,000,000 or less, or if we fall
below certain other thresholds, our common shares will be subject to certain
“penny stock” rules promulgated by the SEC. Those rules impose certain sales
practice requirements on brokers who sell penny stocks to persons other than
established customers and accredited investors (generally institutions with
assets in excess of $5,000,000 or individuals with net worth in excess of
$1,000,000). For transactions covered by the penny stock rules, the broker must
make a special suitability determination for the purchaser and receive the
purchaser’s written consent to the transaction prior to the sale. Furthermore,
the penny stock rules generally require, among other things, that brokers
engaged in secondary trading of penny stocks provide customers with written
disclosure documents, monthly statements of the market value of penny stocks,
disclosure of the bid and asked prices and disclosure of the compensation to the
brokerage firm and disclosure of the sales person working for the brokerage
firm. These rules and regulations adversely affect the ability of brokers to
sell our common shares and limit the liquidity of our securities.
We may seek to
make acquisitions that prove unsuccessful or strains or diverts our
resources. We may seek to expand our business through the acquisition of
related businesses and assets. We may not be able to complete any acquisitions
on favorable terms or at all. Acquisitions present risks that could materially
and adversely affect our business and financial performance,
including:
|
·
|
the diversion of our management’s
attention from our everyday business
activities;
|
|
·
|
the contingent and latent risks
associated with the past operations of, and other unanticipated problems
arising in, the acquired business;
and
|
|
·
|
the need to expand
management, administration, and operational
systems.
|
If we
make such acquisitions we cannot predict whether:
|
·
|
we will be able to successfully
integrate the operations and personnel of any new businesses into our
business;
|
|
·
|
we will realize any anticipated
benefits of completed acquisitions;
or
|
|
·
|
there will be substantial
unanticipated costs associated with acquisitions, including potential
costs associated with environmental liabilities undiscovered at the time
of acquisition.
|
In
addition, future acquisitions by us may result in:
|
·
|
Potentially dilutive issuances of
our equity securities;
|
|
·
|
the incurrence of additional
debt;
|
|
·
|
restructuring charges;
and
|
|
·
|
the
recognition of significant charges for depreciation and amortization
related to intangible assets.
|
We do not intend
to pay any dividends on our Common Stock in the foreseeable future. We
currently intend to retain all future earnings, if any, to finance our current
and proposed business activities and do not anticipate paying any cash dividends
on our Common Stock in the foreseeable future. We may also incur indebtedness in
the future that may prohibit or effectively restrict the payment of cash
dividends on our Common Stock.
We will incur
increased costs as a result of changes in laws and regulations relating to
corporate governance matters. As a public reporting company, we will need
to comply with the Sarbanes-Oxley Act of 2002 and the related rules and
regulations adopted by the SEC and by The NASDAQ Capital Market, including
expanded disclosures, accelerated reporting requirements and more complex
accounting rules. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002
and other requirements will increase our costs and require additional management
resources. Additionally, these laws and regulations could make it more difficult
or more costly for us to obtain certain types of insurance, including director
and officer liability insurance, and we may be forced to accept reduced policy
limits and coverage or incur substantially higher costs to obtain the same or
similar coverage. The impact of these events could also make it more difficult
for us to attract and retain qualified persons to serve on our board of
directors, our board committees or as executive officers. We are presently
evaluating and monitoring developments with respect to these laws and
regulations and cannot predict or estimate the amount or timing of additional
costs we may incur to respond to their requirements.
We do not have an
effective system of internal control over financial reporting, a failure which
might prevent us from accurately reporting our financial results or detecting
and preventing fraud. We were subject to reporting obligations under the
U.S. securities law. In this annual report for the fiscal year ending December
31, 2008, we are required to prepare a management report on our internal control
over financial reporting containing our management’s assessment of the
effectiveness of our internal control over financial reporting.
Our
management and our independent registered public accounting firms concluded that
there was material weakness in our internal control over financial reporting as
of December 31, 2008. The identified material weakness relate to the lack
of internal controls over project budgeting process, specifically relating to
the lack of project budgeting personnel and ineffective design of project
budgeting processes, and the lack of internal accounting staff with adequate US
GAAP knowledge. Management believes that until the remaining material
weakness are corrected, a potential misapplication of generally accepted
accounting principles or potential misstatements in our financial statements
could occur. Enhancing our internal controls to correct these deficiencies
has and will result in increased costs to us.
For the
fiscal year ending December 31, 2009, our management may continue to conclude
that our internal control over our financial reporting is not effective.
Moreover, even if our management concludes that our internal control over
financial reporting is effective, our independent registered public accounting
firm may still decline to attest to the effectiveness or may issue a report that
is adverse if it is not satisfied with our controls or the level at which our
controls are documented, designed, operated or reviewed, or if it interprets the
relevant requirements differently from us. Our reporting obligations as a public
company will place a significant strain on our management, operational and
financial resources and systems for the foreseeable future.
Certain
stockholders can exert control over the Company and may not make decisions that
further the best interests of all stockholders. Our officers, directors
and principal stockholders (greater than 5% stockholders) together will own an
aggregate of approximately 65% of our outstanding Common Stock on a fully
diluted basis. Consequently, these stockholders, if they act individually or
together, may exert a significant degree of influence over our management and
affairs and over matters requiring stockholder approval, including the election
of directors and approval of significant corporate transactions. In addition,
this concentration of ownership may delay or prevent a change of control of us
and might affect the market price of our Common Stock, even when a change of
control may be in the best interest of all stockholders. Furthermore, the
interests of this concentration of ownership may not always coincide with our
interests or the interests of other stockholders, and accordingly, they could
cause us to enter into transactions or agreements which we would not otherwise
consider.
Item
1B. Unresolved Staff Comments
There are
no unresolved comments from the SEC.
Item
2. Properties
All land
in China is owned by the State. Individuals and companies are permitted to
acquire rights to use land or land use rights for specific purposes. In the case
of land used for industrial purposes, the land use rights are granted for a
period of 50 years. This period may be renewed at the expiration of the initial
and any subsequent terms. Granted land use rights are transferable and may be
used as security for borrowings and other obligations.
We
currently own approximately 23,573 square meters of land in Beijing, consisting
of manufacturing facilities, employee quarters, warehouses, and office
buildings. We also own approximately 945 square meters office space in the
downtown of Beijing as our headquarters office. We currently lease from Tianjin
Fire Protection Equipment Company Ltd., which has land use rights of
approximately 112,432 square meters land in Tianjin, consisting of manufacturing
facilities, warehouses and office buildings. These constitute the basis of our
operations as a total fire protection solution provider.
Item
3. Legal Proceedings
In 2008,
we filed five lawsuits against four different companies for the infringement of
our intellectual properties. These five cases are still pending. We expect these
five cases will be settled in our favor.
In 2008,
we were sued by three different companies for the invalidation of our
intellectual properties. Two of these three cases were eventually settled in our
favor. The other case is still pending and we expect this case will be settled
in our favor as well.
Although
we cannot predict with certainty the result of the litigation matters, we
believe that the final outcome will not have a material adverse effect on our
business or results of operations.
Item
4. Submission Of Matters To A Vote Of Shareholders
On
October 20, 2008, China Fire’s 2008 Annual Meeting of Stockholders was held at
B-2508 TYG Center, C2 Dongsanhuanbeilu, Chaoyang District, Beijing 100027,
People’s Republic of China. The following seven
directors were elected to serve on the Board of Directors until the next annual
meeting of stockholders of the Company or until such person shall resign, be
removed or otherwise leave office:
Mr. Gangjin
Li, Mr. Brian Lin, Ms. Tieying Guo (resigned February 25, 2009), Mr. Guoyou
Zhang, Mr. Xuewen Xiao, Mr. Xianghua Li and Mr. Albert McLelland.
The
following table is the tally of votes:
Total
Outstanding Shares
|
|
|
27,586,593 |
|
|
|
|
|
|
|
Total
Shares Voted
|
|
|
27,586,593 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Director
Information
|
|
|
|
|
|
|
|
|
|
|
Director
Name
|
|
For
|
|
|
Against
|
|
|
Abstain
|
|
Gangjin Li
|
|
|
18,680,000 |
|
|
|
0 |
|
|
|
8,906,593 |
|
Brian Lin
|
|
|
18,680,000 |
|
|
|
0 |
|
|
|
8,906,593 |
|
Tieying Guo
|
|
|
18,680,000 |
|
|
|
0 |
|
|
|
8,906,593 |
|
Guoyou
Zhang
|
|
|
18,680,000 |
|
|
|
0 |
|
|
|
8,906,593 |
|
Xuewen
Xiao
|
|
|
18,680,000 |
|
|
|
0 |
|
|
|
8,906,593 |
|
Xiangwen
Li
|
|
|
18,680,000 |
|
|
|
0 |
|
|
|
8,906,593 |
|
Albert
Mclelland
|
|
|
18,680,000 |
|
|
|
0 |
|
|
|
8,906,593 |
|
PART
II
Item
5. Market For Registrant’s Common Equity, Related Shareholder Matters, And
Issuer Purchases Of Equity Securities
Market
Price Information
Our
common stock has been quoted on The NASDAQ Capital Market under the symbol
“CFSG” since July 16, 2007. The following table provides the high and low sales
prices for our common stock as reported for the periods indicated.
Year ending December 31,
2009
|
|
High
|
|
|
Low
|
|
First
Quarter (ended on March 13)
|
|
$
|
8.73
|
|
|
$
|
6.11
|
|
Year ending December 31,
2008
|
|
High
|
|
|
Low
|
|
First
Quarter
|
|
$
|
13.00
|
|
|
$
|
3.55
|
|
Second
Quarter
|
|
$
|
13.00
|
|
|
$
|
6.85
|
|
Third
Quarter
|
|
$
|
12.75
|
|
|
$
|
7.28
|
|
Fourth
Quarter
|
|
$
|
10.63
|
|
|
$
|
5.70
|
|
Year ending December 31,
2007
|
|
High
|
|
|
Low
|
|
First
Quarter
|
|
$
|
5.50
|
|
|
$
|
3.10
|
|
Second
Quarter
|
|
$
|
7.05
|
|
|
$
|
4.25
|
|
Third
Quarter
|
|
$
|
12.43
|
|
|
$
|
6.02
|
|
Fourth
Quarter
|
|
$
|
18.10
|
|
|
$
|
10.56
|
|
On March
13, 2009, the last reported sale price of our common stock on The NASDAQ Capital
Market was $7.98 per share.
Shareholders
As of
March 13, 2009, we had outstanding 27,586,593 shares of common stock, held
by approximately 1,500 stockholders of record and beneficially.
Dividend
Policy
To date,
we have neither declared nor paid any cash dividends on shares of our common
stock. We presently intend to retain earnings to finance the operation and
expansion of our business and do not anticipate declaring cash dividends in the
foreseeable future.
Repurchases
of Equity Securities
No
repurchases of our common stock were made in any month within the fourth quarter
of the fiscal year covered by this report.
Item
6. Selected Financial Data
You
should read the following selected consolidated financial data in conjunction
with “Management's Discussion and Analysis of Financial Condition and Results of
Operations,” the financial statements and related notes, and the other financial
information included in this report.
CONSOLIDATED STATEMENTS OF
INCOME
|
|
Years Ended December 31
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
Revenues
|
|
$
|
69,079,119
|
|
|
$
|
46,753,837
|
|
|
$
|
32,455,036
|
|
|
$
|
21,178,476
|
|
|
$
|
16,457,194
|
|
Cost
of revenues
|
|
|
29,581,246
|
|
|
|
21,090,854
|
|
|
|
16,226,307
|
|
|
|
8,642,234
|
|
|
|
7,181,115
|
|
Gross
profits
|
|
|
39,497,873
|
|
|
|
25,662,983
|
|
|
|
16,228,729
|
|
|
|
12,536,242
|
|
|
|
9,276,079
|
|
Operating
expenses
|
|
|
15,931,124
|
|
|
|
10,776,553
|
|
|
|
8,250,285
|
|
|
|
5,495,578
|
|
|
|
4,069,467
|
|
Income
from operations
|
|
|
23,566,749
|
|
|
|
14,886,430
|
|
|
|
7,978,444
|
|
|
|
7,040,664
|
|
|
|
5,206,612
|
|
Other
income (expenses)
|
|
|
1,184,526
|
|
|
|
1,920,287
|
|
|
|
-926,597
|
|
|
|
577,673
|
|
|
|
344,303
|
|
Income
before provision for income taxes
|
|
|
24,751,275
|
|
|
|
16,806,717
|
|
|
|
7,051,847
|
|
|
|
7,618,337
|
|
|
|
5,550,915
|
|
Provision
for income taxes
|
|
|
47,423
|
|
|
|
5,081
|
|
|
|
82,206
|
|
|
|
202,920
|
|
|
|
128,654
|
|
Net
income
|
|
|
24,703,852
|
|
|
|
16,801,636
|
|
|
|
6,969,641
|
|
|
|
7,272,134
|
|
|
|
5,219,468
|
|
Comprehensive
income
|
|
$
|
28,440,879
|
|
|
$
|
19,304,231
|
|
|
$
|
7,551,573
|
|
|
$
|
7,755,724
|
|
|
$
|
5,219,468
|
|
Weighted
average number of shares
|
|
|
27,568,214
|
|
|
|
26,873,742
|
|
|
|
24,340,196
|
|
|
|
24,000,000
|
|
|
|
-
|
|
Earnings
per share
|
|
$
|
0.90
|
|
|
$
|
0.63
|
|
|
$
|
0.29
|
|
|
$
|
0.30
|
|
|
|
-
|
|
Weighted
average number of shares Diluted
|
|
|
28,210,620
|
|
|
|
27,721,171
|
|
|
|
24,539,414
|
|
|
|
24,000,000
|
|
|
|
-
|
|
Earnings
per share Diluted
|
|
$
|
0.88
|
|
|
$
|
0.61
|
|
|
$
|
0.28
|
|
|
$
|
0.30
|
|
|
|
-
|
|
|
|
Years Ended December 31
|
|
CONSOLIDATED BALANCE SHEETS
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
26,655,333
|
|
|
$
|
17,110,449
|
|
|
$
|
9,426,091
|
|
|
$
|
2,357,399
|
|
|
$
|
5,626,498
|
|
Accounts
receivables
|
|
|
25,826,343
|
|
|
|
16,525,161
|
|
|
|
13,211,721
|
|
|
|
7,687,260
|
|
|
|
5,657,675
|
|
Receivables
from related party
|
|
|
466,223
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Inventories
|
|
|
6,538,938
|
|
|
|
4,048,283
|
|
|
|
4,190,830
|
|
|
|
2,410,020
|
|
|
|
1,179,684
|
|
Total
current assets
|
|
|
91,449,840
|
|
|
|
62,190,368
|
|
|
|
43,295,272
|
|
|
|
24,630,283
|
|
|
|
17,840,430
|
|
Plant
and equipment, net
|
|
|
8,445,254
|
|
|
|
6,568,250
|
|
|
|
3,529,808
|
|
|
|
3,615,374
|
|
|
|
3,560,188
|
|
Total
assets
|
|
|
105,408,918
|
|
|
|
71,646,427
|
|
|
|
48,308,828
|
|
|
|
28,844,363
|
|
|
|
21,952,652
|
|
Total
current liabilities
|
|
|
26,719,771
|
|
|
|
21,438,311
|
|
|
|
20,649,342
|
|
|
|
28,766,633
|
|
|
|
16,249,303
|
|
Total
shareholder's equity
|
|
$
|
78,689,147
|
|
|
$
|
50,208,116
|
|
|
$
|
24,978,675
|
|
|
$
|
-
|
|
|
$
|
5,636,276
|
|
Item
7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
General
The
following discussion and analysis provides information which the management of
China Fire & Security Group, Inc., (the "Company" or "CFSG") believes to be
relevant to an assessment and understanding of the Company's results of
operations and financial condition. This discussion should be read together with
the Company's financial statements and the notes to financial statements, which
are included in this report.
Overview
We are
engaged in the design, development, manufacturing and sale of fire protection
products and services for large industrial consumers in China. We have developed
a proprietary product line that addresses all aspects of industrial fire safety
from fire detection to fire system control and extinguishing. The Company is the
first company in China to utilize high technology for fire protection
and safety of its clients in the iron and steel companies, power
plants, petrochemical plants, as well as, special purpose construction in
China.
Reorganization
We were
organized as a Florida corporation on June 17, 2003.
On
September 1, 2006, we entered into a share exchange agreement, pursuant to which
we acquired all of the outstanding capital shares of China Fire Protection Group
Inc. in exchange for a controlling interest in our common shares. The
transaction was completed on Oct 27, 2006.
China
Fire Protection Group was organized on June 2, 2006 for the purpose of acquiring
all of the capital shares of Sureland Industrial Fire Safety Limited (Sureland
Industrial), a Chinese corporation, and, Sureland Industrial Fire Equipment Co.,
Ltd. (Sureland Equipment), a Chinese corporation, which collectively engage in
the design, development, manufacturing and sale of fire protection products and
services for large industrial consumers in China. As a result of the
transactions described above, both Sureland Industrial Fire Safety Limited and
Sureland Industrial Fire Equipment Co., Ltd became wholly-owned subsidiaries of
China Fire Protection Group Limited, and China Fire Protection Group Limited is
a wholly-owned subsidiary of Unipro.
On
February 9, 2007, Unipro changed its name to China Fire & Security Group,
Inc. (CFSG) and started trading on OTC Bulletin Board under its new ticker
symbol CFSG. On July 16, 2007, China Fire & Security Group, Inc. began
trading on Nasdaq Capital Market and retained the ticker symbol
CFSG.
CFSG
owns, through its wholly owned subsidiary China Fire Protection Group, Inc.,
Sureland Industrial and Sureland Equipment (jointly “Sureland”). Sureland is
engaged primarily in the design, development, manufacture and sale in China of a
variety of fire safety products for the industrial fire safety market and of
design and installation of industrial fire safety systems that utilizes its own
fire safety products. To a minor extent, it also provides maintenance services
for customers that use its industrial fire safety systems. Its business is
primarily in China, but it has recently begun contract manufacturing products
for the export market and it has begun to provide a fire safety system for a
Chinese company operating abroad.
Sureland
markets its industrial fire safety products and systems primarily to major
companies in the iron and steel, power and petrochemical industries in China. 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.
Sureland
has internal research and development facilities engaged primarily in furthering
fire safety technologies. It believes that its technologies allow it to offer
cost-effective and high-quality fire safety products and systems. It has
developed products for industrial fire detecting and extinguishing. It believes
that it is the only manufacturer in China which has successfully developed a
comprehensive line of linear heat detectors.
By
December 31, 2008, Sureland operated more than 20 sales and liaison offices in
China.
