Unassociated Document
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-QSB
 
(Mark one)
 
x
Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the Quarterly Period Ended September 30, 2007
or
 
o
Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
 
Commission File Number 000-50491
 
 
China Fire & Security Group, Inc.
(Name of small business issuer in its charter)
 
Florida
65-1193022
(State or other jurisdiction
of incorporation or organization)
(I.R.S. Employer
Identification No.)
   
South Banbidian Industrial Park
Liqiao Township, Shunyi District
Beijing 101304
People’s Republic of China
101304
(Address of principal executive offices)
(Zip Code)
 
Issuer's telephone number:  (86-10) 8416 3816.
 
 
Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x No o
 
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o No x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes o No x
 
As of November 10, 2007, the Registrant had 27,556,893 shares of common stock outstanding.


China Fire & Security Group, Inc.
 
Table of Contents
 
 
 
 
  
Page
PART I -
 
FINANCIAL INFORMATION
  
 
 
 
 
  
 
Item 1.
 
Financial Statements (Unaudited):
  
 
 
 
 
  
 
 
 
Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006
  
1
 
 
 
  
 
 
 
Consolidated Statements of Income and Other Comprehensive Income
  
 
 
 
For the Three Months and Nine Months Ended September 30, 2007 and 2006
  
2
 
 
 
  
 
 
 
Consolidated Statements of Stockholders' Equity
 
3
 
 
 
  
 
 
 
Consolidated Statements of Cash Flows
  
 
 
 
For the Nine Months Ended September 30, 2007 and 2006
  
4
 
 
    
 
 
 
Notes to Consolidated Financial Statements (Unaudited)
  
5
 
 
 
  
 
Item 2.
 
Management's Discussion and Analysis or Plan of Operation
  
22
 
 
 
  
 
Item 3.
 
Controls and Procedures
  
32
 
 
 
  
 
PART II -
 
OTHER INFORMATION
  
 
 
 
 
  
 
Item 1.
 
Legal Proceedings
  
33
 
 
 
  
 
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
  
33
 
 
 
  
 
Item 3.
 
Defaults Upon Senior Securities
  
33
 
 
 
  
 
Item 4.
 
Submission of Matters to a Vote of Security Holders.
  
33
 
 
 
  
 
Item 5.
 
Other Information
  
33
 
 
 
  
 
Item 6.
 
Exhibits and Reports on Form 8-K
  
33

PART I - FINANCIAL INFORMATION
 
Item 1. Financial Statements.
 
CHINA FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS UNIPRO FINANCIAL SERVICES, INC.)
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2007 AND DECEMBER 31, 2006
 
   
September 30,
  
December 31,
  
   
2007
  
2006
  
   
Unaudited
     
ASSETS
CURRENT ASSETS:
          
Cash
  
$
12,978,897
  
$
9,426,091
  
Restricted cash
    
829,534
   
1,622,833
 
Accounts receivable, net of allowance for doubtful accounts of $1,779,084 and
             
$1,252,947 as of September 30, 2007 and December 31, 2006, respectively 
    
17,129,943
   
13,211,721
  
Notes receivable
    
1,284,242
   
903,425
 
Other receivables
   
1,381,321
   
875,119
  
Inventories
    
4,334,244
   
4,190,830
 
Costs and estimated earnings in excess of billings
    
11,576,823
   
9,020,122
 
Employee advances
    
2,539,279
    
1,641,138
  
Employee advances - officers and directors
     18,067     7,422  
Prepayments and deferred expenses
    
3,066,828
   
2,396,571
 
Total current assets 
    
55,139,178
   
43,295,272
 
               
PLANT AND EQUIPMENT, net
    
4,057,117
   
3,529,808
 
 
              
OTHER ASSETS:
              
Accounts receivable - retentions
    
564,834
   
383,375
 
Deferred expenses - non current
    
19,257
   
40,830
 
Advances on building purchases
    
2,395,369
   
-
 
Investment in joint ventures
    
1,152,077
   
501,288
 
Intangible assets, net of accumulated amortization
    
1,153,888
    
558,255
 
Total other assets 
    
5,285,425
   
1,483,748
 
 
              