Sureland
has twice been ranked as the leading Chinese industrial fire safety company by
the China Association for Fire Prevention based on six major factors including
total revenue, growth rate, net profit, return on assets, investment in research
and development and intellectual property. Its key products include linear heat
detectors and water mist extinguishers, whose sales volumes are the largest in
China. Customers in over 20 provinces have utilized its products.
Critical
Accounting Policies and Estimates
While our
significant accounting policies are more fully described in Note 2 to our
consolidated financial statements appearing at the end of this report, we
believe that the following accounting policies are the most critical to aid you
in fully understanding and evaluating our reported financial
results.
Revenue
recognition
Revenue
is recognized when it is probable that the economic benefits will flow to the
Company as follows:
1.
|
Revenue from system contracting
projects are recognized using the percentage-of-completion method of
accounting and, therefore, take into account the costs, estimated earnings
and revenue to date on contracts not yet completed. Revenue recognized is
that percentage of the total contract price that cost expended to date
bears to anticipated final total cost, based on current estimates of costs
to complete. Contract costs include all direct material and labor costs
and those indirect costs related to contract performance, such as indirect
labor, supplies, tools, repairs, and depreciation costs. Selling, general,
and administrative costs are charged to expense as incurred. At the time a
loss on a contract becomes known, the entire amount of the estimated
ultimate loss is recognized in the consolidated financial statements.
Claims for additional contract costs are recognized upon a signed change
order from the customer 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 the
value-added tax (VAT). All of the Company’s products that are sold in the
PRC are subject to a Chinese value-added tax at a rate of 17 percent of
the gross sales price. This VAT may be offset by VAT paid by the Company
on raw materials and other materials included in the cost of producing
their finished product.
|
3.
|
Revenue from the rendering of
Maintenance Services is recognized when such services are
provided.
|
4.
|
Provision
is made for foreseeable losses as soon as they are anticipated by
management.
|
5.
|
Where contract costs incurred to
date plus recognized profits less recognized losses exceed progress
billings, the surplus is treated as an amount due from contract consumers.
Where progress billings exceed contract costs incurred to date plus
recognized profits less recognized losses, the surplus is treated as an
amount due to contract
customers.
|
Foreign currency
translation
The
reporting currency of the Company is the US dollar. The Company uses their local
currency, Renminbi (RMB), 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 engaged in 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
Plant and
equipment are stated at cost less accumulated depreciation. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets with a 5 percent residual value.
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
Comparison
of the Year Ended on December 31, 2008 and 2007:
|
|
For the Year Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Y/Y Change
|
|
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount ($)
|
|
|
%
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
|
57,101,984
|
|
|
|
82.7
|
%
|
|
|
34,581,376
|
|
|
|
74.0
|
%
|
|
|
22,520,608
|
|
|
|
65.1
|
%
|
Products
|
|
|
9,673,922
|
|
|
|
14.0
|
%
|
|
|
10,592,683
|
|
|
|
22.7
|
%
|
|
|
-918,761
|
|
|
|
-8.7
|
%
|
Maintenance
Services
|
|
|
2,303,213
|
|
|
|
3.3
|
%
|
|
|
1,579,778
|
|
|
|
3.4
|
%
|
|
|
723,435
|
|
|
|
45.8
|
%
|
Total
Revenue
|
|
|
69,079,119
|
|
|
|
100.0
|
%
|
|
|
46,753,837
|
|
|
|
100.0
|
%
|
|
|
22,325,282
|
|
|
|
47.8
|
%
|
Total
revenues were approximately $69.1 million for the year ended December 31, 2008
as compared to approximately $46.8 million for the year ended December 31, 2007,
an increase of approximately $22.3 million or 47.8 percent. This increase was
primarily due to the increase in our revenues from our total solution system
contracting projects and maintenance services, offset by the decrease in
revenues from product sales during the period. The Company recognized revenues
from 333 total solution, product sales and maintenance contracts for the year
ended December 31, 2008 as compared to 274 contracts for the year ended December
31, 2007.
Revenues
from our total solution system contracting projects increased by 65.1 percent to
$57.1 million derived from 177 contracts for the year ended December 31, 2008,
compared to $34.6 million derived from 130 contracts for the year ended December
31, 2007. This increase in the revenues from system contracting
projects was mainly attributable to the increase in the number of system
contracting projects we executed and the successful execution of large-size
projects like the Canfeidian Project of Capital Iron and Steel Group during the
period. Revenues from our product sales were $9.7 million with 115
contracts executed for the year ended December 31, 2008, compared to $10.6
million with 111 contracts executed for the year ended December 31, 2007.
The decrease in the revenues from product sales was mainly due to the
decrease in the average contract value of product sales contracts. The revenues
from maintenance service increased by 45.8 percent to $2.3 million derived from
43 contracts for the year ended December 31, 2008, compared to $1.6 million
derived from 39 contracts for the year ended December 31, 2007. The increase in
revenues from maintenance service was mainly attributable to the increase
in the number of maintenance service contracts that we executed as the result of
the expansion of our customer base during the period.
In
particular, the three largest customers were Capital Iron and Steel Group,
Anshan Iron and Steel Group and Datang Tashan Power Plant, which collectively
contributed approximately $23.2 million of revenues, representing 40.6 percent
of total revenues for the year ended December 31, 2008.
|
|
For the Year Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Y/Y Change
|
|
|
|
Amount ($)
|
|
|
% of
Revenue
|
|
|
Amount ($)
|
|
|
% of
Revenue
|
|
|
Amount ($)
|
|
|
%
|
|
Cost
of Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
|
25,805,086
|
|
|
|
45.2
|
%
|
|
|
16,158,844
|
|
|
|
46.7
|
%
|
|
|
9,646,242
|
|
|
|
59.7
|
%
|
Products
|
|
|
2,558,844
|
|
|
|
26.5
|
%
|
|
|
4,329,067
|
|
|
|
40.9
|
%
|
|
|
-1,770,223
|
|
|
|
-40.9
|
%
|
Maintenance
Services
|
|
|
1,217,316
|
|
|
|
52.9
|
%
|
|
|
602,943
|
|
|
|
38.2
|
%
|
|
|
614,373
|
|
|
|
101.9
|
%
|
Total
Cost of Revenues
|
|
|
29,581,246
|
|
|
|
42.8
|
%
|
|
|
21,090,854
|
|
|
|
45.1
|
%
|
|
|
8,490,392
|
|
|
|
40.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
|
31,296,898
|
|
|
|
54.8
|
%
|
|
|
18,422,532
|
|
|
|
53.3
|
%
|
|
|
12,874,366
|
|
|
|
69.9
|
%
|
Products
|
|
|
7,115,078
|
|
|
|
73.5
|
%
|
|
|
6,263,616
|
|
|
|
59.1
|
%
|
|
|
851,462
|
|
|
|
13.6
|
%
|
Maintenance
Services
|
|
|
1,085,897
|
|
|
|
47.1
|
%
|
|
|
976,835
|
|
|
|
61.8
|
%
|
|
|
109,062
|
|
|
|
11.2
|
%
|
Total
Gross Profit
|
|
|
39,497,873
|
|
|
|
57.2
|
%
|
|
|
25,662,983
|
|
|
|
54.9
|
%
|
|
|
13,834,890
|
|
|
|
53.9
|
%
|
Cost of
Revenues for the year ended December 31, 2008 was approximately $29.6 million,
as compared to $21.1 million for the year ended December 31, 2007, representing
an increase of approximately $8.5 million or 40.3%. Gross profit for the year
ended December 31, 2008 was approximately $39.5 million, as compared to $25.7
million for the year ended December 31, 2007, an increase of approximately $13.8
million or 53.9 percent. Gross margin for the year ended December 31, 2008 was
57.2 percent, which is higher than the gross margin of 54.9 percent for the year
ended December 31, 2007. The increase in our gross margin was mainly due to the
increase in the gross margin of our system contracting projects and product
sales during the period.
Gross
margin of our total solution system contracting projects was 54.8 percent for
the year ended December 31, 2008, compared to 53.3 percent for the year ended
December 31, 2007. This slight increase in the gross margin of system
contracting projects was due to the execution of total solution contacts that
contributed higher gross margins, offset by the increase in the cost of raw
materials during the period. The gross margin of product sales was 73.5 percent
for the year ended December 31, 2008, compared to 59.1 percent for the year
ended December 31, 2007. The increase in the gross margin of product sales was
mainly attributable to a higher percentage of our in-house manufactured
proprietary products sold in product sales contracts, which contributed higher
gross margins than our outsourced products manufactured by third
parties.
|
|
For the Year Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Y/Y Change
|
|
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount ($)
|
|
|
%
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
Expense
|
|
|
6,434,887
|
|
|
|
9.3
|
%
|
|
|
3,907,067
|
|
|
|
8.4
|
%
|
|
|
2,527,820
|
|
|
|
64.7
|
%
|
General
Administrative
|
|
|
6,680,992
|
|
|
|
9.7
|
%
|
|
|
5,661,356
|
|
|
|
12.1
|
%
|
|
|
1,019,636
|
|
|
|
18.0
|
%
|
Depreciation
and Amortization
|
|
|
712,269
|
|
|
|
1.0
|
%
|
|
|
535,751
|
|
|
|
1.1
|
%
|
|
|
176,518
|
|
|
|
32.9
|
%
|
R&D
|
|
|
2,102,976
|
|
|
|
3.0
|
%
|
|
|
672,379
|
|
|
|
1.4
|
%
|
|
|
1,430,597
|
|
|
|
212.8
|
%
|
Total
Operating Expenses
|
|
|
15,931,124
|
|
|
|
23.1
|
%
|
|
|
10,776,553
|
|
|
|
23.0
|
%
|
|
|
5,154,571
|
|
|
|
47.8
|
%
|
Operating
expenses were approximately $15.9 million for the year ended December 31, 2008
as compared to approximately $10.8 million for the year ended December 31, 2007,
an increase of approximately $5.2 million or 47.8 percent. The increase in
operating expenses was mainly due to the increase in our selling expense and
R&D expenditure during the period.
Selling
expenses were approximately $6.4 million for the year ended December 31, 2008 as
compared to approximately $3.9 million for the year ended December 31, 2007, an
increase of approximately $2.5 million or 64.7 percent. The significant increase
in our selling expenses was mainly attributable to the increase in our
sales-related activities and our efforts to expand our business into new
industries including nuclear power and transportations. General administrative
expenses were approximately $6.7 million for the year ended December 31, 2008,
as compared to approximately $5.7 million for the year ended December 31, 2007,
an increase of approximately $1.0 million or 18.0 percent. The increase in
general administrative expenses were mainly attributable to the increase in
staff and greater bad debt allowance. Depreciation and amortization expenses
were approximately $0.7 million for the year ended December 31, 2008 as compared
to approximately $0.5 million for the year ended December 31, 2007, an increase
of approximately $176,518 or 32.9 percent. The increase in depreciation and
amortization expenses was mainly due to the increase in our plant and equipment
related to business operations. R&D expenses were approximately $2.1 million
for the year ended December 31, 2008 as compared to approximately $0.7 million
for the year ended December 31, 2007, an increase of approximately $1.4 million
or 212.8 percent. The significant percentage increase in our R&D expenses
was mainly attributable to our efforts in new product development including an
anti-explosive gas bottles and alternant foam storage and mix devices and the
improvement of our existing product offerings including linear heat directors
and water mist systems.
Operating
income was approximately $23.6 million for the year ended December 31, 2008 as
compared to approximately $14.9 million for the year ended December 31, 2007, an
increase of $8.7 million or 58.3 percent. The increase in our operating income
was mainly attributable to the increase in our revenues and higher gross margins
during this period.
Total
other income was approximately $1.2 million for the year ended December 31, 2008
as compared to approximately $1.9 million for the year ended December 31, 2007,
a decrease of $0.7 million or 38.3 percent. If excluding the one-time gain of
$1.2 million for the change in fair value of derivatives in the year 2007, our
total other income actually increased by $0.5 million. This increase was mainly
attributable to the increase in the VAT tax return to Beijing Hua An and the
increase in our interest income, offset by our one-time donation of 500,000 RMB
($72,150) in charitable aid for Wenchuan’s “5.19” earthquake.
Our net
income was approximately $24.7 million for the year ended December 31, 2008 as
compared to approximately $16.8 million net income for the year ended December
31, 2007, an increase of $7.9 million or 47.0 percent. Excluding the one-time
gain of $1.2 million for the change in fair value of derivatives in the year
2007, our non-GAAP net income increased by $9.1 million or 58.4 percent for the
year ended December 31, 2008. The reason for this increase in the net income was
mainly due to the increase in our revenues and improvement in our gross margins
during the period.
Currency
translation adjustments resulting from RMB appreciation process amounted to
$3,737,027 and $2,502,595 as of the year ended December 31, 2008 and 2007,
respectively.
The
comprehensive income, which adds the currency adjustment to the net income, were
approximately $28.4 million for the year ended December 31, 2008 as compared to
approximately $19.3 million comprehensive income for the year ended December 31,
2007, an increase of $9.1 million or 47.3 percent.
Liquidity
and Capital Resources
As of
December 31, 2008, we had working capital of $64.7 million including cash and
cash equivalents of $26.7 million. The following table sets forth a summary of
our cash flows for the periods indicated:
Statement
of Cash Flow
|
Year Ended December 31
|
|
|
2008
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
$ |
13,361,704 |
|
|
$ |
9,773,114 |
|
|
|
8,935,061 |
|
Net
cash (used in) investing activities
|
|
|
(1,945,199
|
) |
|
|
(3,929,978 |
) |
|
|
(10,949,752 |
) |
Net
cash (used in) provided by financing activities
|
|
|
(3,097,855
|
) |
|
|
1,051,952 |
|
|
|
8,935,521 |
|
Effect
of foreign currency translation on cash and cash
equivalents
|
|
|
1,226,234 |
|
|
|
789,270 |
|
|
|
147,862 |
|
Net
cash flow
|
|
$ |
9,544,884 |
|
|
$ |
7,684,358 |
|
|
|
7,068,692 |
|
Operating
Activities
Net cash
provided by operating activities was approximately $13.4 million for the year
ended December 31, 2008 as compared to approximately $9.8 million net cash
provided by operating activities for the same period in 2007. Net cash provided
by operating activities in the year ended December 31, 2008 was mainly due to
net income of $24.7 million and $1.7 million increase in accrued liabilities,
offset by $10.6 million increase in accounts receivable, $2.2 million increase
in inventories, $3.8 million increase in costs and estimated earnings in excess
of billing. The increase in accrued liabilities, accounts receivable,
inventories and cost and estimated earnings in excess of billing was mainly
attributable to the growth of our business during the period.
The
increase of $3.8 million in costs and estimated earnings in excess of billings
was mainly due to the increase in aggregate value of projects where we have
recognized revenues more than we have billed the customers for these projects,
while the decrease in billings in excess of costs and estimated earnings was
mainly due to the decrease in aggregate value of projects where we have billed
our customers less than we have recognized revenues for these
projects.
Net cash
provided by operating activities was approximately $9.8 million for the year
ended December 31, 2007 as compared to approximately $8.9 million net cash
provided by operating activities for the same period in 2006. Net cash provided
by operating activities in the year ended December 31, 2007 was mainly due to
net income of $16.8 million, $1.8 million increase in customer deposits, $2.2
million increase in accrued liabilities offset by $3.2 million increase in
account receivable, $2.3 million increase in notes receivable, $3.3 million
increase in costs and estimated earnings in excess of billings, $4.4 million
decrease in billings in excess of costs and estimated earnings. The increase of
$3.3 million in costs and estimated earnings in excess of billings is mainly due
to the increased number of projects where we have billed the customers more than
we have recognized revenues for these projects, while the decrease of $4.4
million in billings in excess of costs and estimated earnings is mainly due to
the decreased number of projects where we have billed the customers less than we
have recognized revenues for these projects.
Investing
Activities
Net cash
used in investing activities in the year ended December 31, 2008 was $1.9
million as compared to net cash used in investing activities of $3.9 million in
the same period of 2007. The cash used in investing activities in the year ended
December 31, 2008 was mainly attributable to capital expenditure in the purchase
of new equipments and the improvement of office and manufacturing
facilities.
Net cash
used in investing activities in the year ended December 31, 2007 was $3.9
million, which is a decrease of $7.0 million from net cash used in investing
activities of $10.9 million in the same period of 2006. Net cash used in
investing activities was mainly attributable to $3.8 million used to purchase
building and equipment, $0.6 million used to purchase intangible asset, and $1.0
million used to invest in King Galaxy Investment Limited offset by $0.5 million
proceeds from the sale of investment in Tianjin Fire Safety Equipment Co. Ltd.
and $1.1 million proceeds from the restructure in Beijing Zhong
Xiao.
Financing
Activities
Net cash
used in financing activities in the year ended December 31, 2008 totaled $3.1
million as compared to $1.1 million provided by financing activities in the same
period of 2007. The cash used in financing activities in the year ended December
31, 2008 was mainly attributable to the increase in restricted cash during the
period.
As a
result of the total cash activities, net cash increased $9.5 million from
December 31, 2007 to December 31, 2008. We believe that our currently
available working capital of $64.7 million including cash and cash equivalents
of $26.7 million should be adequate to sustain our current operations and our
anticipated expansion.
Net cash
provided by financing activities in the year ended December 31, 2007 totaled
$1.1 million as compared to $8.9 million used in financing activities in the
same period of 2006. Net cash provided by financing activities in the year ended
December 31, 2007 was attributable to the proceeds of $4.2 million from issuance
of common stock and the proceeds of $1.4 million from the sale of Beijing Zhong
Xiao, offset by $2.0 million increase in restricted cash, which represents the
cash required to be deposited in the bank to guarantee the execution of signed
contracts, and the payment of $2.5 million to Beijing Zhong Xiao to clear the
balance between our Company and Beijing Zhong Xiao.
As a
result of the total cash activities, net cash increased $7.7 million from
December 31, 2006 to December 31, 2007.
Off-Balance
Sheet Arrangements
We do not
have any off-balance sheet arrangements that have or are reasonably likely to
have a current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that are material to our
investors.
Contractual
Obligations
The
following table summarizes our contractual obligations as of December 31,
2008:
|
|
Payments Due by Period
|
|
|
|
Total
|
|
|
Less than 1 year
|
|
|
1-3 Years
|
|
|
3-5 Years
|
|
|
5 Years +
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Obligations :
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank
Indebtedness
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Other
Indebtedness
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Capital
Lease Obligations
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Operating
Leases (1)
|
|
$
|
48,385
|
|
|
$
|
48,385
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Purchase
Obligations
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Total
Contractual Obligations:
|
|
$
|
48,385
|
|
|
$
|
48,385
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
(1)
Currently we are engaged in an operating lease with Tianjin Fire Protection
Equipment Company Ltd for the use of approximately 112,432 square meters land in
Tianjin, consisting of manufacturing facilities, warehouses and office
buildings. The term of the operating lease is two years,
beginning from May 2007. The monthly payment for the lease is 66,000RMB or
$9,677.
Comparison of the Year Ended
on December 31, 2007 and 2006:
|
|
For the Year Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Y/Y Change
|
|
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount ($)
|
|
|
%
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
|
34,581,376
|
|
|
|
74.0
|
%
|
|
|
24,008,170
|
|
|
|
74.0
|
%
|
|
|
10,573,206
|
|
|
|
44.0
|
%
|
Products
|
|
|
10,592,683
|
|
|
|
22.7
|
%
|
|
|
7,701,986
|
|
|
|
23.7
|
%
|
|
|
2,890,697
|
|
|
|
37.5
|
%
|
Maintenance
Services
|
|
|
1,579,778
|
|
|
|
3.4
|
%
|
|
|
744,880
|
|
|
|
2.3
|
%
|
|
|
834,898
|
|
|
|
112.1
|
%
|
Total
Revenue
|
|
|
46,753,837
|
|
|
|
100.0
|
%
|
|
|
32,455,036
|
|
|
|
100.0
|
%
|
|
|
14,298,801
|
|
|
|
44.1
|
%
|
Total
revenues were approximately $46.8 million for the year ended December 31, 2007
as compared to approximately $32.5 million for the year ended December 31, 2006,
an increase of approximately $14.3 million or 44.1 percent. This increase
was mainly attributable to the further penetration of the Company’s customer
base in the iron and steel, power generation, petrochemical and other industries
and the execution of more contracts in the period. The Company recognized
revenues from 274 total solution, product sales and maintenance contracts for
the year ended December 31, 2007 as compared to 221 contracts for the year
ended December 31, 2006.
Revenues
from system contracting projects increased by 44.0 percent to $34.6 million
derived from 130 contracts for the year ended December 31, 2007, compared to
$24.0 million derived from 103 contracts for the year ended December 31, 2006.
This increase in the revenues from system contracting projects was mainly
attributable to the increase in the number of system contracting projects we
executed during the period. Revenues from our product sales were $10.6
million with 111 contracts executed for the year ended December 31, 2007,
compared to $7.7 million with 98 contracts executed for the year ended December
31, 2006. The increase in the revenues from product sales was mainly due to the
increase in the number of product sales contracts executed during the period.
The revenues from maintenance service increased by 112.1 percent to $1.6 million
derived from 39 contracts for the year ended December 31, 2007, compared to $0.7
million derived from 20 contracts for the year ended December 31, 2006. The
increase in revenues from maintenance service was mainly due to the increase in
the number of maintenance service contracts that we executed as the result of
the expansion in our customer basis during the period.
In
particular, the three largest customers were Maanshan Iron and Steel, Sichuan
Dongfang Electronic Equipment, and Ningbo Jianlong Iron and Steel who
collectively contributed approximately $15.1 million of revenue, representing
32.2 percent of our total revenue for the year ended December 31,
2007.
|
|
For the Year Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Y/Y Change
|
|
|
|
Amount ($)
|
|
|
% of
Revenue
|
|
|
Amount ($)
|
|
|
% of
Revenue
|
|
|
Amount ($)
|
|
|
%
|
|
Cost of Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
|
16,158,844
|
|
|
|
46.7
|
%
|
|
|
12,893,082
|
|
|
|
53.7
|
%
|
|
|
3,265,762
|
|
|
|
25.3
|
%
|
Products
|
|
|
4,329,067
|
|
|
|
40.9
|
%
|
|
|
3,272,438
|
|
|
|
42.5
|
%
|
|
|
1,056,629
|
|
|
|
32.3
|
%
|
Maintenance
Services
|
|
|
602,943
|
|
|
|
38.2
|
%
|
|
|
60,787
|
|
|
|
8.2
|
%
|
|
|
542,156
|
|
|
|
891.9
|
%
|
Total
Cost of Revenues
|
|
|
21,090,854
|
|
|
|
45.1
|
%
|
|
|
16,226,307
|
|
|
|
100.0
|
%
|
|
|
4,864,547
|
|
|
|
30.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Profit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
|
18,422,532
|
|
|
|
53.3
|
%
|
|
|
11,115,088
|
|
|
|
46.3
|
%
|
|
|
7,307,444
|
|
|
|
65.7
|
%
|
Products
|
|
|
6,263,616
|
|
|
|
59.1
|
%
|
|
|
4,429,548
|
|
|
|
57.5
|
%
|
|
|
1,834,068
|
|
|
|
41.4
|
%
|
Maintenance
Services
|
|
|
976,835
|
|
|
|
61.8
|
%
|
|
|
684,093
|
|
|
|
91.8
|
%
|
|
|
292,742
|
|
|
|
42.8
|
%
|
Total
Gross Profit
|
|
|
25,662,983
|
|
|
|
54.9
|
%
|
|
|
16,228,729
|
|
|
|
50.0
|
%
|
|
|
9,434,254
|
|
|
|
58.1
|
%
|
Cost of
Revenues for the year ended December 31, 2007 was approximately $21.1
million, as compared to $16.2 million for the year ended December 31, 2006, an
increase of approximately $4.9 million or 30.0%. Gross profit for the year ended
December 31, 2007 was approximately $25.7 million, as compared to $16.2 million
for the year ended December 31, 2006, an increase of approximately $9.4 million
or 58.1 percent. Gross margin for the year ended December 31, 2007 was 54.9
percent, which is higher than the gross margin of 50.0 percent for the year
ended December 31, 2006. The increase in our gross margin was mainly
attributable to the increase in the gross margin of our system contracting
projects and product sales, offset by the decrease in gross margin of our
maintenance services during the period.
Gross
margin of system contracting projects was 53.3 percent for the year ended
December 31, 2007, compared to 46.3 percent for the year ended December 31,
2006. This increase in the gross margin of system contracting projects was
due to the use of a higher percentage of our self-manufactured
proprietary products that contribute higher margins and the higher selling price
of some of our proprietary products during the period. The gross margin of
product sales was 59.1 percent for the year ended December 31, 2007, compared to
57.5 percent for the year ended December 31, 2006. This increase in the gross
margin of product sales was mainly attributable to the higher selling price of
some of our proprietary products during the period.
|
|
For the Year Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Y/Y Change
|
|
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount ($)
|
|
|
% of
Total
Revenue
|
|
|
Amount
($)
|
|
|
%
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
Expense
|
|
|
3,907,067
|
|
|
|
8.4
|
%
|
|
|
2,827,838
|
|
|
|
8.7
|
%
|
|
|
1,079,229
|
|
|
|
38.2
|
%
|
General
Administrative
|
|
|
5,661,356
|
|
|
|
12.1
|
%
|
|
|
3,665,776
|
|
|
|
11.3
|
%
|
|
|
1,995,580
|
|
|
|
54.4
|
%
|
Depreciation
and Amortization
|
|
|
535,751
|
|
|
|
1.1
|
%
|
|
|
498,499
|
|
|
|
1.5
|
%
|
|
|
37,252
|
|
|
|
7.5
|
%
|
R&D
|
|
|
672,379
|
|
|
|
1.4
|
%
|
|
|
1,258,172
|
|
|
|
3.9
|
%
|
|
|
-585,793
|
|
|
|
-46.6
|
%
|
Total
Operating Expenses
|
|
|
10,776,553
|
|
|
|
23.0
|
%
|
|
|
8,250,285
|
|
|
|
25.4
|
%
|
|
|
2,526,268
|
|
|
|
30.6
|
%
|
Operating
expenses were approximately $10.8 million for the year ended December 31, 2007
as compared to approximately $8.3 million for the year ended December 31, 2006,
an increase of approximately $2.5 million or 30.6 percent. The increase in
operating expenses was mainly due to the increase in our selling expenses and
general administrative expenses, offset by the decrease in our R&D expenses
during the period.
Selling
expenses were approximately $3.9 million for the year ended December
31, 2007 as compared to approximately $2.8 million for the year ended
December 31, 2006, an increase of approximately $1.1 million or 38.2 percent.
The increase in selling expenses was mainly attributable to the increase in our
sales-related activities to expand our customer basis. General administrative
expenses were approximately $5.7 million for the year ended December 31, 2007,
as compared to approximately $3.7 million for the year ended December 31, 2006,
an increase of approximately $2.0 million or 54.4 percent. The increase in
general administrative expenses were mainly attributable to the increase in the
number of our employees and the higher compensation for our officers and
directors. Depreciation and amortization expenses were approximately $0.5
million for the year ended December 31, 2007 as compared to approximately $0.5
million for the year ended December 31, 2006, an increase of $37,252 or 7.5
percent. R&D expenses were approximately $0.7 million for the year ended
December 31, 2007 as compared to approximately $1.3 million for the year
ended December 31, 2006, a decrease of approximately $0.6 or 46.6 percent. The
decrease in our R&D expenses was mainly attributable to the lower
expenditure requirement in the early stage of our new product development
cycle.
Operating
income was approximately $14.9 million for the year ended December 31, 2007 as
compared to approximately $8.0 million for the year ended December 31, 2006, an
increase of $6.9 million or 86.6 percent. The increase in our operating income
was mainly due to the increase in our revenues and higher gross margin during
this period. If excluding the one-time charge of $0.4 million for reverse merger
and the one-time non-cash charge of $0.5 million for the management option
expenses in 2006, the increase in operating income would be $6.0 million or 67.7
percent for the year ended December 31, 2007 as compared to the year ended
December 31, 2006. The increase was mainly due to the increase in our revenues
and higher gross margin in this period.
Total
other income was approximately $1.9 million for the year ended December 31, 2007
as compared to a loss of approximately $0.9 million for the year ended December
31, 2006. In 2006, the Company issued warrants that permitted the holder under
certain circumstances to redeem the warrants for cash. Therefore, the
Company had to record the fair value of the warrants as a derivative liability
on the date of grant and then record a gain or loss each subsequent reporting
period for the change in fair value of the warrants. In 2006, the
change in fair value of the warrants from the date of issue through year end
resulted in a loss of $1.5 million. On May 3, 2007, the Company
restructured the warrants so that they were no longer redeemable for
cash. Therefore, the warrants were no longer subject to derivative
accounting, and the Company reclassified the warrants to equity at the fair
value on the date of the restructuring. The change in fair value
between December 31, 2006 and the date of restructuring resulted in a gain of
$1.2 million. Excluding this factor, our total other income stayed almost the
same.
Our net
income was approximately $16.8 million for the year ended December 31, 2007 as
compared to approximately $7.0 million net income for the year ended December
31, 2006, an increase of $9.8 million or 141.1 percent. Excluding the one-time
charge of $0.4 million for reverse merger, the one-time non-cash charge of $0.5
million for the management option expenses and the $1.6 million charge for the
change in fair value of derivative in the year 2006, and the $1.2 million gain
for the change in fair value of derivative in the year 2007, our non-GAAP net
income was $15.6 million for the year ended December 31, 2007 as compared to
approximately $9.4 million for the same period in 2006, an increase of $6.2
million or 65.2 percent. The reason for the increase in the net income was
mainly due to the increase in revenues and gross margin.
Currency
translation adjustments resulting from RMB appreciation process amounted to
$2,502,595 and $581,932 as of the year ended December 31, 2007 and 2006,
respectively.
The
comprehensive income, which adds the currency adjustment to the net income, were
approximately $19.3 million for the year ended December 31, 2007 as compared to
approximately $7.6 million comprehensive income for the year ended December 31,
2006, an increase of $11.8 million or 155.9 percent.
Item
7A. Quantitative And Qualitative Disclosures About Market Risk
Market
risk is the risk of loss to future earnings, to fair values or to future cash
flows that may result from changes in the price of a financial instrument. The
value of a financial instrument may change as a result of changes in interest
rates, exchange rates, commodity prices, equity prices and other market changes.
Our cash and cash equivalents are held for working capital purposes and consist
primarily of bank deposits. We do not enter into investments for trading or
speculative purposes.
Interest
Rate Risk
We
currently do not have any long-term debt. Our exposure to interest rate risk
primarily relates to the interest income generated by excess cash invested in
demand deposits. We have not used derivative financial instruments in our
investment portfolio in order to reduce interest rate risk. Interest earning
instruments carry a degree of interest rate risk and our future interest income
may change, depending on market interest rate movement.
Foreign
Currency Risk
Our
business is operated in the PRC, and its value is effectively denominated in
Renminbi. The fluctuation of foreign exchange rate between U.S. dollars and
Renminbi could affect the value of our common stock. Our revenues and expenses
are primarily denominated in Renminbi, and so our exposure to foreign exchange
risks should generally be limited. We do not have material monetary assets and
liabilities denominated in U.S. dollars, although to the extent that we do in
the future, the fluctuation of foreign exchange rate would affect the value of
these monetary assets and liabilities denominated in U.S. dollars. Generally,
appreciation of Renminbi against U.S. dollars will devaluate the assets and
liabilities denominated in U.S. dollar, while devaluation of Renminbi again U.S.
dollars will appreciate the assets and liabilities denominated in U.S. dollar.
In China, very limited hedging transactions are available to reduce our exposure
to exchange rate fluctuations. To date, we have not entered into any hedging
transactions in an effort to reduce our exposure to foreign currency exchange
risk. While we may decide to enter into hedging transactions in the future, the
availability and effectiveness of these hedges may be limited and we may not be
able to successfully hedge our exposure at all.
Item
8. Financial Statements And Supplementary Data
(a)
|
Financial
statements required by Item 8 are set forth at the pages indicated in
item 15(a) below.
|
QUARTERLY DATA
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31
|
|
2008
|
|
First Quarter
|
|
|
Second Quarter
|
|
|
Third Quarter
|
|
|
Fourth Quarter
|
|
|
Full Year
|
|
Revenues
|
|
|
14,696,626
|
|
|
|
16,653,724
|
|
|
|
16,743,267
|
|
|
|
20,985,502
|
|
|
|
69,079,119
|
|
Gross
profits
|
|
|
8,044,395
|
|
|
|
10,184,293
|
|
|
|
9,864,431
|
|
|
|
11,404,754
|
|
|
|
39,497,873
|
|
Net
income
|
|
|
4,740,780
|
|
|
|
6,676,100
|
|
|
|
6,457,964
|
|
|
|
6,829,008
|
|
|
|
24,703,852
|
|
Earnings
per share
|
|
$
|
0.17
|
|
|
$
|
0.24
|
|
|
$
|
0.23
|
|
|
$
|
0.26
|
|
|
$
|
0.90
|
|
Earnings
per share Diluted
|
|
$
|
0.17
|
|
|
$
|
0.24
|
|
|
$
|
0.23
|
|
|
$
|
0.24
|
|
|
$
|
0.88
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
9,499,460
|
|
|
|
11,547,185
|
|
|
|
11,596,970
|
|
|
|
14,110,220
|
|
|
|
46,753,837
|
|
Gross
profits
|
|
|
5,015,905
|
|
|
|
6,309,513
|
|
|
|
6,867,432
|
|
|
|
7,470,133
|
|
|
|
25,662,983
|
|
Net
income
|
|
|
4,130,116
|
|
|
|
4,242,521
|
|
|
|
4,392,035
|
|
|
|
4,036,964
|
|
|
|
16,801,636
|
|
Earnings
per share
|
|
$
|
0.16
|
|
|
$
|
0.16
|
|
|
$
|
0.16
|
|
|
$
|
0.15
|
|
|
$
|
0.63
|
|
Earnings
per share Diluted
|
|
$
|
0.15
|
|
|
$
|
0.16
|
|
|
$
|
0.16
|
|
|
$
|
0.14
|
|
|
$
|
0.61
|
|
Item
9. Changes In and Disagreements With Accountants On Accounting and
Financial Disclosure
Not
applicable.
Item
9A. Controls And Procedures
(a) Management’s
annual report on disclosure control and procedures.
As
required by Exchange Act Rule 13a-15(b), our management has carried out an
evaluation, under the supervision of our Chief Executive Officer and Principal
Accounting Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of December 31, 2008.
Disclosure
controls and procedures refer to controls and other procedures designed to
ensure that information required to be disclosed in the reports we file or
submit under the Securities Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the SEC and
that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Principal Accounting Officer, as
appropriate, to allow timely decisions regarding required
disclosure.
Based on
that evaluation, the Chief Executive Officer and Principal Accounting Officer
have concluded that our disclosure controls and procedures were not effective as
of December 31, 2008 because of the material weaknesses described in
Management’s Report on Internal Control over Financial Reporting
below.
(b)
Management’s annual report on internal control over financial
reporting.
As
required by Exchange Act Rule 13a-15(c), our management has carried out an
evaluation, under the supervision of our Chief Executive Officer and Principal
Accounting Officer, of the effectiveness of the design and operation of our
internal control over financial reporting as of December 31, 2008.
Management
is responsible for establishing and maintaining adequate internal control over
financial reporting. The Company's internal control over financial reporting is
a process that is designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles, and includes those policies and procedures that:
|
·
|
Pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of assets of the
Company,
|
|
·
|
Provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles,
and that receipts and expenditures are being made only in accordance with
authorizations of management and the board of directors of the Company,
and
|
|
·
|
Provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use,
or disposition of the Company's assets that could have a material effect
on the financial statements.
|
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies and procedures may deteriorate.
Management
performed an assessment of the effectiveness of the Company's internal control
over financial reporting as of December 31, 2008. In making this assessment, we
used the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on
our assessment, we determined that, as of December 31, 2008, our internal
control over financial reporting was not effective as a result of the following
material weaknesses:
|
l
|
Lack of internal controls over
the project budgeting process – Due to lack of project budgeting personnel
and an ineffective design of project budgeting process, we do not maintain
sufficient control over project budgeting process. Although this material
weakness did not result in significant adjustments to our consolidated
financial statements (less than 1% adjustment on our revenue) this
material weakness resulted in the possibility that a material
misstatement of our consolidated financial statements might not be
prevented or detected in a timely
basis.
|
|
l
|
Lack of internal accounting staff
with adequate US GAAP knowledge and inadequate supervisory review of the
construction accounting process - We did not maintain effective controls
over the financial reporting process due to an insufficient complement of
internal personnel with a sufficient level of accounting knowledge,
experience and training in the application of U.S. GAAP. We did not
implement adequate supervisory review of the construction accounting
process to ensure the financial statements were prepared in accordance
with U.S. GAAP.
|
The
material weakness in our project budgeting process was mainly due to the lack of
project budgeting personnel and the ineffective design of our project budgeting
process. The growth of our project budgeting team, which is in charge of the
estimation of the project budget costs, could not meet the expansion of our
business. By the end of 2008, we were in need of project budget personnel, who
are responsible for both the project cost estimations for new projects and the
update of cost budgets for on-going projects. The currently ineffective design
of our project budgeting process was mainly due to the lack of monitoring
procedures in our project budget process to prevent any untimely updates of
on-going projects’ budgets. Consequently, due to these two shortages in our
project budget process, there were five project budgets (out of 221 projects)
that were not updated in a timely manner. These errors were identified by our
independent auditors during their annual audit work and the adjustments to our
consolidated financial statements were less than 1% of our revenue. Although the
adjustment was immaterial, we understand that as the project budget process is a
key process in our control systems for a construction company, the lack of
monitoring procedures in this process can result in the possibility that a
material misstatement of our consolidated financial statement might not be
prevented or detected in a timely basis.