Total assets
  
$
64,481,720
  
$
48,308,828
  
               
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
              
Accounts payable
  
$
6,893,026
  
$
6,117,733
  
Customer deposits
    
4,937,818
   
2,713,451
 
Billings in excess of costs and estimated earnings
    
4,443,456
   
8,867,624
 
Other payables
    
615,571
   
438,957
  
Accrued liabilities
    
2,502,714
   
1,891,628
 
Taxes payable
    
627,072
   
619,949
 
Total current liabilities 
    
20,019,657
   
20,649,342
 
               
FAIR VALUE OF DERIVATIVE INSTRUMENTS
    
-
   
2,680,811
 
               
COMMITMENTS AND CONTINGENCIES
    
-
   
-
 
               
SHAREHOLDERS' EQUITY:
              
Common stock, $0.001 par value, 65,000,000 shares authorized,
             
27,428,810 shares and 26,461,678 issued and outstanding as of
September 30, 2007 and December 31, 2006, respectively 
    
27,429
   
26,462
 
Additional paid-in-capital
    
18,760,431
   
13,393,171
 
Statutory reserves
    
3,123,127
   
3,728,127
 
Retained earnings
    
20,135,068
   
6,765,393
 
Accumulated other comprehensive income
    
2,416,008
   
1,065,522
 
Total shareholders' equity 
    
44,462,063
   
24,978,675
 
               
 Total liabilities and shareholders' equity
  
$
64,481,720
  
$
48,308,828
  

The accompanying notes are an integral part of these consolidated financial statements.
1

CHINA FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS UNIPRO FINANCIAL SERVICES, INC.)
 
 
 
 
 
 
 
 
 
 
CONSOLIDATED STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(Unaudited)
                   
   
Three months ended
September 30,
  
Nine months ended
September 30,
  
   
2007
 
2006
 
2007
 
2006
  
REVENUES
                  
System contracting projects
  
$
6,105,899
  
$
5,664,761
  
$
23,270,285
  
$
17,353,668
  
Products
    
5,188,117
   
2,225,380
   
8,827,922
   
5,366,832
 
Maintenance services
    
302,954
   
152,059
   
545,410
   
347,783
 
Total revenues
    
11,596,970
   
8,042,200
   
32,643,617
   
23,068,283
 
                           
COST OF REVENUES
                          
System contracting projects
    
2,539,812
   
2,676,347
   
10,564,382
   
8,679,358
 
Products
    
2,065,515
   
1,516,652
   
3,705,298
   
2,203,146
 
Maintenance services
    
124,211
   
25,006
   
181,085
   
60,501
 
Total cost of revenues
    
4,729,538
   
4,218,005
   
14,450,765
   
10,943,005
 
                           
GROSS PROFIT
   
6,867,432
   
3,824,195
   
18,192,852
   
12,125,278
 
                           
OPERATING EXPENSE
                          
Selling and marketing
    
1,082,176
   
1,184,060
   
2,843,685
   
2,033,140
 
General and administrative
   
1,420,221
   
1,103,316
   
3,605,574
   
2,195,730
 
Depreciation and amortization
    
128,394
   
106,581
   
387,933
   
376,359
 
Research and development
   
139,205
   
269,389
   
457,126
   
672,909
 
Total operating expense
    
2,769,996
   
2,663,346
   
7,294,318
   
5,278,138
 
                           
INCOME FROM OPERATIONS
    
4,097,436
   
1,160,849
   
10,898,534
   
6,847,140
 
                           
OTHER INCOME (EXPENSE)
                          
Other income
    
249,537
   
371,747
   
577,535
   
597,231
 
Other expense
    
(1,400
)
  
-
   
(7,817
)
  
-
 
Interest income
    
46,462
   
13,566
   
90,632
   
19,646
 
Interest expense
    
-
   
(32,456
)
  
-
   
(75,475
)
Change in fair value of derivative instruments
    
-
   
-
   
1,205,791
   
-
 
Total other income (expense)
    
294,599
   
352,857
   
1,866,141
   
541,402
 
                           
INCOME BEFORE PROVISION FOR INCOME TAXES AND MINORITY INTEREST
    
4,392,035
   
1,513,706
   
12,764,675
   
7,388,542
 
                           
PROVISION FOR INCOME TAXES
    
-
   
(17,619
)
  