The
material weakness in our financial reporting process due to the lack of internal
accounting staff with adequate U.S. GAAP knowledge and inadequate supervisory
review of the construction accounting process resulted from the fact that the
Company’s operations are in China and our accounting staff that service our
supervisory review of the construction accounting process possess adequate
knowledge of PRC GAAP, but only possess limited knowledge in U.S. GAAP. Although
the conformity of PRC GAAP to U.S. GAAP was observed, there still exist
meaningful differences between the two accounting principles, which cause the
material weakness in our internal control over financial
reporting. In China’s market, it is difficult to recruit qualified
accounting staff with adequate U.S. GAAP knowledge at competitive cost. The
growth of our accounting department did not keep up with the expansion of our
business and the lack of accounting personnel resulted into the inadequate
supervisory review of the construction accounting process.
Due to
this material weakness, one material adjustment of $6.3 million was made due to
a missing close-out entry between Cost & Estimated Earnings and Progress
Billings for disclosure purpose. This error was mainly due to the difference
between PRC GAAP and US GAAP for project construction
accounting.
Moore
Stephens Wurth Frazer and Torbet, LLP, an independent registered public
accounting firm, has audited the financial statements included in this annual
report and, as part of the audit, has issued a report, included herein, on the
effectiveness of our internal control over financial reporting as of December
31, 2008.
(c)
Changes in Internal Controls over Financial Reporting
During
the year ended December 31, 2008, there was no change in our internal controls
over financial reporting that has materially affected, or that is
reasonably likely to materially affect, our internal control over financial
reporting.
Regarding
the material weakness described above, we have identified the
following changes necessary to improve our internal control over financial
reporting:
|
·
|
We
will hire more skilled project budgeting personnel to enhance our project
budgeting team to meet the increased needs of our expanding number of
projects. We will redesign our project budgeting process and augment
monitoring procedures to ensure timely updates of project budgets that
will reflect the best estimate of project costs under construction. We
will also increase the effectiveness and frequency of communication
between our accounting, project budgeting and project implementation
departments through regularly scheduled inter-department
meetings.
|
|
·
|
We
will hire more skilled accounting personnel with an appropriate level of
technical accounting knowledge and experience in the application of U.S.
GAAP. We also plan to hire an external U.S. GAAP accounting consultant
with relevant accounting experience, skills and knowledge in the financial
reporting processes to provide U.S. GAAP knowledge training to our
existing accounting staff. We will enforce senior management’s
checks and approvals process to ensure the accuracy of our daily book
keeping.
|
We
anticipates the remedial actions described above will strengthen the Company’s
internal control over financial reporting, and will address the related material
weakness that management identified at December 31, 2008.
(d)
Independent Registered Public Accounting Firm’s Attestation Report
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Stockholders of
China
Fire & Security Group, Inc.
We have
audited China Fire & Security Group, Inc. and subsidiaries’ (the “Company”)
internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company’s management is responsible
for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in the accompanying “Management’s Report on Internal Control Over
Financial Reporting.” Our responsibility is to express an opinion on
the company’s internal control over financial reporting based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of the inherent limitations of internal control over financial reporting,
including the possibility of collusion or improper management override of
controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of effectiveness
of the internal control over financial reporting to future periods are subject
to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may
deteriorate.
A
material weakness is a control deficiency, or combination of deficiencies, in
internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the Company’s annual or interim
financial statements will not be prevented or detected on a timely basis. The
following material weaknesses have been identified and included in management’s
assessment:
The
Company did not maintain a sufficient complement of personnel with the
appropriate level of accounting knowledge, experience and training in the
application of generally accepted accounting principles commensurate with the
Company’s financial reporting requirements and did not implement adequate
supervisory review of the construction accounting process to ensure the
financial statements were prepared in accordance with generally accepted
accounting principles of the Unites States of America. These resulted in
material adjustments to the Company’s preliminary consolidated financial
statements. The Company also did not design and maintain effective controls over
the budgeting process. This material weakness did not result in
material adjustments to the Company’s consolidated financial statements;
however, there is a reasonable possibility that due to this control deficiency,
a material misstatement of the Company’s consolidated financial statements
related to the revenues and costs and estimated earnings accounts will not be
prevented or detected on a timely basis. These material weaknesses
were considered in determining the nature, timing, and extent of audit tests
applied in our audit of the 2008 financial statements, and this report does not
affect our report dated March 16, 2009 on those financial
statements.
In our
opinion, because of the effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, the Company has not
maintained effective internal control over financial reporting as of December
31, 2008, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets and the related
statements of income and comprehensive income, shareholders’ equity, and cash
flows of the Company, and our report dated March 16, 2009 expressed an
unqualified opinion.
/s/ Moore
Stephens Wurth Frazer and Torbet, LLP
Walnut,
California
March 16,
2009
Item
9B. Other Information
None.
PART
III
Item
10. Directors, Executive Officers and Corporate Governance
Executive
Officers and Directors
We have
provided below certain information about our executive officers and directors.
Our directors serve for a term of one year or until their successors are duly
elected. Our executive officers serve at the pleasure of our board of directors
and have no fixed term of office.
Name
|
|
Age
|
|
Position
|
Brian Lin
|
|
44
|
|
Director
and Chief Executive Officer
|
Weishe
Zhang
|
|
44
|
|
Director
and Chief Technology Officer
|
Xiaoyuan
(Robert) Yuan
|
|
34
|
|
Principal
Accounting Officer
|
Weigang
Li
|
|
51
|
|
Vice
President of Sales
|
Haijun
Yang
|
|
36
|
|
Vice
President of Operations
|
Gangjin Li
|
|
47
|
|
Chairman
of the Board
|
Albert
McLelland
|
|
50
|
|
Independent
Director
|
Xianghua
Li
|
|
64
|
|
Independent
Director
|
Xuewen
Xiao
|
|
40
|
|
Independent
Director
|
Guoyou
Zhang
|
|
57
|
|
Independent
Director
|
Mr. Brian Lin, CEO, Director,
44. Mr. Lin serves as Director and Chief Executive Officer of China Fire &
Security Group, Inc. Mr. Lin has served as a Director since October 2006. Mr.
Lin has over 17 years of management and technical experience both in the US and
China. Mr. Lin is an early stage investor and co-founder of the Company and has
been providing strategic guidance since its inception. Prior to joining the
Company full time in January 2006, Mr. Lin served as CEO of Beijing Linkhead
Technologies, and held various management and technical positions with UTStarcom
in China and Nortel Networks and Motorola in the US from 2001 to 2005. Mr. Lin
received his Master’s Degree in Electrical Engineering from University of
Toronto, Canada in 1989.
Mr. Weishe Zhang, Chief
Technology Officer, Director, 44. Mr. Zhang has served as a director and our
Chief Technology Officer since February 2009. From 2002 to February 2009, Mr.
Zhang held various positions in the field of product research and development,
including Director of System Integration, Director of Product Research and
Development Center and Chief Engineer in Sureland Industrial (a wholly owned
subsidiary of China Fire). With over 15 years of experience in the China fire
protection industry, Mr. Zhang is the inventor of dozens of international and
domestic product and technology patents. Mr. Zhang received a
Master’s Degree in Engineering from Beijing University of Aeronautics &
Astronautics in 1989.
Mr. Weigang Li, Vice President
of Sales of China Fire, General Manager of Sureland Industrial, 41. Mr. Li has
served as our VP of Sales since February 2009. Mr. Li co-founded Sureland
Industrial in 1995 and held various positions, including deputy director,
director and deputy General Manager of Sales. Mr. Li has been influential in
winning a number of large, notable contracts since the Company’s inception. Mr.
Li has over 15 years of hands on experience in project sales and sales force
management in the China fire protection industry. He is currently completing a
business diploma in an advanced program for young Chinese entrepreneurs at
Tsinghua University. Mr. Li is the brother of Mr. Gangjin Li, the Chairman of
the Board.
Mr. Haijun Yang, Vice
President of Operations, the Company’s Secretary, Deputy General Manager of
Sureland Industrial, 36. Mr. Yang has served as our Vice President of Operations
and the Company’s Secretary since February 2009. From 2000 to February 2009, Mr.
Yang held various positions including Executive Assistant to the General
Manager, Secretary of the Board of Sureland and Deputy General Manager in charge
of preparation for going public, merger and acquisition and operation management
in Sureland Industrial. With 9 years of working experience in the China fire
protection industry, Mr. Yang is responsible for internal operation management,
including human resource, legal affairs, mergers and acquisitions, to support
the Company’s continued growth. Mr. Yang received his MBA from Renmin
University of China in 2000 and is currently pursuing his Ph.D. in business
management since 2004.
Mr. Xiaoyuan (Robert) Yuan,
Principal Accounting Officer, 34, Mr. Xiaoyuan (Robert) Yuan joined the Company
as the Company's Secretary in July 2007 and has served as the Principal
Accounting Officer since August 2008. From October 2006 to July 2007, Mr.
Yuan worked for CCG Elite Investor Relations, a global investor relations
company, as an account executive representing a number of public companies
listed in the U. S. From 2003 to 2005, Mr. Yuan held various positions in the
fields of industry research, strategic planning and M&A for Lenovo Group Co.
Ltd. (HKSE: 0992.HK), the largest PC manufacturer in China. Mr. Yuan graduated
from Texas Christian University with his Ph.D. degree in Physics and MBA with
concentration in finance in 2003.
Mr. Gangjin Li, Chairman
of the Board, 47. Mr. Li has served as our Chairman of the Board since
October 2006. Mr. Li is the founder of Sureland, and served as Chairman of
the Board and the General Manager of Sureland Industrial from 1995 until January
2009. Mr. Li is an executive director of China Fire Protection Association
(CFPA), and vice-chairman of “Electrical Fire Prevention Committee of CFPA”.
Mr. Li holds a bachelor’s degree from Wuhan University of Science and
Technology and a Master degree in management science from Beijing
University.
Mr. Albert
McLelland, Director, 50, Albert Mclelland has
served as an independent Director since September 2008. Since 2003,
Mr. McLelland has been the Senior Managing Director of AmPac Strategic Capital
LLC (AmPac) Prior to founding AmPac, Mr. McLelland was responsible
for the day-to-day operations of the cross-border transactions Initiative of
PricewaterhouseCoopers’ (PwC) Financial Advisory Services. Albert possesses
extensive investment and merchant banking experience. He has built two Asian
based financial service firms and also ran corporate finance at CEF
Taiwan Limited. Mr. McLelland began his investment banking career at Shearson
Lehman. Mr. McLelland is also teaching “Venturing in China” at the Caruth
Institute for Entrepreneurship at the Cox School of Business at Southern
Methodist University. Mr. McLelland holds an MBA degree from the University of
Chicago and a Master of International Affairs from Columbia. He did his
undergraduate studies at the University of South Florida and also studied
Mandarin at the National Normal University in Taiwan.
.
Mr. Xianghua Li, Director, 64,
Mr. Xianghua Li has served as an independent Director since September
2008. Mr. Li was the vice chairman of China Fire Protection Association
since October 2003. Mr. Li had his diploma from Military School of
Mechanical Technology.
Mr. Xuewen Xiao, Director, 40,
Mr. Xuewen Xiao has served as an independent Director since September 2008. Mr.
Xiao has been the president of Chongqing Iron & Steel Design & Research
Institute and the chairman of CISDI Engineering Co, Ltd, a state-owned
company since March 2003. Mr. Xiao graduated from Tsinghua University
with Master of Science degree in Mechanical Engineering in 1994.
Mr. Guoyou Zhang,
Director, 57, Mr. Zhang has served as an independent Director
since April 2007. Mr. Zhang is currently the Vice President of Beijing
University and the director of the Institute of International Business
Management, Beijing University. Professor Zhang has extensive experience in
teaching economics and business management and has written and/or edited many
published articles and books over the past 20 years. Mr. Zhang has been teaching
in Beijing University since 1976. He received his Ph.D. degree in Economics from
Beijing University in 1991.
Family
Relationships
Mr.
Weigang Li is the brother of Mr. Gangjin Li, Chairman of the Board.
Board
Composition and Committees
Our Board
has seven (7) members, of which four (4) are independent directors. We have an
Audit Committee, a Compensation Committee and a Nominating and Corporate
Governance Committee. The Audit Committee has been established as a separately
designated standing committee in accordance with section 3(a)(58)(A) of the
Exchange Act. The Audit Committee has at least one member, Mr. Albert Mclelland,
who meets the definition of a “financial expert” under SEC rules and whom the
Board has determined to be “independent”.
Audit Committee. The Audit
Committee is currently comprised of Mr. Albert Mclelland, Mr. Xianghua Li and
Mr. Guoyou Zhang with Mr. Albert Mclelland as the chairman, each of whom are
“independent” as that term is defined by SEC rules and under the NASDAQ listing
standards. The Audit Committee is directly responsible for the appointment,
retention, compensation and oversight of the work of any registered public
accounting firm employed by the Company (including resolution of disagreements
between management and the accounting firm regarding financial reporting) for
the purpose of preparing or issuing an audit report or related work or
performing other audit, review or other services. The Audit Committee has the
ultimate authority and responsibility to evaluate and, where appropriate,
replace the registered public accounting firm. The Audit Committee has the
authority to review and approve transactions between the Company and its
directors, officers and affiliates.
Compensation Committee. The
Compensation Committee is responsible for the administration of all salary,
bonus and incentive compensation plans for our officers and key employees. The
members of the Compensation Committee are Mr. Guoyou Zhang, Mr. Xianghua Li and
Mr. Xuewen Xiao, with Mr. Guoyou Zhang as the chairman. All of the members of
the Compensation Committee are “independent” directors.
Nominating and Corporate Governance
Committee. The Nominating and Corporate Governance Committee is
responsible for preparing the list of candidates to fill the expiring terms of
directors on our Board of Directors. The committee submits the list of
candidates to the Board of Directors who determines which candidates will be
nominated to serve on the Board of Directors. The nominees are then submitted
for election at the annual meeting of stockholders. The committee also submits
to the entire Board of Directors, a list of candidates to fill any interim
vacancies on the Board of Directors resulting from the departure of a member of
the Board of Directors for any reason prior to the expiration of his term. In
recommending candidates for the Board of Directors, the committee keeps in mind
the functions of this body.
The
committee considers various criteria, including the ability of the individual to
meet SEC and NASDAQ “independence” requirements, general business experience,
general financial experience, knowledge of the company’s industry
(including past industry experience), education, and demonstrated character and
judgment. The committee will consider director candidates recommended by a
stockholder if the stockholder mails timely notice to the secretary of the
Company at its principal offices, which notice includes (i) the name, age and
business address of such nominee, (ii) the principal occupation of such nominee,
(iii) a brief statement as to such nominee’s qualifications, (iv) a statement
that such nominee consents to his or her nomination and will serve as a director
if elected, (v) whether such nominee meets the definition of an “independent”
director under the SEC rules and under NASDAQ listing standards and (vi) the
name, address, class and number of shares of company stock held by the
nominating stockholder.
Any
person nominated by a stockholder for election to the Board of Directors will be
evaluated based on the same criteria as all other nominees. The committee also
oversees our adherence to our corporate governance standards. The members
of the committee are Mr. Xuewen Xiao, Mr. Guoyou Zhang, and Mr. Xianghua Li,
with Xuewen Xiao as the chairman.
The Board
had 11 meetings during last fiscal year. All members attended at
least 75% of the meetings.
Section
16(a) Beneficial Ownership Reporting Compliance
Section
16(a) of the Exchange Act requires our executive officers, directors and
beneficial owners of more than ten percent (10%) to report their beneficial
ownership of equity interests in the company to the SEC. Their initial reports
are required to be filed using the SEC's Form 3, and they are required to report
subsequent purchases, sales, and other changes using the SEC's Form 4, which
must be filed within two business days of most transactions. Officers,
directors, and persons owning more than 10% of our capital shares are required
by SEC regulations to furnish us with copies of all of reports they file
pursuant to Section 16(a).
Mr.
Xiaoyuan Yuan, Principal Financial Officer of the Company, did not file the
required Form 3 in a timely manner. Directors, Mr. Albert
McLelland, Xuewen Xiao and Mr. Xianghua Li, did not file the required Form 3 in
a timely manner. Worldtime Investment Advisors, Ltd. did not file the required
Form 5 in a timely manner.
Code
of Ethics
We have
adopted a Code of Ethics (as defined in Item 406 of Regulation S-K) that applies
to our principal executive, financial and accounting officers. China Fire &
Security Group, Inc. will provide a copy of its code of ethics, without charge,
to any person that requests it. Requests should be addressed in writing to Mr.
Brian Lin, Chief Executive Officer, B-2508 TYG Center, C2 Dongsanhuanbeilu,
Chaoyang District, Beijing 100027, People’s Republic of China.
Item 11. Executive
Compensation
Compensation Discussion and
Analysis
The
Company’s executive compensation program is designed to pay key management
personnel competitive remuneration based on the authority, responsibility and
accountability of the position held by the individual. In addition, the Company
considers the competitive environment relative to compensation paid to senior
management with comparable job scopes in companies in related industries and of
the same approximate size.
Our
senior officers receive compensation in the form of salaries, annual bonuses and
stock options. We have entered into service agreements with each of our senior
officers. None of these service agreements provide benefits to our senior
officers upon termination.
An
understanding of our executive compensation program begins with an understanding
of the objectives the program is intended to serve. These include:
|
|
·
|
Offering
competitive compensation. We seek to offer a compensation
package that is attractive and competitive with the compensation practices
of the peer companies with which we compete for
talent.
|
|
|
·
|
Rewarding
performance. Our
compensation program is intended to closely align executive compensation
with performance by tying a significant portion of compensation to the
achievement of financial and other Company goals and the executive’s
contributions to the accomplishment of those
goals.
|
|
|
·
|
Aligning
the interests of our executives with those of our shareholders. Over 90% of the total
compensation paid to our Named Executive Officers is in the form of
equity-based compensation. This serves to further align the interests of
our executives with those of our
shareholders.
|
Elements
of Our Executive Compensation Programs
Our
Compensation mainly consists of two parts, Cash Compensation and Equity
Incentive Compensation. The Cash Compensation consists of Base Salary and Bonus.
The Equity Incentive Compensation aligns executives’ and shareholders’ interests
by providing executives an ownership stake in the Company.
Base
Salary. Base salaries for our named executives are set based on their
professional qualifications and experiences, education background, scope of
their responsibilities, taking into account competitive market compensation
levels paid by other similar-sized companies for similar positions and
reasonableness and fairness when compared to other similar positions of
responsibility within the Company. Base salaries are reviewed annually by the
Compensation Committee and may be adjusted annually as
needed.
Bonus. To
achieve our goal of pay-for-performance, bonuses will be paid to our named
executives when company financial goals are achieved. The bonus is typically a
percentage of the Base Salary and is part of the cash compensation of our named
executives. The Compensation Committee has determined that when the Company
actual financial results are better than the guidance provided by the Company,
the bonuses will be paid in full. Otherwise, no bonuses will be paid to our
named executives. The financial guidance was determined based on the
condition of the industry and industry trends in the fire protection market and
the historical financial performance of the Company. The financial guidance
approved by the board of directors in fiscal year 2008 was $60.7 million in
revenue and $21.8 million in net income, representing 30% growth compared to the
results in fiscal year 2007. The actual financial results in 2008 were $69.1
million in revenue and $24.7 million in net income, which surpassed the
financial guidance. Consequently, the bonuses to Mr. Brian Lin and Mr. Xiaoyuan
Yuan were fully paid in fiscal year 2008.
Equity
Incentive Compensation. A key element of our pay-for-performance philosophy is
our reliance on performance-based equity awards through the Company’s stock
option plan. This program aligns executives’ and shareholders’ interests by
providing executives an ownership stake in the Company. Our Compensation
Committee has the authority to award equity incentive compensation, i.e. stock
options, to our executive officers in such amounts and on such terms as the
Compensation Committee determines in its sole discretion. The Compensation
Committee reviews each executive’s individual performance and his or her
contribution to our strategic goals and determines the amount of stock options
to be awarded towards the end of the fiscal year. The exercise price is the
closing market price on the date of the grant.
The
following is a discussion of our executive compensation program and the
compensation decisions made for fiscal year 2008 with respect the executive
officers named in the Compensation Table on page 44.
In 2008,
the Compensation Committee, which is responsible for approving and overseeing
executive compensation, accepted recommendations from senior management and
reviewed such recommendations with market data to determine the compensation to
be paid to the Company’s executive officers. Important determining factors
included the Company’s financial performance, the level of compensation paid to
similarly situated executives in comparably-sized public companies and the
contributions made by each of the executive officers to the success of the
Company.
How Executive Compensation
is Determined
The
Compensation Committee of the company seeks to offer our executives compensation
packages that are attractive and competitive with compensation practices of the
peer companies with which we might compete for talent. The Compensation
Committee has determined that a peer company would have the following
characteristics:
|
·
|
majority
of the business is providing solutions and systems to industrial customers
in China
|
|
·
|
listed
on a major exchange in the United States with market capitalization
between US$200 million to US$800
million
|
The
Compensation Committee collected the executive compensation information of the
following companies (“Comparison Group”) during the course of discussing and
finalizing the compensation for our executives.
|
|
|
|
Fiscal
Year 2007
|
|
|
|
|
|
Salary
|
|
|
Option
|
|
|
Total
|
|
1
|
|
China
Security & Surveillance (CSR)
|
|
|
|
|
|
CEO
|
|
|
40,840 |
|
|
|
206,304 |
|
|
|
247,144 |
|
|
|
CFO
|
|
|
153,594 |
|
|
|
206,304 |
|
|
|
359,898 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2
|
|
China
Information Security Technology, Inc. (CPBY)
|
|
|
|
|
|
CEO
|
|
|
45,949 |
|
|
|
369,000 |
|
|
|
414,949 |
|
|
|
CFO
|
|
|
60,360 |
|
|
|
- |
|
|
|
60,360 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
COGO
Group, Inc. (COGO)
|
|
|
|
|
|
CEO
|
|
|
30,776 |
|
|
|
271,339 |
|
|
|
302,115 |
|
|
|
CFO
|
|
|
125,000 |
|
|
|
752,994 |
|
|
|
877,994 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
Harbin
Electric, Inc. (HRBN)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CEO
|
|
|
23,715 |
|
|
|
47,784 |
|
|
|
71,499 |
|
|
|
CFO
|
|
|
14,229 |
|
|
|
31,856 |
|
|
|
46,085 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5
|
|
Shengdatech,
Inc. (SDTH)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CEO
|
|
|
300,000 |
|
|
|
- |
|
|
|
300,000 |
|
|
|
CFO
|
|
|
100,000 |
|
|
|
- |
|
|
|
100,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6
|
|
Wonder
Auto Technology, Inc. (WATG)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CEO
|
|
|
90,000 |
|
|
|
- |
|
|
|
90,000 |
|
|
|
CFO
|
|
|
60,000 |
|
|
|
- |
|
|
|
60,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Highest
|
|
|
Lowest
|
|
|
|
|
|
|
|
CEO
|
|
|
414,949 |
|
|
|
71,499 |
|
|
|
|
|
|
|
CFO
|
|
|
877,994 |
|
|
|
46,085 |
|
|
|
|
|
The
Compensation Committee conducted a comparison of the proposed executive
compensation structure and practices to those of the Comparison Group, including
base salary, target bonus and equity grants. The market analysis developed was
used to determine pay targets for 2008.
In 2008, the proposed compensation for
Mr. Brian Lin is as
follows:
Cash Compensation: $120,000 where the
Base Salary is $84,000 (70%) and the Bonus is $36,000 (30%). The Bonus will be
paid in full if the company’s actually financial results meet or beat the financial
guidance approved by the board of directors and released to the public.
Otherwise, no Bonus will be paid to Brian Lin.
Equity Compensation: Per stock option
agreement dated July 1, 2006, 18,750 options shares will be vested during the year of 2008. There is no additional
equity based compensation for Brian Lin in 2008.
In 2008, the proposed compensation for
Mr. Xiaoyuan Yuan is as
follows:
Cash Compensation: $36,800 where the
Base Salary is $29,440 (80%) and the Bonus is $7,360 (20%). The Bonus will be paid in
full if the company’s actually financial results meet or
beat the financial guidance approved by the board of directors and released to
the public. Otherwise, no Bonus will be paid to Xiaoyuan
Yuan.
Equity Compensation: Per stock option agreement dated
July 1, 2007, 5,000 options shares will be vested during the
year of 2008. There is no additional equity based compensation for Xiaoyuan Yuan
in 2008.
Based on
its review in 2008, the Compensation Committee concluded that the structure of
CFSG’s proposed compensation program is reasonably consistent with industry
practices. The target parameters for the compensation of Mr. Brian
Lin, our CEO and Mr. Xiaoyuan Yuan, our Principal Accounting Officer, in fiscal
year 2008 were determined based on the range of compensation for the above
Comparison Group. The actual compensation for Mr. Brian Lin in fiscal
year 2008 was $124,000, which fell within the targeted parameters of $71,499 and
$414,949 for CEOs. The actual compensation for Mr. Xiaoyuan Yuan in fiscal year
2008 was $49,900, which also fell within the targeted parameters of
$46,085 to $877,944 for CFOs.
The
Compensation Committee reviewed and approved the compensation paid to the named
executives of the company as listed in the Compensation Table. Recommendations
for annual increases in compensation to named executives other than our CEO are
recommended by our CEO. These recommendations are presented to the Compensation
Committee and are subject to their approval. The annual increase in compensation
of the CEO was both recommended and approved by our Compensation Committee Pay
increases for non-named employee will be at the discretion of the employee’s
supervisor and subject to senior management approval.
Stock-Based
Compensation Plans
In
2008, our board of directors and shareholders adopted our 2008 stock option
plan. The Plan is intended to enhance the Company’s and its Affiliates’ (as
defined herein) ability to attract and retain highly qualified officers,
directors, key employees and other persons, and to motivate such officers,
directors, key employees and other persons to serve the Company and its
Affiliates and to expend maximum effort to improve the business results and
earnings of the Company, by providing to such persons an opportunity to acquire
or increase a direct proprietary interest in the operations and future success
of the Company. To this end, the Plan provides for the grant of stock options,
stock appreciation rights, restricted stock, restricted stock units,
unrestricted stock and cash awards. At the time of adoption, 2,000,000 common
shares were reserved for issuance under the plan. The plan has a term of ten
years but may be terminated earlier by our board of directors.
We have
not issued stock based compensations to any of our executives nor directors in
2008. On January 2, 2009, pursuant to the Company's 2008 Omnibus Long-term
Incentive Plan, the Company's Board of Directors authorized the issuance of
1,000,000 shares of options for its employees with a total of 800,000 shares
options issued to executive officers. The options will vest evenly
each quarter over the following four years, starting from the first quarter of
2009.
Compensation
Table
Name & Principal
Position
|
|
Year
|
|
Salary
|
|
|
Bonus
|
|
|
Option*
Awards
|
|
|
All other
Compensation
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gangjin
Li, Chairman**
|
|
2008
|
|
$
|
65,800
|
|
|
|
—
|
|
|
$
|
8,400
|
|
|
|
—
|
|
$
|
74,200
|
|
|
2007
|
|
|
65,800
|
|
|
|
—
|
|
|
|
62,550
|
|
|
|
—
|
|
|
128,350
|
|
|
2006
|
|
|
12,000
|
|
|
|
—
|
|
|
|
257,600
|
|
|
|
—
|
|
|
269,600
|
Brian
Lin, CEO and PAO prior to August 2008
|
|
2008
|
|
$
|
120,000
|
|
|
|
—
|
|
|
$
|
4,200
|
|
|
|
—
|
|
$
|
124,200
|
|
|
2007
|
|
|
120,000
|
|
|
|
—
|
|
|
|
31,275
|
|
|
|
—
|
|
|
151,275
|
|
|
2006
|
|
|
12,000
|
|
|
|
—
|
|
|
|
128,800
|
|
|
|
—
|
|
|
140,800
|
Xiaoyuan
Yuan, Principal Accounting Officer (since August 2008)
|
|
2008
|
|
$
|
36,800
|
|
|
|
—
|
|
|
$
|
14,300
|
|
|
|
—
|
|
$
|
49,900
|
*The
assumptions made in valuing the option were disclosed in the financial
statements Note 14.
**Mr. Li
has not been involved in the day-to-day operation of the Company
since January 2008.
Grants
of Plan-Based Awards
The
Company currently does not have any award plans. No options were granted to any
officer in 2008.
Outstanding
Equity Awards at Fiscal Year-End Table
The
following table provides information concerning unexercised options, stock that
has not vested, and equity incentive plan awards for our named executive
officers outstanding as of December 31, 2008.
|
|
Option
Awards
|
|
Name
|
|
Number
of
Securities
Underlying
Unexercised
Options
(#)
Exercisable
|
|
Number
of
Securities
Underlying
Unexercised
Options
(#)
Unexercisable
|
|
Equity
Incentive
Plan
Awards:
Number
of
Securities
Underlying
Unexercised
Unearned
Options
(#)
|
|
Option
Exercise
Price
($)
|
|
Option
Expiration
Date
|
|
Brian
Lin
|
|
|
150,000
|
|
0
|
|
|
|
|
1.25
|
|
June
30, 2016
|
|
Gangjin
Li
|
|
|
300,000
|
|
0
|
|
|
|
|
1.25
|
|
June
30, 2016
|
|
Xiaoyuan
(Robert) Yuan
|
|
|
7,500
|
|
12,500
|
|
|
|
|
6.70
|
|
June
30, 2012
|
|
Option
Exercises and Stock Vested
No
options were exercised and no shares of stock were vested in 2008.
Pension
Benefits
The
Company does not have any pension plans for its officers.
Nonqualified
Deferred Compensation
There was
no nonqualified deferred compensation for the officers in 2008.
Potential
Payment Upon Termination or Change in Control
The
Company currently does not have payment arrangements for its officers upon
termination or change in control.
Director
Compensation
The
following table provides information concerning compensation paid by us to our
directors during the fiscal year ended December 31, 2008.
DIRECTOR
COMPENSATION
Name
|
|
Fees
Earned
or Paid
in Cash
($)
|
|
Stock
Awards
($)
|
|
Option
Awards
($)
|
|
|
Non-Equity
Incentive Plan
Compensation
($)
|
|
|
Nonqualified
Deferred
Compensation
Earnings
|
|
|
All Other
Compensation
($)
|
|
|
Total
($)
|
|
Gene
Bennett (1)
|
|
|
20,100
|
|
|
|
|
5,368
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
25,468
|
|
Qihong
Wu (1)
|
|
|
5,400
|
|
|
|
|
3,068
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,468
|
|
Yushen
Liu (1)
|
|
|
5,400
|
|
|
|
|
3,068
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,468
|
|
Guoyou
Zhang
|
|
|
14,800
|
|
|
|
|
3,068
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,868
|
|
Xuewen
Xiao (2)
|
|
|
7,700
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7,700
|
|
Xianghua
Li (2)
|
|
|
5,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,800
|
|
Albert
McLelland (2)
|
|
|
18,300
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,300
|
|
(1)
Represents directors resigned in September 2008.
(2)
Represents directors took office in September 2008.
Compensation
Committee Report
The
Compensation Committee has reviewed and discussed the Compensation Analysis and
Discussion with the management of the Company. Based on the review and the
discussions, the Compensation Committee recommended to Board of Directors that
the Compensation Analysis and Discussions be included in the
Company’s annual report on Form 10-K. The members of the Compensation
Committee are:
Mr.
Guoyou Zhang, Chairman
Mr.
Xianghua Li
Mr.
Xuewen Xiao
Item
12. Security Ownership Of Certain Beneficial Owners And Management And Related
Shareholders Matters
The
following table sets forth certain information regarding the beneficial
ownership of our Common Stock, including 27,586,593 shares of Common Stock,
10,000 warrants, and 830,750 stock options that are exercisable within 60 days
from March 13, 2009:
|
·
|
each person who is known by us to
be the beneficial owner of more than five percent (5%) of our issued
and outstanding shares of Common
Stock;
|
|
·
|
each of our directors, executive
officers and nominees to become directors;
and
|
|
·
|
all directors and executive
officers as a group.
|
Title of
Class
|
|
Name and Address of Beneficial Owner*
|
|
Amount and
Nature of
Beneficial Owner
|
|
|
Percent
of Class
|
|
Common
|
|
Li
Brothers Holding Inc.
|
|
|
12,768,000
|
(1)
|
|
|
44.91
|
%
|
Common
|
|
Vyle
Investment Inc.
|
|
|
2,622,000
|
(2)
|
|
|
9.22
|
%
|
Common
|
|
China
Honor Investment Limited
|
|
|
2,667,600
|
(3)
|
|
|
9.38
|
%
|
Common
|
|
Worldtime
Investments Advisors Ltd.
|
|
|
1,976,400
|
(4)
|
|
|
6.95
|
%
|
Common
|
|
Gangjin
Li
|
|
|
6,684,000
|
(5)
|
|
|
23.51
|
%
|
Common
|
|
Brian
Lin
|
|
|
955,350
|
(6)
|
|
|
3.36
|
%
|
Common
|
|
Weishe
Zhang
|
|
|
543,150
|
(7)
|
|
|
1.91
|
%
|
Common
|
|
Xiaoyuan
Yuan
|
|
|
8,750
|
(8)
|
|
|
0.03
|
%
|
Common
|
|
Weigang
Li
|
|
|
6,493,375
|
(9)
|
|
|
22.84
|
%
|
Common
|
|
Albert
Mclelland
|
|
0
|
|
|
|
0.00
|
%
|
Common
|
|
Xuewen
Xiao
|
|
|
0
|
|
|
|
0.00
|
%
|
Common
|
|
Xianghua
Li
|
|
0
|
|
|
|
0.00
|
%
|
Common
|
|
Guoyou
Zhang
|
|
|
2,000
|
(10)
|
|
|
0.01
|
%
|
Common
|
|
Directors
and executive officers as a group (9 persons)
|
|
|
14,686,625
|
(11)
|
|
|
51.66
|
%
|
*
|
The
address for the officers and directors is B-2508 TYG Center, C2
Dongsanhuanbeilu, Chaoyang District, Beijing 100027, People’s Republic of
China and Telephone (86-10) 8441
7400.
|
(1)
|
Li
Brothers Holding Inc. is a BVI company. Mr. Gangjin Li is the sole
director of Li Brothers Holding Inc. with 100% of voting power and owns
50% of economic interest. Mr. Weigang Li, the brother of Mr. Gangjin Li
and Vice President of Sureland Industrial, owns 50% of economic interest
of Li Brothers Holding Inc.
|
(2)
|
Vyle
Investment Inc. is a BVI company. Mr. Brian Lin is a director of Vyle
Investment Inc. with 100% of voting power and 30% ownership. Mr. Weishe
Zhang holds 20% ownership.
|
(3)
|
China
Honor Investment Limited is a BVI company of which Mr. Ang Li, the
son of Mr. Gangjin Li, has 100%
ownership.
|
(4)
|
Worldtime
Investment Advisors Limited is a BVI company of which Ms. Huiwen Liu,
sister-in-law of Mr. Brian Lin, is the sole director with 100% of voting
power, but without economic interest. Mr. Zengliang Feng owns 100% of
economic interest.
|
(5)
|
Represents
the number of shares of Common Stock plus options to purchase 300,000
shares of Common Stock that is exercisable within 60 days from March 13,
2009.
|
(6)
|
Represents
the number of shares of Common Stock plus options to purchase 168,750
shares of Common Stock that is exercisable within 60 days from March 13,
2009.
|
(7)
|
Represents
the number of shares of Common Stock plus options to purchase 18,750
shares of Common Stock that is exercisable within 60 days from March 13,
2009.
|
(8)
|
Represents
the number of options to purchase 8,750 shares of Common Stock that is
exercisable within 60 days from March 13,
2009.
|
(9)
|
Represents
the number of options to purchase 109,375 shares of Common Stock that is
exercisable within 60 days from March 13,
2009.
|
(10)
|
Represents
the number of options to purchase 2,000 shares of Common Stock that is
exercisable within 60 days from March 13, 2009.
|
|
|
(11)
|
Represents
the number of options to purchase 605,625 shares of Common Stock that is
exercisable within 60 days from March 13,
2009.
|
Item
13. Certain Relationships And Related Transactions and Director
Independence
The
Company has accounts receivable from Hubei Shou An Changjiang Fire Protection
Co., Ltd. (“Hubei Shou An”), in which the Company has 19% ownership interest.
The receivable due from Hubei Shou An was $466,223 as of December 31,
2008.
Item
14. Principal Accounting Fees And Services
Moore
Stephens Wurth Frazer and Torbet, LLP has audited our financial statements
annually since the 2004 fiscal year. All of the services described below were
approved by our board and audit committee prior to performance. The board has
determined that the payments made to its independent accountant for these
services are compatible with maintaining such auditor's
independence.
Audit
Fees
The
aggregate fees for professional services rendered by Moore Stephens Wurth Frazer
and Torbet, LLP in connection with its audit of our internal control over
financial reporting, audit of our annual consolidated financial statements in
our Form 10-K or 10-KSB and the review of our quarterly consolidated
financial statements included in our Forms 10-Q or 10-QSB for the
fiscal years ended December 31, 2008, 2007 and 2006 totaled
approximately $305,000, $245,000 and
$180,000 respectively.