-
   
39,181
 
                           
NET INCOME
    
4,392,035
   
1,531,325
   
12,764,675
   
7,349,361
 
                           
OTHER COMPREHENSIVE INCOME
                          
Foreign currency translation adjustment
    
540,152
   
210,268
   
1,350,486
   
330,945
 
                           
COMPREHENSIVE INCOME
 
$
4,932,187
  
$
1,741,593
  
$
14,115,161
  
$
7,680,306
  
                           
BASIC                          
Weighted average number of shares
    
27,026,221
   
24,000,000
   
26,649,859
   
24,000,000
 
Earning per share
  
$
0.16
  
$
0.06
  
$
0.48
  
$
0.31
  
                           
DILUTED                          
Weighted average number of shares
     27,825,442     24,000,000     27,436,695     24,000,000  
Earning per share
  
$
0.16
  
$
0.06
  
$
0.47
  
$
0.31
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
2
 
CHINA FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS UNIPRO FINANCIAL SERVICES, INC.)

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                   
               
 
 
Accumulated
 
 
 
 
 
Common Stock
 
Additional
 
Retained Earnings
 
Owner
 
other
 
 
 
 
 
Shares
 
Par value
 
paid-in-capital
 
Statutory
reserves
 
Unrestricted
 
contribution
receivable
 
comprehensive
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
                            
6,775,212
               
6,775,212
 
Cash proceeds from investment in Sureland Equipment Co., Ltd
                
165,000
                           
165,000
 
Option issued to employees
                
553,000
                           
553,000
 
Foreign currency translation adjustment
                                        
330,945
   
330,945
 
                                                   
BALANCE, Septemper 30, 2006 (Unaudited)
   
24,000,000
 
$
24,000
  
$
6,774,058
  
$
3,458,325
  
$
6,840,766
  
$
(10,087,527
)
$
814,535
  
$
7,824,157
  
                                                   
Net income
                            
194,429
               
194,429
 
Adjustment to statutory reserves
                      
269,802
   
(269,802
)
              
-
 
Collection of contribution receivable
                
4,973
               
10,087,527
         
10,092,500
 
Cash proceeds from investment in Sureland Equipment Co., Ltd
                
495,000
                           
495,000
 
Issuance of common stock
    
2,461,678
   
2,462
   
6,028,140
                           
6,030,602
 
Options issued to employees
                
91,000
                           
91,000
 
Foreign currency translation adjustment
                                        
250,987
   
250,987
 
                                                   
BALANCE, December 31, 2006
   
26,461,678
 
$
26,462
  
$
13,393,171
  
$
3,728,127
  
$
6,765,393
  
$
-
  
$
1,065,522
  
$
24,978,675
  
                                                   
Net income
                            
12,764,675
               
12,764,675
 
Warrants reclassified from liabilities
                
1,475,020
                           
1,475,020
 
Issuance of common stock
    
876,985
   
877
    
3,638,768
                           
3,639,645
 
Warrants exercised
    
90,147
   
90
    
(90
)
                          
-
 
Warrants issued for services
                
94,274
                           
94,274
 
Options issued to employees
                
159,288
                           
159,288
 
Adjustment from statutory reserves
                      
(605,000
)
  
605,000
               
-
 
Foreign currency translation adjustment
                                        
1,350,486
   
1,350,486
 
                                                   
BALANCE, September 30, 2007 (Unaudited)
   
27,428,810
 
$
27,429
  
$
18,760,431
  
$
3,123,127
  
$
20,135,068
  
$
-
  
$
2,416,008
  
$
44,462,063
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
3
 
CHINA FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS UNIPRO FINANCIAL SERVICES, INC.)
           