Audit-Related
Fees
No fees
were paid or accrued by us for assurance and related services rendered by Moore
Stephens Wurth Frazer and Torbet, LLP in connection with its audit and review of
our financial statements for the fiscal years ended December 31, 2008,
2007 and 2006.
Tax
Fees
$10,000
and $5,000 were paid or accrued by us for professional services
rendered by Moore Stephens Wurth Frazer and Torbet, LLP for tax compliance, tax
advice and tax planning for the fiscal years December 31, 2008 and 2007,
respectively, and no fee were paid or accrued for the fiscal years ended
December 31, 2006.
All
Other Fees
No fees
were paid or accrued by us for other services rendered by Moore Stephens Wurth
Frazer and Torbet, LLP for the fiscal years ended December 31, 2008, 2007 and
2006.
PART
IV
Item
15. Exhibits and Financial Statement Schedules
(a)(1) The Following financial
statements are included in this Annual Report on Form 10-K commencing on the
page numbers specified below
Report
of Independent Registered Public Accounting Firm
|
|
F-1
|
|
|
|
Consolidated
Balance Sheets at December 31, 2008 and 2007
|
|
F-2
|
|
|
|
Consolidated
Statements of Income and Other Comprehensive Income for the Years Ended
December 31, 2008, 2007 and 2006
|
|
F-3
|
|
|
|
Consolidated
Statements of Shareholders’ equity
|
|
F-4
|
|
|
|
Consolidated
Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and
2006
|
|
F-5
|
|
|
|
Notes
to Consolidated Financial Statements
|
|
F-6
|
(2)
Financial Statement Schedules
None
(3)
Exhibits
The
exhibits listed on the Exhibit Index (following the Financial Statements of this
report) are included, or incorporated by reference, in this annual
report.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant certifies that it has duly caused this Annual Report on
Form 10-K/A to be signed on its behalf by the undersigned, thereunto duly
authorized, in Beijing.
|
CHINA
FIRE & SECURITY GROUP, INC.
|
|
|
|
Dated:
November 2, 2009
|
|
|
|
By:
|
/s/
Brian Lin
|
|
|
Brian
Lin
|
|
|
Chief
Executive Officer,
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this Annual Report
on Form 10-K/A has been signed by the following persons in the capacities
indicated as of November 2, 2009.
Signature
|
|
Title
|
|
|
|
/s/
Gangjin Li
|
|
Chairman
of the Board
|
Gangjin
Li
|
|
|
|
|
|
/s/
Brian Lin
|
|
Director
and Chief Executive Officer
|
Brian
Lin
|
|
|
|
|
|
/s/ Xiaoyuan
Yuan
|
|
Principal
Accounting Officer and Principal Financial Officer
|
Xiaoyuan
Yuan
|
|
|
|
|
|
/s/
Weishe Zhang
|
|
Director
and Chief Technology Officer
|
Weishe
Zhang
|
|
|
|
|
|
/s/ Albert
McLelland
|
|
Director
|
Albert
McLelland
|
|
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Stockholders of
China
Fire & Security Group, Inc.
We have
audited the accompanying consolidated balance sheets of China Fire &
Security Group, Inc. and subsidiaries as of December 31, 2008 and 2007, and
the related consolidated statements of income and other comprehensive income,
shareholders’ equity, and cash flows for each of the years in the three-year
period ended December 31, 2008. China Fire & Security Group, Inc.’s
management is responsible for these consolidated financial statements. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of China Fire & Security
Group, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results
of its operations and its cash flows for each of the years in the three-year
period ended December 31, 2008, in conformity with accounting principles
generally accepted in the United States of America.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), China Fire & Security Group, Inc.’s
internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated March 16, 2009 expressed an
adverse opinion.
/s/ Moore
Stephens Wurth Frazer and Torbet, LLP
Walnut
California
March 16,
2009
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
AS OF
DECEMBER 31, 2008 AND 2007
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
ASSETS
|
|
|
|
|
|
|
CURRENT
ASSETS:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
26,655,333
|
|
|
$
|
17,110,449
|
|
Restricted
cash
|
|
|
5,377,933
|
|
|
|
3,829,927
|
|
Notes
receivable
|
|
|
3,670,259
|
|
|
|
3,315,811
|
|
Accounts
receivable, net of allowance for doubtful accounts of $4,370,362 and
$2,483,359 as of December 31, 2008 and 2007, respectively
|
|
|
25,826,343
|
|
|
|
16,525,161
|
|
Receivables
from related party
|
|
|
466,223
|
|
|
|
-
|
|
Other
receivables
|
|
|
1,532,259
|
|
|
|
748,195
|
|
Inventories
|
|
|
6,538,938
|
|
|
|
4,048,283
|
|
Costs
and estimated earnings in excess of billings
|
|
|
17,821,708
|
|
|
|
13,068,036
|
|
Employee
advances
|
|
|
743,868
|
|
|
|
1,326,115
|
|
Prepayments
and deferred expenses
|
|
|
2,816,976
|
|
|
|
2,218,391
|
|
Total
current assets
|
|
|
91,449,840
|
|
|
|
62,190,368
|
|
|
|
|
|
|
|
|
|
|
PLANT
AND EQUIPMENT, net
|
|
|
8,445,254
|
|
|
|
6,568,250
|
|
|
|
|
|
|
|
|
|
|
OTHER
ASSETS:
|
|
|
|
|
|
|
|
|
Restricted
cash - non current
|
|
|
1,872,828
|
|
|
|
-
|
|
Accounts
receivable - retentions
|
|
|
1,107,450
|
|
|
|
193,029
|
|
Deferred
expenses - non current
|
|
|
-
|
|
|
|
21,234
|
|
Advances
on building and equipment purchases
|
|
|
249,859
|
|
|
|
366,317
|
|
Investment
in joint ventures
|
|
|
1,167,238
|
|
|
|
1,156,294
|
|
Intangible
assets, net of accumulated amortization
|
|
|
1,116,449
|
|
|
|
1,150,935
|
|
Total
other assets
|
|
|
5,513,824
|
|
|
|
2,887,809
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$
|
105,408,918
|
|
|
$
|
71,646,427
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS'
EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
6,664,090
|
|
|
$
|
6,327,182
|
|
Customer
deposits
|
|
|
6,102,026
|
|
|
|
4,757,179
|
|
Billings
in excess of costs and estimated earnings
|
|
|
4,237,528
|
|
|
|
4,882,217
|
|
Other
payables
|
|
|
837,973
|
|
|
|
168,868
|
|
Accrued
liabilities
|
|
|
6,785,409
|
|
|
|
4,214,530
|
|
Taxes
payable
|
|
|
2,092,745
|
|
|
|
1,088,335
|
|
Total
current liabilities
|
|
|
26,719,771
|
|
|
|
21,438,311
|
|
|
|
|
|
|
|
|
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
SHAREHOLDERS'
EQUITY:
|
|
|
|
|
|
|
|
|
Common
stock, $0.001 par value, 65,000,000 shares authorized, 27,586,593 shares
and 27,556,893 issued and outstanding as of December 31, 2008 and 2007,
respectively
|
|
|
27,586
|
|
|
|
27,556
|
|
Additional
paid-in-capital
|
|
|
19,357,409
|
|
|
|
19,317,287
|
|
Statutory
reserves
|
|
|
7,148,827
|
|
|
|
5,067,061
|
|
Retained
earnings
|
|
|
44,850,181
|
|
|
|
22,228,095
|
|
Accumulated
other comprehensive income
|
|
|
7,305,144
|
|
|
|
3,568,117
|
|
Total
shareholders' equity
|
|
|
78,689,147
|
|
|
|
50,208,116
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities and shareholders' equity
|
|
$
|
105,408,918
|
|
|
$
|
71,646,427
|
|
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of this statement.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR THE
YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
REVENUES
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
$
|
57,101,984
|
|
|
$
|
34,581,376
|
|
|
$
|
24,008,170
|
|
Products
|
|
|
9,673,922
|
|
|
|
10,592,683
|
|
|
|
7,701,986
|
|
Maintenance
services
|
|
|
2,303,213
|
|
|
|
1,579,778
|
|
|
|
744,880
|
|
Total
revenues
|
|
|
69,079,119
|
|
|
|
46,753,837
|
|
|
|
32,455,036
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF REVENUES
|
|
|
|
|
|
|
|
|
|
|
|
|
System
contracting projects
|
|
|
25,805,086
|
|
|
|
16,158,844
|
|
|
|
12,893,082
|
|
Products
|
|
|
2,558,844
|
|
|
|
4,329,067
|
|
|
|
3,272,438
|
|
Maintenance
services
|
|
|
1,217,316
|
|
|
|
602,943
|
|
|
|
60,787
|
|
Total
cost of revenues
|
|
|
29,581,246
|
|
|
|
21,090,854
|
|
|
|
16,226,307
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
39,497,873
|
|
|
|
25,662,983
|
|
|
|
16,228,729
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSE
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
and marketing
|
|
|
6,434,887
|
|
|
|
3,907,067
|
|
|
|
2,827,838
|
|
General
and administrative
|
|
|
6,680,992
|
|
|
|
5,661,356
|
|
|
|
3,665,776
|
|
Depreciation
and amortization
|
|
|
712,269
|
|
|
|
535,751
|
|
|
|
498,499
|
|
Research
and development
|
|
|
2,102,976
|
|
|
|
672,379
|
|
|
|
1,258,172
|
|
Total
operating expense
|
|
|
15,931,124
|
|
|
|
10,776,553
|
|
|
|
8,250,285
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
FROM OPERATIONS
|
|
|
23,566,749
|
|
|
|
14,886,430
|
|
|
|
7,978,444
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income
|
|
|
929,919
|
|
|
|
581,192
|
|
|
|
738,680
|
|
Other
expense
|
|
|
(127,620
|
)
|
|
|
(14,932
|
)
|
|
|
(43,323
|
)
|
Interest
income
|
|
|
382,227
|
|
|
|
148,236
|
|
|
|
28,038
|
|
Interest
expense
|
|
|
-
|
|
|
|
-
|
|
|
|
(79,417
|
)
|
Change
in fair value of derivative instruments
|
|
|
-
|
|
|
|
1,205,791
|
|
|
|
(1,570,575
|
)
|
Total
other income (expense)
|
|
|
1,184,526
|
|
|
|
1,920,287
|
|
|
|
(926,597
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME
BEFORE PROVISION FOR INCOME TAXES
|
|
|
24,751,275
|
|
|
|
16,806,717
|
|
|
|
7,051,847
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PROVISION
FOR INCOME TAXES
|
|
|
47,423
|
|
|
|
5,081
|
|
|
|
82,206
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET
INCOME
|
|
|
24,703,852
|
|
|
|
16,801,636
|
|
|
|
6,969,641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OTHER
COMPREHENSIVE INCOME
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation adjustment
|
|
|
3,737,027
|
|
|
|
2,502,595
|
|
|
|
581,932
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
COMPREHENSIVE
INCOME
|
|
$
|
28,440,879
|
|
|
$
|
19,304,231
|
|
|
$
|
7,551,573
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BASIC
EARNINGS PER SHARE
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares
|
|
|
27,568,214
|
|
|
|
26,873,742
|
|
|
|
24,340,196
|
|
Earnings
per share
|
|
$
|
0.90
|
|
|
$
|
0.63
|
|
|
$
|
0.29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DILUTED
EARNINGS PER SHARE
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of shares
|
|
|
28,210,620
|
|
|
|
27,721,171
|
|
|
|
24,539,414
|
|
Earnings
per share
|
|
$
|
0.88
|
|
|
$
|
0.61
|
|
|
$
|
0.28
|
|
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of this statement.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS' EQUITY
|
|
|
|
|
|
Retained
Earnings
|
|
|
Owner
|
|
|
Accumulated
other
|
|
|
|
|
|
|
Common
Stock
|
|
|
Additional
|
|
|
Statutory
|
|
|
|
|
|
contribution
|
|
|
comprehensive
|
|
|
|
|
|
|
Shares
|
|
|
Par
value
|
|
|
paid-in-capital
|
|
|
reserves
|
|
|
Unrestricted
|
|
|
receivable
|
|
|
income
|
|
|
Totals
|
|
BALANCE,
December 31, 2005
|
|
|
24,000,000
|
|
|
$
|
24,000
|
|
|
$
|
6,056,058
|
|
|
$
|
3,458,325
|
|
|
$
|
65,554
|
|
|
$
|
(10,087,527
|
)
|
|
$
|
483,590
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,969,641
|
|
|
|
|
|
|
|
|
|
|
|
6,969,641
|
|
Collection
of contribution receivable
|
|
|
|
|
|
|
|
|
|
|
4,973
|
|
|
|
|
|
|
|
|
|
|
|
10,087,527
|
|
|
|
|
|
|
|
10,092,500
|
|
Cash
proceeds from investment in Sureland Equipment Co., Ltd
|
|
|
|
|
|
|
|
|
|
|
660,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
660,000
|
|
Issuance
of common stock
|
|
|
2,461,678
|
|
|
|
2,462
|
|
|
|
6,028,140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,030,602
|
|
Options
issued to employees
|
|
|
|
|
|
|
|
|
|
|
644,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
644,000
|
|
Adjustment
to statutory reserves
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
572,302
|
|
|
|
(572,302
|
)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
581,932
|
|
|
|
581,932
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE,
December 31, 2006
|
|
|
26,461,678
|
|
|
$
|
26,462
|
|
|
$
|
13,393,171
|
|
|
$
|
4,030,627
|
|
|
$
|
6,462,893
|
|
|
$
|
-
|
|
|
$
|
1,065,522
|
|
|
$
|
24,978,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,801,636
|
|
|
|
|
|
|
|
|
|
|
|
16,801,636
|
|
Warrants
reclassified from liabilities
|
|
|
|
|
|
|
|
|
|
|
1,475,020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,475,020
|
|
Issuance
of common stock
|
|
|
984,680
|
|
|
|
983
|
|
|
|
4,164,214
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,165,197
|
|
Warrants
exercised
|
|
|
110,535
|
|
|
|
111
|
|
|
|
(111
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Warrants
issued for services
|
|
|
|
|
|
|
|
|
|
|
94,274
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
94,274
|
|
Options
issued to employees
|
|
|
|
|
|
|
|
|
|
|
190,719
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
190,719
|
|
Adjustment
on registered capital
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(605,000
|
)
|
|
|
605,000
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Adjustment
on statutory reserves
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,641,434
|
|
|
|
(1,641,434
|
)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,502,595
|
|
|
|
2,502,595
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE,
December 31, 2007
|
|
|
27,556,893
|
|
|
$
|
27,556
|
|
|
$
|
19,317,287
|
|
|
$
|
5,067,061
|
|
|
$
|
22,228,095
|
|
|
$
|
-
|
|
|
$
|
3,568,117
|
|
|
$
|
50,208,116
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24,703,852
|
|
|
|
|
|
|
|
|
|
|
|
24,703,852
|
|
Warrants
exercised
|
|
|
29,700
|
|
|
|
30
|
|
|
|
(30
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Options
issued to employees
|
|
|
|
|
|
|
|
|
|
|
40,152
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
40,152
|
|
Adjustment
on statutory reserves
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,081,766
|
|
|
|
(2,081,766
|
)
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Foreign
currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,737,027
|
|
|
|
3,737,027
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE,
December 31, 2008
|
|
|
27,586,593
|
|
|
$
|
27,586
|
|
|
$
|
19,357,409
|
|
|
$
|
7,148,827
|
|
|
$
|
44,850,181
|
|
|
$
|
-
|
|
|
$
|
7,305,144
|
|
|
$
|
78,689,147
|
|
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of this statement.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
FOR THE
YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
24,703,852
|
|
|
$
|
16,801,636
|
|
|
$
|
6,969,641
|
|
Adjustments
to reconcile net income to cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
728,080
|
|
|
|
555,604
|
|
|
|
526,240
|
|
Amortization
|
|
|
75,041
|
|
|
|
54,257
|
|
|
|
13,041
|
|
Provision
for doubtful accounts
|
|
|
1,683,336
|
|
|
|
1,111,051
|
|
|
|
691,242
|
|
(Gain)
Loss on disposal of equipment
|
|
|
(35,689
|
)
|
|
|
17,715
|
|
|
|
23,635
|
|
Stock
compensation to employees
|
|
|
40,152
|
|
|
|
190,719
|
|
|
|
644,000
|
|
Warrants
issued for services
|
|
|
-
|
|
|
|
94,274
|
|
|
|
-
|
|
Change
in fair value of derivative instruments
|
|
|
-
|
|
|
|
(1,205,791
|
)
|
|
|
1,570,575
|
|
Provision
for estimated warranty claims
|
|
|
518,940
|
|
|
|
-
|
|
|
|
-
|
|
Change
in operating assets and liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes
receivable
|
|
|
(120,143
|
)
|
|
|
(2,256,606
|
)
|
|
|
377,087
|
|
Accounts
receivable
|
|
|
(10,571,077
|
)
|
|
|
(3,206,458
|
)
|
|
|
(6,222,846
|
)
|
Receivables
from related party
|
|
|
(458,119
|
)
|
|
|
-
|
|
|
|
-
|
|
Other
receivables
|
|
|
(718,956
|
)
|
|
|
182,485
|
|
|
|
69,393
|
|
Inventories
|
|
|
(2,168,821
|
)
|
|
|
416,317
|
|
|
|
(1,664,322
|
)
|
Costs
and estimated earnings in excess of billings
|
|
|
(3,771,899
|
)
|
|
|
(3,286,191
|
)
|
|
|
(3,125,106
|
)
|
Employee
advances
|
|
|
663,369
|
|
|
|
419,589
|
|
|
|
(272,928
|
)
|
Prepayments
and deferred expenses
|
|
|
(412,888
|
)
|
|
|
334,603
|
|
|
|
(621,609
|
)
|
Accounts
payable
|
|
|
(98,219
|
)
|
|
|
(117,311
|
)
|
|
|
2,015,302
|
|
Customer
deposits
|
|
|
994,154
|
|
|
|
1,781,869
|
|
|
|
928,949
|
|
Billings
in excess of costs and estimated earnings
|
|
|
(969,403
|
)
|
|
|
(4,418,793
|
)
|
|
|
5,635,038
|
|
Other
payables
|
|
|
645,855
|
|
|
|
(287,672
|
)
|
|
|
(100,911
|
)
|
Accrued
liabilities
|
|
|
1,722,071
|
|
|
|
2,168,961
|
|
|
|
1,483,068
|
|
Taxes
payable
|
|
|
912,068
|
|
|
|
422,856
|
|
|
|
(4,428
|
)
|
Net
cash provided by operating activities
|
|
|
13,361,704
|
|
|
|
9,773,114
|
|
|
|
8,935,061
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase
of plant and equipment
|
|
|
(2,015,051
|
)
|
|
|
(3,419,056
|
)
|
|
|
(583,208
|
)
|
Advances
on building and equipment purchase
|
|
|
-
|
|
|
|
(351,809
|
)
|
|
|
-
|
|
Proceeds
from sale of equipment
|
|
|
69,852
|
|
|
|
20,820
|
|
|
|
22,979
|
|
Purchase
of intangible assets
|
|
|
-
|
|
|
|
(613,582
|
)
|
|
|
-
|
|
Payments
for investment in Hubei Sureland Changjiang Fire Safety Technology Co.,
Ltd.
|
|
|
-
|
|
|
|
(150,104
|
)
|
|
|
-
|
|
Payments
for investment in King Galaxy Investments Limited
|
|
|
-
|
|
|
|
(1,000,000
|
)
|
|
|
-
|
|
Payments
for acquisition of Sureland Industrial assets
|
|
|
-
|
|
|
|
-
|
|
|
|
(10,087,527
|
)
|
Payments
for investment in Tianjin Fire Safety Equipment Co., Ltd.
|
|
|
-
|
|
|
|
-
|
|
|
|
(301,996
|
)
|
Proceeds
from sale of investment in Tianjin Fire Safety Equipment Co.,
Ltd.
|
|
|
-
|
|
|
|
514,856
|
|
|
|
-
|
|
Proceeds
from sale of Beijing Zhong Xiao Fire Safety Technology Co.,
Ltd
|
|
|
-
|
|
|
|
1,068,897
|
|
|
|
-
|
|
Net
cash used in investing activities
|
|
|
(1,945,199
|
)
|
|
|
(3,929,978
|
)
|
|
|
(10,949,752
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in restricted cash
|
|
|
(3,097,855
|
)
|
|
|
(2,011,480
|
)
|
|
|
(35,017
|
)
|
Dividend
distributions to original shareholders and minority interest
shareholders
|
|
|
|
|
|
|
|
|
|
|
(8,886,800
|
)
|
Payments
on notes payables
|
|
|
-
|
|
|
|
-
|
|
|
|
(2,532,000
|
)
|
Proceeds
from note payables
|
|
|
-
|
|
|
|
-
|
|
|
|
2,496,000
|
|
Proceeds
from increase in paid-in capital
|
|
|
-
|
|
|
|
-
|
|
|
|
660,000
|
|
Proceeds
from original shareholders
|
|
|
-
|
|
|
|
-
|
|
|
|
10,092,500
|
|
Payments
to Beijing Zhong Xiao Fire Safety Technology Co., Ltd.
|
|
|
-
|
|
|
|
(2,466,395
|
)
|
|
|
-
|
|
Proceeds
from Beijing Zhong Xiao Fire Safety Technology Co., Ltd
|
|
|
-
|
|
|
|
1,364,630
|
|
|
|
-
|
|
Proceeds
from issuance of common stock
|
|
|
-
|
|
|
|
4,165,197
|
|
|
|
7,140,838
|
|
Net
cash (used in) provided by financing activities
|
|
|
(3,097,855
|
)
|
|
|
1,051,952
|
|
|
|
8,935,521
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EFFECT
OF EXCHANGE RATE CHANGES ON CASH
|
|
|
1,226,234
|
|
|
|
789,270
|
|
|
|
147,862
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCREASE
IN CASH
|
|
|
9,544,884
|
|
|
|
7,684,358
|
|
|
|
7,068,692
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH
and CASH EQUIVALENTS, beginning of year
|
|
|
17,110,449
|
|
|
|
9,426,091
|
|
|
|
2,357,399
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH
and CASH EQUIVALENTS, end of year
|
|
$
|
26,655,333
|
|
|
$
|
17,110,449
|
|
|
$
|
9,426,091
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
taxes paid
|
|
$
|
29,048
|
|
|
$
|
46,390
|
|
|
$
|
147,822
|
|
Interest
paid
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
79,025
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
$
|
139,638
|
|
|
$
|
-
|
|
|
$
|
-
|
|
See
report of independent registered public accounting firm.
The
accompanying notes are an integral part of this statement.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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, manufacture and sale 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.
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.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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.
|
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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.
Enterprise Wide
Disclosure
Almost
all the Company’s products (fire detecting products, fire alarm control device,
and water mist/sprinkler systems) are sold via system contracting projects or as
part of the integrated products sales. The composition of these three types of
products varies significantly from project to project, both in quantity and in
dollar amounts. Although the Company could provide a breakdown of sales
contribution for 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.
The
Company’s chief operating decision-makers (i.e. chief executive officer and his
direct reports) review financial information presented on a consolidated basis,
accompanied by disaggregated information about revenues by business lines for
purposes of allocating resources and evaluating financial performance. There are
no segment managers who are held accountable for operations, operating results
and plans for levels or components below the consolidated unit level. Based on
qualitative and quantitative criteria established by SFAS 131, “Disclosures
about Segments of an Enterprise and Related Information”, the Company considers
itself to be operating within one reportable segment.
Shipping and
handling
Costs
related to shipping and 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 $7,305,144 and $3,568,117 as of December 31, 2008 and
2007, respectively. Asset and liability accounts at December 31, 2008
were translated at 6.82 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 years ended December 31, 2008, 2007 and 2006 were 6.94 RMB,
7.59 RMB and 7.96 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.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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 years ended December 31, 2008,
2007 and 2006, depreciation expense amounted to $728,080, $555,604, and $526,240
respectively.
Estimated
useful lives of the assets are as follows:
|
Useful
Life
|
Buildings
and improvements
|
40
years
|
Transportation
equipment
|
5
years
|
Machinery
|
10
years
|
Office
equipment
|
5
years
|
Furniture
|
5
years
|
Construction
in progress represents the costs incurred in connection with the construction of
buildings or additions to the Company’s plant facilities. No depreciation is
provided for construction in progress until such time as the assets are
completed and placed into service.
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 December 31,
2008, the Company expects these assets to be fully recoverable.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
Plant and
equipment consist of the following:
|
|
December 31,
2008
|
|
|
December 31,
2007
|
|
Buildings
and improvements
|
|
$
|
6,417,304
|
|
|
$
|
5,077,373
|
|
Transportation
equipment
|
|
|
2,747,038
|
|
|
|
1,985,701
|
|
Machinery
|
|
|
1,249,470
|
|
|
|
970,500
|
|
Office
equipment
|
|
|
1,262,426
|
|
|
|
1,047,350
|
|
Furniture
|
|
|
90,882
|
|
|
|
35,972
|
|
Total
|
|
|
11,767,120
|
|
|
|
9,116,896
|
|
Less
accumulated depreciation
|
|
|
(3,321,866
|
)
|
|
|
(2,548,646
|
)
|
Plant
and equipment, net
|
|
$
|
8,445,254
|
|
|
$
|
6,568,250
|
|
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 December 31, 2008 and 2007,
the Company had deposits (including restricted cash balances) totaling to
$30,765,488 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.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
The
Company has one major customer who represents approximately 25% of the Company’s
sales for the year ended December 31, 2008. Accounts receivable from this
customer was $0 as of December 31, 2008. The Company had one major customer who
represents approximately 20% of the Company’s sales for the year ended December
31, 2007. Accounts receivable from this customer was $266,660 as of
December 31, 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. Cash and cash
equivalents also include unrestricted time deposits.
Restricted
cash
Restricted
cash represents cash required to be deposited in a separate bank account subject
to withdrawal restrictions by its system contracting projects and product sales
customers to guarantee its contracts will be performed. The deposit cannot be
drawn or transferred by the Company until the restriction period has
expired.
|
|
December 31,
2008
|
|
|
December 31,
2007
|
|
Restricted
cash
|
|
|
|
|
|
|
Products
sales
|
|
$
|
1,608,056
|
|
|
$
|
102,355
|
|
System
contracting projects
|
|
|
5,642,705
|
|
|
|
3,727,572
|
|
Total
restricted cash
|
|
|
7,250,761
|
|
|
|
3,829,927
|
|
Restricted
cash - non current
|
|
|
(1,872,828
|
)
|
|
|
-
|
|
Restricted
cash - current
|
|
$
|
5,377,
933
|
|
|
$
|
3,829,927
|
|
Inventories
Inventories
are stated at the lower of cost or market, using weighted average method.
Inventories consisted of the following as of December 31,
|
|
2008
|
|
|
2007
|
|
Raw
materials
|
|
$
|
896,797
|
|
|
$
|
310,255
|
|
Finished
goods
|
|
|
4,597,407
|
|
|
|
2,617,638
|
|
Work
in progress
|
|
|
1,044,734
|
|
|
|
1,120,390
|
|
Total
|
|
$
|
6,538,938
|
|
|
$
|
4,048,283
|
|
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
Raw
materials consist primarily of materials used in production. Finished goods
consist primarily of equipment used in product sales and system contracting
projects. The costs of finished goods include direct costs of raw materials as
well as direct labor used in production. Indirect production costs such as
utilities and indirect labor related to production such as assembling, shipping
and handling costs are also included in the cost of inventory. The
Company reviews its inventories periodically to determine if any reserves are
necessary for potential obsolescence. As of December 31, 2008 and 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. Delinquent account balances are written-off after
management has determined that the likelihood of collection is not probable,
known bad debts are written off against allowance for doubtful accounts when
identified.
Accounts
receivable consists of the following:
|
|
December 31,
2008
|
|
|
December 31,
2007
|
|
Accounts
receivable:
|
|
|
|
|
|
|
System
contracting projects
|
|
$
|
19,167,096
|
|
|
$
|
10,296,762
|
|
Maintenance
services
|
|
|
3,193,166
|
|
|
|
670,357
|
|
Products
sales
|
|
|
8,943,893
|
|
|
|
8,234,430
|
|
Total
accounts receivable
|
|
|
31,304,155
|
|
|
|
19,201,549
|
|
Allowance
for bad debts
|
|
|
(4,370,362
|
)
|
|
|
(2,483,359
|
)
|
Accounts
receivable, net
|
|
|
26,933,793
|
|
|
|
16,718,190
|
|
Accounts
receivable - non-current retentions
|
|
|
(1,107,450
|
)
|
|
|
(193,029
|
)
|
Accounts
receivable - current
|
|
$
|
25,826,343
|
|
|
$
|
16,525,161
|
|
The
activity in the allowance for doubtful accounts for trade accounts receivable
for the years ended December 31, 2008 and 2007 is as follows:
|
|
2008
|
|
|
2007
|
|
Beginning
allowance for doubtful accounts
|
|
$
|
2,483,359
|
|
|
$
|
1,252,947
|
|
Additional
charged to bad debt expense
|
|
|
1,683,336
|
|
|
|
1,111,051
|
|
Write-off
charged against the allowance
|
|
|
-
|
|
|
|
(12,700
|
)
|
Foreign
currency translation adjustment
|
|
|
203,667
|
|
|
|
132,061
|
|
Ending
allowance for doubtful accounts
|
|
$
|
4,370,362
|
|
|
$
|
2,483,359
|
|
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
Retentions
held by customers of system contracting projects included in the Company’s
accounts receivable as following:
|
|
December 31,
2008
|
|
|
December 31,
2007
|
|
Retentions
|
|
|
|
|
|
|
Current
|
|
$
|
3,685,136
|
|
|
$
|
2,829,250
|
|
Non-current
|
|
|
1,107,450
|
|
|
|
193,029
|
|
Total
retentions
|
|
$
|
4,792,586
|
|
|
$
|
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.
|
|
December 31,
2008
|
|
|
December 31,
2007
|
|
Contract
costs incurred plus recognized
|
|
|
|
|
|
|
profits
less recognized losses to date
|
|
$
|
68,149,817
|
|
|
$
|
50,877,880
|
|
Less:
progress billings
|
|
|
50,328,109
|
|
|
|
37,809,844
|
|
Costs
and estimated earnings in excess of billings
|
|
$
|
17,821,708
|
|
|
$
|
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.
|
|
December 31,
2008
|
|
|
December 31,
2007
|
|
Progress
billings
|
|
$
|
31,456,807
|
|
|
$
|
15,713,786
|
|
Less:
contracts costs incurred plus recognized
|
|
|
|
|
|
|
|
|
profits
less recognized losses to date
|
|
|
27,219,279
|
|
|
|
10,831,569
|
|
Billings
in excess of costs and estimated earnings
|
|
$
|
4,237,528
|
|
|
$
|
4,882,217
|
|
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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.
Warranty
Generally,
the Company’s products are not covered by specific warranty terms. However, it
is the Company’s policy to replace parts if they become defective within one
year after deployment at no additional charge. The Company maintains
a provision for potential warranty costs on these products for one
year. This provision represents management’s assessment of our
history of warranty costs while incorporating estimates by our quality review
staff of our potential product failure rates. The Company records a
warranty obligation in selling expense at the time of revenue are
recognized. For the years ended December 31, 2008, 2007 and 2006, the
Company made $518,940, $0 and $0, respectively, provision for estimated warranty
claims for our products.
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.
|
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
The
Company invested $167,238 (RMB 1,140,000) 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 December 31, 2008
amounted to $1,167,238. 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
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
|
|
December 31,
2008
|
|
|
December 31,
2007
|
|
Land
use rights
|
|
$
|
770,789
|
|
|
$
|
720,445
|
|
Technology
rights
|
|
|
608,745
|
|
|
|
608,745
|
|
Accumulated
amortization
|
|
|
(263,085
|
)
|
|
|
(178,255
|
)
|
Balance
|
|
$
|
1,116,449
|
|
|
$
|
1,150,935
|
|
Amortization
expense amounted to $75,041, $54,257, and $13,041 for the years ended December
31, 2008, 2007 and 2006, respectively.
Intangible
assets of the Company are reviewed annually, more often when circumstances
require, 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 December 31, 2008, the Company
expects these assets to be fully recoverable.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
Income
taxes
The
Company reports income taxes pursuant to SFAS 109, “Accounting for Income
Taxes”. 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 December 31, 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.
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.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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 $6,941,766 and $5,183,036 for the year
ended December 31, 2008, $6,279,253 and $4,485,292 for the year ended December
31, 2007, and $2,501,949 and $3,258,567 for the year ended December 31, 2006,
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 SFAS 123R “Accounting for Stock-Based Compensation” at the
beginning of 2006, which defines a fair-value-based method of accounting for
stock based employee compensation and transactions in which an entity issues its
equity instruments to acquire goods and services from non-employees. Stock
compensation for stock granted to non-employees has been determined in
accordance with SFAS 123R and the EITF. 96-18, "Accounting for Equity
Instruments that are issued to Other than Employees for Acquiring, or in
Conjunction with Selling Goods or Services", as the fair value of the
consideration received or the fair value of equity instruments issued, whichever
is more reliably measured.
Recently issued accounting
pronouncements
In
February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial
Assets and Financial Liabilities—including an amendment of FASB Statement No.
115. SFAS 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 SFAS 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.
SFAS 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 159 on January 1, 2008. The Company
chose not to elect the option to measure the fair value of eligible financial
assets and liabilities.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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 was effective beginning in 2008. 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.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and
Hedging Activities - An Amendment of SFAS No. 133”. 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 162, "The Hierarchy of Generally Accepted Accounting
Principles". 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 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.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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.
In
January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment
Guidance of EITF Issue No. 99-20, “Recognition of Interest Income and Impairment
on Purchased and Retained Beneficial Interests in Securitized Financial Assets”.
FSP EITF 99-20-1 changes the impairment model included within EITF 99-20 to be
more consistent with the impairment model of SFAS No. 115. FSP EITF 99-20-1
achieves this by amending the impairment model in EITF 99-20 to remove its
exclusive reliance on “market participant” estimates of future cash flows used
in determining fair value. Changing the cash flows used to analyze
other-than-temporary impairment from the “market participant” view to a holder’s
estimate of whether there has been a “probable” adverse change in estimated cash
flows allows companies to apply reasonable judgment in assessing whether an
other-than-temporary impairment has occurred. The adoption of FSP EITF 99-20-1
did not have a material impact on our consolidated financial statements because
all of our investments in debt securities are classified as trading
securities.
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.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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.
The
following is a reconciliation of the basic and diluted earnings per share
computation for the years ended December 31:
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Net
income for earnings per share
|
|
$
|
24,703,852
|
|
|
$
|
16,801,636
|
|
|
$
|
6,969,641
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares used in basic computation
|
|
|
27,568,214
|
|
|
|
26,873,742
|
|
|
|
24,340,196
|
|
Diluted
effect of stock options and warrants
|
|
|
642,406
|
|
|
|
847,429
|
|
|
|
199,218
|
|
Weighted
average shares used in diluted computation
|
|
|
28,210,620
|
|
|
|
27,721,171
|
|
|
|
24,539,414
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.90
|
|
|
$
|
0.63
|
|
|
$
|
0.29
|
|
Diluted
|
|
$
|
0.88
|
|
|
$
|
0.61
|
|
|
$
|
0.28
|
|
At
December 31, 2008 and 2007, all outstanding stock options and warrants were
included in the calculation of diluted earnings per share. At December 31, 2006,
1,169,306 warrants were excluded from the calculation because of their
antidilutive nature.
Note
4 – Related party transactions
The
Company has accounts receivable from Hubei Shou An Changjiang Fire Protection
Co., Ltd. (“Hubei Shou An”), in which the Company has 19% ownership interest.
The receivable due from Hubei Shou An was $114,388 and $0 as of December 31,
2008 and 2007, respectively. This balance was resulted from product sales
totaling $96,068 plus 17% VAT of $19,408 and resulted in translation loss of
$1,088. This amount was expected to be repaid by December 31, 2009 in
cash. .
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
The
Company has other receivable from Hubei Shou An, in which the Company has 19%
ownership interest. The receivable due from Hubei Shou An was $351,835 and $0 as
of December 31, 2008 and 2007, respectively. This balance was for the operating
capital in Hubei Shou An and expected to be repaid by June 30, 2009 in
cash.
Note
5 - Notes receivable
Notes
receivable represents trade accounts receivable due from various customers where
the customers’ bank has guaranteed the payment of the receivable. This amount is
non-interest bearing and is normally paid within three to 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 $3,670,259 and $3,315,811 as of December
31, 2008 and 2007, respectively.
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 $2,816,976 and
$2,218,391 as of December 31, 2008 and 2007, respectively.
Note
7 - Investment in joint ventures
During
the second quarter of 2007, the Company invested $167,238 (RMB 1,140,000) for a
19% interest in Hubei Shou An Changjiang Fire Protection Co., Ltd., located in
China Hubei, PRC. The investment is recorded under the cost
accounting method.
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.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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 December 31, 2008 and
2007, customer deposits amounted to $6,102,026 and $4,757,179,
respectively.
Note
9 - Accrued liabilities
Accrued
liabilities represent subcontractors’ expenses incurred as of balance sheet date
for system contracting projects. Accrued liabilities also represent accrued
estimation of warranty expenses. As of December 31, 2008 and 2007,
accrued liabilities amounted to $6,785,409 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.