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(Unaudited)
           
   
2007
 
2006
  
CASH FLOWS FROM OPERATING ACTIVITIES:
          
Net income
 
$
12,764,675
  
$
7,349,361
  
Adjustments to reconcile net income to cash
             
provided by operating activities:
              
Depreciation 
    
409,261
   
406,387
 
Amortization 
    
35,539
   
9,734
 
Provision for doubtful accounts 
    
465,482
   
553,000
 
Gain on disposal of equipment 
    
(9,136
)
  
-
 
Compensation expense for options issued to employees 
    
159,288
   
-
 
Issuance of warrants for services 
    
94,274
   
-
 
Change in fair value of derivative instruments 
    
(1,205,791
)
  
-
 
Change in operating assets and liabilities:
              
Accounts receivable 
    
(3,389,580
)
  
(1,930,261
)
Notes receivable 
    
(337,052
)
  
624,138
 
Other receivables 
    
(458,743
)
  
(199,443
)
Inventories 
    
26,023
   
(1,850,652
)
Costs and estimated earnings in excess of billings 
    
(2,145,503
)
  
(3,948,092
)
Employee advances 
    
(814,369
)
  
(482,133
)
Employee advance from officers and directors
    
(10,130
 )   -  
Prepayments and deferred expenses 
    
(1,090,443
)
  
(751,797
)
Accounts payable 
    
617,376 
    
1,419,996
 
Customer deposits 
    
2,070,561
   
1,599,483
 
Billings in excess of costs and estimated earnings 
    
(4,684,877
)
  
3,816,044
 
Other payables 
    
156,501
    
(72,300
)
Accrued liabilities 
    
586,981
   
1,789,923
 
Taxes payable 
    
(3,407
)
  
34,945
 
 Net cash provided by operating activities
    
3,236,930
   
8,368,333
 
             
CASH FLOWS FROM INVESTING ACTIVITIES:
              
Purchase of equipment
    
(971,743
)
  
(202,732
)
Advances on building purchases
    
(2,345,809
)
  
-
 
Additions to construction in progress
    
-
   
(235,188
)
Purchase of intangible assets
    
(608,782
)
  
-
 
Proceeds from sale of equipment
    
19,646
   
16,405
 
Proceeds from sale of investment in Tianjin Fire Safety Equipment Co. Ltd.
    
510,829
   
-
 
Proceeds from sale of Beijing Zhong Xiao Fire Safety Technology Co., Ltd
    
1,060,535
   
-
 
Payments for investment in Tianjin Fire Safety Equipment Co., Ltd.
   
-
   
(310,008
)
Payments for investment in King Galaxy Investments Limited
    
(1,000,000
)
  
-
 
Payments for investment in Hubei Sureland Changjiang Fire Safety
             
Technology Co., Ltd.
    
(148,930
)
  
-
 
 Net cash used in investing activities
    
(3,484,254
)
  
(731,523
)
               
CASH FLOWS FROM FINANCING ACTIVITIES:
              
Decrease (increase) in restricted cash
    
841,349
   
(220,605
)
Dividend distributions to original shareholders and minority interest shareholders
    
-
   
(7,836,040
)
Proceeds from note payables
    
-
   
2,496,000
 
Payments on notes payables
    
-
   
(2,532,000
)
Proceeds from increase in paid-in capital
    
-
   
165,000
 
Payments to Beijing Zhong Xiao Fire Safety Technology Co., Ltd
    
(2,447,101
)
  
-
 
Proceeds from Beijing Zhong Xiao Fire Safety Technology Co., Ltd
    
1,353,955
   
-
 
Proceeds from issuance of common stock
    
3,639,645
   
-
 
 Net cash provided by (used in) financing activities
    
3,387,848
   
(7,927,645
)
               
EFFECTS OF EXCHANGE RATE CHANGE IN CASH
    
412,282
   
108,216
 
               
INCREASE (DECREASE) IN CASH
    
3,552,806
   
(182,619
)
               
CASH, beginning of period
    
9,426,091
   
2,357,399
 
               
CASH, end of period
  
$
12,978,897
  
$
2,174,780
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
4
Note 1 - Background

China Fire & Security Group Inc. (the “Company”, formerly known as Unipro Financial Services, Inc. “Unipro”), is a Florida corporation. The Company, through its subsidiaries, is engaged in the design, development, manufacturing and sales of fire protection products and services for industrial customers in China.