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 were paying the following tax rate for the year ended
December 31, 2006.
Subsidiaries
|
|
Income
tax
exemption
|
|
|
Effective
income
tax
rate
|
|
Sureland
Industrial
|
|
|
9
|
%
|
|
|
24
|
%
|
Sureland
Equipment
|
|
|
33
|
%
|
|
|
0
|
%
|
Beijing
Hua An
|
|
|
33
|
%
|
|
|
0
|
%
|
Beijing
Zhong Xiao Fire Safety Technology Co., Ltd.
|
|
|
18
|
%
|
|
|
15
|
%
|
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
The
Company’s subsidiaries were paying the following tax rate for the year ended
December 31, 2007.
Subsidiaries
|
|
Income
tax
exemption
|
|
|
Effective
income
tax
rate
|
|
Sureland
Industrial
|
|
|
33
|
%
|
|
|
0
|
%
|
Sureland
Equipment
|
|
|
33
|
%
|
|
|
0
|
%
|
Beijing
Hua An
|
|
|
33
|
%
|
|
|
0
|
%
|
Tianxiao
Equipment
|
|
|
0
|
%
|
|
|
33
|
%
|
Beginning
from January 1, 2008, the new Enterprise Income Tax (“EIT”) law replaced the
existing income tax laws for Domestic Enterprises (“DES”) and Foreign Invested
Enterprises (“FIEs”).
The key
changes are:
a.
|
The
new standard EIT rate of 25% will replace the 33% rate currently
applicable to both DES and FIEs, except for High Tech companies who pays a
reduced rate of 15%;
|
b.
|
Companies
established before March 16, 2007 will continue to enjoy tax holiday
treatment approved by local government for a grace period of the next 5
years or until the tax holiday term is completed, whichever is
sooner.
|
The
Company’s subsidiaries are paying the following tax rate for the year ended
December 31, 2008.
Subsidiaries
|
|
Income
tax
exemption
|
|
|
Effective
income
tax
rate
|
|
Sureland
Industrial
|
|
|
25
|
%
|
|
|
0
|
%
|
Sureland
Equipment
|
|
|
12.5
|
%
|
|
|
12.5
|
%
|
Beijing
Hua An
|
|
|
25
|
%
|
|
|
0
|
%
|
Tianxiao
Equipment
|
|
|
0
|
%
|
|
|
25
|
%
|
The
provision for income taxes amounted to $47,423, $5,081, and $82,206 for the
years ended December 31, 2008, 2007 and 2006, respectively.
The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the years ended December 31:
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
U.S.
Statutory rates
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
Foreign
income not recognized in USA
|
|
|
(34.0
|
)
|
|
|
(34.0
|
)
|
|
|
(34.0
|
)
|
China
income taxes
|
|
|
25.0
|
|
|
|
33.0
|
|
|
|
33.0
|
|
China
income tax exemption
|
|
|
(24.8
|
)
|
|
|
(33.0
|
)
|
|
|
(32.0
|
)
|
Total
provision for income taxes
|
|
|
0.2
|
%
|
|
|
0.0
|
%
|
|
|
1.0
|
%
|
The
estimated tax savings for the years ended December 31, 2008, 2007 and 2006
amounted to $6,382,286, $5,441,008 and $3,206,276, respectively. If the income
tax had been applied, the net effect on both basic and diluted earnings per
share for the years ended December 31, 2008, 2007 and 2006 by $0.23, $0.20 and
$0.13, respectively.
China
Fire & Security Group, Inc. was incorporated in the United States and has
incurred net operating losses of $0, $47,946 and $3,478 for income tax purposes
for the years ended December 31, 2008, 2007 and 2006,
respectively. The net operating loss carry forwards for United States
income taxes amounted to $1,004,414 which may be available to reduce future
years’ taxable income. These carry forwards will expire, if not
utilize, from 2025 through 2027. Management believes that the
realization of the benefits from these losses appears uncertain due to the
Company’s limited operating history and continuing losses for United States
income tax purposes. Accordingly, the Company has provided a 100%
valuation allowance on the deferred tax asset benefit to reduce the asset to
zero. The net change in the valuation allowance for the year ended
December 31, 2008 was $0 and the accumulated valuation allowance as of December
31, 2008 amounted to $341,501. Management reviews this valuation
allowance periodically and makes adjustments as warranted.
Taxes
payable
Taxes
payable consisted of the following:
|
|
December
31,
2008
|
|
|
December
31,
2007
|
|
VAT
taxes payable
|
|
$
|
1,094,089
|
|
|
$
|
71,367
|
|
Income
taxes payable
|
|
|
38,406
|
|
|
|
5,915
|
|
Sales
taxes
|
|
|
936,164
|
|
|
|
979,999
|
|
Other
taxes payable
|
|
|
24,086
|
|
|
|
31,054
|
|
Total
|
|
$
|
2,092,745
|
|
|
$
|
1,088,335
|
|
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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 $250,720,
$158,279, and $37,444 for the years ended December 31, 2008, 2007 and 2006,
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 years ended December 31, 2008, 2007 and 2006, the Company
transferred $2,081,766, $1,641,434 and $572,302, respectively. 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 $6,515,000 (RMB 50,000,000) to
$13,030,000 (RMB 100,000,000). $605,000 (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. This
balance was reflected in the Company’s consolidated shareholders’ equity for the
year ended December 31, 2007.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
Enterprise
fund
The
enterprise fund may be used to acquire plant and equipment or to increase the
working capital to expend on production and operation of the business. No
minimum contribution is required and the Company did not make any contribution
to this fund for the years ended December 31, 2008, 2007 and 2006.
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 and Series B warrants issued to
certain investors on October 27 and December 5, 2006 pursuant to the Securities
Purchase Agreement in connection with a private placement (the “Amendment”). The
Amendment eliminates the right of the warrant holders to be paid in cash in the
event of a merger or other types of reorganization. The warrants no longer need
to be accounted for as derivative instrument liabilities. The fair value
of the warrants were transferred to equity on the signing date and no further
accounting (i.e., no mark-to-market) is required going forward. At April 26,
2007, the Company determined the fair value of the warrants was $1,475,020 using
the Cox-Ross-Rubinstein binomial model with the following assumptions:
volatility 25%; risk free interest rate 4.59%; dividend yield of 0% and expected
term of 4.5 years. On April 26, 2007, the fair value of the warrants was
transferred to additional paid-in capital.
In 2007,
492,340 series A warrants were exercised at $3.58 and 492,340 series B warrants
were exercised at $4.88 for a total of 984,680 shares of common stock. The
Company received a total of $4,165,197 from various warrant
holders.
In 2007,
a total of 179,626 warrants were converted into 110,535 shares of common stock
by the warrants holders using the cashless exercise options. In 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.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
On
February 1, 2007, CFPG issued 50,000 warrants to Hayden Communication, the
Company’s investor relations consultant, as part of its compensation. These
warrants meet the conditions for equity classification pursuant to SFAS 133 and
EITF 00-19. Therefore, the warrants were classified as equity and accounted as
compensation expenses. The warrants vested on February 1, 2008. The Company used
the Black Scholes model to value the options at the time they were issued, based
on the exercise price of $4.25 and expiration dates of the instruments, a
risk-free rate of 4.84% and volatility at 50%. These 50,000 warrants had a fair
value of $94,274 on the date of grant and were recognized over the one year
service period. In 2008, Hayden Communication converted 40,000 warrants into
26,066 shares of common stock in a cashless exercise.
The
Company’s warrant activity is as follows:
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
|
Warrants
|
|
|
Warrants
|
|
|
Exercise
|
|
|
Contractual
|
|
|
|
Outstanding
|
|
|
Exercisable
|
|
|
Price
|
|
|
Life
|
|
Outstanding,
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
1,169,306
|
|
|
|
1,169,306
|
|
|
$
|
4.23
|
|
|
|
5.00
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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,
December 31, 2008
|
|
|
10,000
|
|
|
|
10,000
|
|
|
$
|
4.25
|
|
|
|
2.09
|
|
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
Note
14 - Options issued to employees
On July
1, 2006, CFPG issued 750,000 options to the employees of Sureland Industrial.
Fifty percent of the options vest immediately, with the balance vesting evenly
each quarter over the following two years. The Company used the
Cox-Ross-Rubinstein binomial model to value the options at the time they were
issued, based on the stated exercise prices and expiration dates of the
instruments and using a risk-free rate of 5.11%. Because the Company does not
have a history of employee stock options, the estimated life is based on one
half of the sum of the vesting period and the contractual life of the option.
This is the same as assuming that the options are exercised at the mid-point
between the vesting date and expiration date.
The
Company’s stock was not traded when the options were granted. Therefore, the
Company had to estimate the market value of its shares. There was no significant
change in the business between July and October 2006, therefore, the company
used the fair value from the October 27 transaction of $2.26 and took a discount
of 30%, to estimate a market price of $1.58. At that market price, the 750,000
employee options had a fair value of approximately $834,000. Because 50% of the
options vested immediately, the related compensation expense was recognized as
the options vest, rather than on a straight-line basis over the total vesting
period, as the amount recognized at any point in time must be at least
equal to the portion vested.
On April
20, 2007, CFPG issued 9,500 options to the Company’s four independent directors
as part of their compensation. The options will vest one year from the issuance
date. The fair value of these options was determined to be $19,428 using the
Black Sholes model with the following assumptions: volatility 45%; risk free
interest rate 4.57%; dividend yield of 0% and expected term of 5 years. Options
were vested immediately at exercise price of $4.51 per share which was the close
price of the Company’s stock on April 19, 2007. Because the services that the
independent directors are to provide started from the second quarter of 2007 and
will last for one year, the related compensation expense is recognized on a
straight-line basis over the total service period.
On July
1, 2007, CFPG issued 20,000 options to Mr. Yuan, Xiaoyuan, who joined the
Company as on the same day. The options will vest over four years.
The Company used the Black Sholes model to value the options at the time they
were issued, based on the exercise price of $6.70, which was the close price of
the Company’s stock on June 30, 2007 and expiration dates of the instruments and
using a risk-free rate of 4.84% and the volatility of 40% that was estimated by
analyzing the trading history of the Company’s stock. The 20,000 employee
options had a fair value of $57,178. The related compensation expense is
recognized on a straight-line basis over the four year vesting
period.
The total
stock option compensation expense recognized for the year ended December 31,
2008, 2007 and 2006 was $40,152, $190,719 and $644,000,
respectively.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
The
Company has stock options as follows:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
Options
Outstanding
|
|
|
Exercise
Price
|
|
|
Intrinsic
Value
|
|
Outstanding,
December 31, 2005
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
750,000
|
|
|
$
|
1.25
|
|
|
$
|
247,500
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
December 31, 2006
|
|
|
750,000
|
|
|
$
|
1.25
|
|
|
$
|
2,250,000
|
|
Granted
|
|
|
29,500
|
|
|
$
|
5.99
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
December 31, 2007
|
|
|
779,500
|
|
|
$
|
1.43
|
|
|
$
|
8,925,615
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding,
December 31, 2008
|
|
|
779,500
|
|
|
$
|
1.43
|
|
|
$
|
4,194,190
|
|
Following
is a summary of the status of options outstanding at December 31,
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
|
|
7.50
|
|
|
750,000
|
|
1.25
|
|
|
7.50
|
|
|
9,500
|
|
|
|
4.51
|
|
3.33
|
|
|
9,500
|
|
4.51
|
|
|
3.33
|
|
|
20,000
|
|
|
|
6.70
|
|
3.50
|
|
|
7,500
|
|
6.70
|
|
|
3.50
|
|
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.
No gain
or loss was recognized through the restructuring of Beijing Zhong Xiao nor any
additional cost incurred to restructure Beijing Zhong Xiao. In
addition, we have no outstanding obligations related to the restructuring after
the disposal of Beijing Zhong Xiao on April 3, 2007.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
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.
Note
16 - Commitments and Contingencies
Operating Lease
Commitments
Currently
the Company are engaged in an operating lease with Tianjin Fire Protection
Equipment Company Ltd for the use of approximately 112,432 square meters land in
Tianjin, consisting of manufacturing facilities, warehouses and office
buildings. The term of the operating lease is two years,
starting from May 2007. The monthly payment for the lease is 66,000RMB or
$9,677. At December 31, 2008, total future minimum lease payments under the
operating lease were as follows:
Year
Ended December 31
|
|
Amount
|
|
2009
|
|
$
|
48,385
|
|
2010
|
|
|
-
|
|
Thereafter
|
|
|
-
|
|
Contingencies
In 2008,
the Company filed five lawsuits against four different companies for the
infringement of the Company’s intellectual properties. These five cases were
still pending. Management expects these five cases will be settled in the
Company’s favor.
In 2008,
the Company was sued by three different companies for the invalidation of our
intellectual properties. Two of these three cases were eventually settled in the
Company’s favor. The other case is still pending and management expects this
case will be settled in the Company’s favor as well.
Management
expects the outcome from the above pending lawsuits will have no material impact
of the Company’s consolidated financial statements.
See
report of independent registered public accounting firm.
CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2008
Note
17 - Subsequent Events
On
January 2, 2009, pursuant to the Company's 2008 Omnibus Long-term Incentive
Plan, the Company's Board of Directors authorized the issuance of 1,000,000
shares of options for its employee with total 800,000 shares options issued to
executive officers. The options will vest evenly each quarter over the following
four years, starting from the first quarter of 2009.
See
report of independent registered public accounting firm.
EXHIBIT
INDEX
Exhibit
Number
|
|
|
2.1*
|
|
Securities
Exchange Agreement, dated as of September 1, 2006, by and among the
Company, China Fire Protection Group and Sureland, its
subsidiary
|
|
|
3.1**
|
|
Restated
Articles of Incorporation, filed with the state of Florida on October 18,
2006.
|
|
|
3.2**
|
|
Articles
of Amendment to Articles of Incorporation & Designating Series A
Convertible present Stock.
|
|
|
3.3
|
|
By-Laws
- Incorporated by reference to Exhibit 3.1 to Form 8-K filed on September
4, 2008.
|
|
|
4.1**
|
|
Registaration
Rights Agreement dated October 27, 2006 between the Company and named
Investors
|
|
|
4.2**
|
|
Registaration
Rights Agreement dated October 27, 2006 between the Company and named
Shareholders
|
|
|
4.3**
|
|
Form
of Series A Warrant to Purchase Shares of Common
Stock of the Company.
|
|
|
4.4**
|
|
Form
of Series B Warrant to Purchase Shares of Common
Stock of the Company
|
|
|
4.5**
|
|
Escrow
Agreement dated October 27, 2006 by and among the Company UNIPRO, H.
C. Wainwright & Co., Inc., the Investor Representative, Gangjin Li,
and Brian Li, and American Stock Transfer & Trust
Company
|
|
|
4.6**
|
|
Form
of H. C. Wainwright & Co., Warrant
|
|
|
10.1**
|
|
Construction
Contract between Anshan Iron & Steel Group Corp. and Sureland
Industrial Fire Safety Co., Ltd. Dated October, 2006
|
|
|
10.2**
|
|
Contract
between Maanshan Iron & Steel Co., Ltd and. and Sureland Industrial
Fire Safety Co., Ltd.
|
|
|
10.3**
|
|
Contract
between Wuhan Iron & Steel (Group) Corp. and Sureland Industrial Fire
Safety Co., Ltd.
|
|
|
10.4**
|
|
Purchase
Contract between Beijing Zhongshiweiye Technologies Co. Ltd.. and Sureland
Industrial Fire Safety Co., Ltd. Dated June 13, 2005
|
|
|
10.5**
|
|
Contract
between Hangzhou New Epoch Fire Protection Science & Technology Co.,
Ltd and Sureland Industrial Fire Safety Co., Ltd. Dated December 5,
2005
|
|
|
10.6**
|
|
Contract
between Guangzhou Jinshengyang Technologies Co. Ltd. and Sureland
Industrial Fire Safety Co., Ltd. Dated May 20, 2005
|
|
|
10.7**
|
|
Purchase
and Sales Contract between Beijing Xinfangsheng Hardware Electric Products
Co. Ltd. and Sureland Industrial Fire Safety Co., Ltd. Dated October,
2005
|
|
|
10.8**
|
|
Purchase
and Sales Contract between Sichuan Firefighting Machinery General Factory
and Sureland Industrial Fire Safety Co., Ltd. Dated July 19,
2005
|
|
|
10.9**
|
|
Purchase
and Sales Contract between Beijing Tianningyihe Pipeline System Equipments
Co. Ltd. and Sureland Industrial Fire Safety Co., Ltd. Dated July 19,
2005
|
Exhibit
Number
|
|
|
|
|
10.10**
|
|
Acceptance
for Carriage Service Contract between Zhaijisong Express Co., LTD and
Sureland Industrial Fire Safety Co., Ltd.
|
|
|
10.11**
|
|
Cooperation
Contract between Lianxin International Trade (Shanghai Waigaoqiao Free
Trade Zone) Co., Ltd. and Sureland Industrial Fire Safety Co.,
Ltd.
|
|
|
10.12**
|
|
Marketing
Memorandum between Xi’an Systemsensor Electronic Co., Ltd and Sureland
Industrial Fire Safety Co., Ltd.
|
|
|
10.13**
|
|
OEM
Cooperation Agreement between Xi’an System Sensor Electronics, Ltd. and
Sureland Industrial Fire Safety Co., Ltd. Dated may 26,
2004
|
|
|
10.14**
|
|
House
Lease Contract between Beijing Bestpower Electrical Technology Ltd. and
Sureland Industrial Fire Safety Co., Ltd. Dated December 1,
2004
|
|
|
10.15**
|
|
Stock
Ownership Assignment Agreement
|
|
|
10.16****
|
|
Employment
Agreement between the Company and Mr. Brian Lin
|
|
|
|
10.17****
|
|
Employment
Agreement between the Company and Mr. Xiaoyuan Yuan
|
|
|
|
14.1***
|
|
Officers’
and Directors’ Code of Ethics
|
|
|
|
21.1****
|
|
List
of Subsidiaries
|
|
|
31.1
|
|
Certification
of Principal Executive Officer under Section 302 of the Sarbanes-Oxley Act
of 2002.
|
|
|
|
31.2
|
|
Certification
of Principal Financial Officer under Section 302 of the Sarbanes-Oxley Act
of 2002.
|
|
|
|
32.1
|
|
Certifications
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
Section 1350
|
*
|
Incorporated
by reference from 8-K filed September 5, 2006 where it was filed as
Exhibit 99.1
|
|
|
**
|
Incorporation
by reference from 8-K filed November 2, 2006 where the exhibits were the
same number
|
***
|
Incorporated
by reference from Form 10-QSB, filed with the Commission on May 24,2004
where it was filed as Exhibit 10.4
|
****
|
Incorporated
by reference from Form 10-K/A, filed with the Commission on October
30,2009 where the exhibits were the same
number
|