On September 1, 2006, the Company signed a Securities Exchange Agreement (the “Agreement”) with China Fire Protection Group, Inc. (“CFPG”). Based on the agreement, each CFPG Shareholder agreed to sell, assign, transfer and deliver to Unipro all of the CFPG’s ordinary shares of capital stock, par value US $0.01 each (the “CFPG Shares”), in exchange for the issuance by Unipro to each such CFPG Shareholder a pro rata share of 701,538.46 Unipro shares of Series A Convertible Preferred Stock, no par value (“Unipro Preferred”). Each CFPG Shareholder’s pro rata share of the Unipro Preferred was determined by multiplying 701,538.46 Unipro Preferred by a fraction, the numerator equaled the total number of CFPG Shares owned by the CFPG Shareholder at the Closing and the denominator was the total number of CFPG Shares issued and outstanding at the closing. The transaction was completed on October 27, 2006. Prior to closing, CFPG had outstanding options to purchase CFPG shares. The options were converted into 750,000 options to purchase Unipro Common Stock, $0.001 par value (“Common Stock”) on the same terms and conditions as the outstanding options. Fractional shares of Unipro Preferred were issued as necessary.

For accounting purpose this transaction was treated as a recapitalization of the CFPG where the CFPG is considered the accounting acquirer. As a result of the reverse acquisition and recapitalization under common control, CFPG’s financial statements are presented as the continuing accounting entity. Thus, the historical financial statements of CFPG were recapitalized with the historical equity shares of the Company.

China Fire Protection Group, Inc. (“CFPG”) was incorporated in the British Virgin Islands as a limited liability company on June 2, 2006. On June 19, 2006, CFPG entered a sales and purchase agreement with the existing five shareholders (“Original Shareholders”) of Sureland Industrial Fire Safety Limited (“Sureland Industrial”) who agreed to transfer their 100% ownership in Sureland Industrial to the CFPG. The total purchase consideration was $10,087,527 which was determined based upon the net asset value of Sureland Industrial as of December 31, 2005. On July 18, 2006, this transfer was approved by the Beijing Bureau of Commerce, and the registration was completed with the Beijing State Administration for Industry and Commerce of the People’s Republic of China, (“PRC”). As a result of this transfer, CFPG became the 100% shareholder of Sureland Industrial. On October 30, 2006, CFPG transferred 25% ownership in Sureland Industrial to Sureland Industrial Fire Equipment Co., Ltd. The $10,087,527 payment was made in December 2006.

During June and July 2006, the CFPG issued 33,500 shares of common stock to the Original Shareholders in consideration of a promissory note receivable totaling $10,752,500 and the total number of shares outstanding in the Company is 33,500. As a result of this transaction, the Original Shareholders exercised control over the Company.

The purchase of Sureland Industrial and the issuance of CFPG’s common stock has been accounted for as a reverse acquisition and recapitalization under common control. The assets and liabilities transferred have been accounted for at historical cost. The consolidated financial statements have been presented as if the acquisition of the subsidiary occurred at the beginning of 2006.

Sureland Industrial Fire Safety Limited (“Sureland Industrial”) was established as a Sino-foreign equity joint venture in Beijing, PRC on February 22, 1995. Sureland Industrial and its subsidiaries in China principally engage in the design, development, manufacturing and sale of fire protection products and services for industrial customers in China.

On June 12, 2006, the Beijing Administration for Industry and Commerce approved the conversion of Sureland Industrial into a limited liability company with registered capital at RMB 50,000,000. On May 17, 2007, the Beijing Shunyi District Business Administration approved the Company to increase registered capital to RMB 100,000,000. The Company obtained a new business license on July 2, 2007 which was issued by the Beijing Administration for Industry and Commerce.
 
5

Beijing Hua An Times Fire Safety Technology Co., Ltd. (“Beijing Hua An”) is a subsidiary of Sureland Industrial established in the PRC as a limited liability company on September 22, 2005 upon its establishment, 80% and 20% of its registered capital was contributed, in cash, by Sureland Industrial and Sureland Creation, respectively. On October 8, 2006, Sureland Industrial and Sureland Creation agreed to transfer the 20% ownership in Beijing Hua An from Sureland Creation to Sureland Industrial, and Sureland Industrial became 100% shareholder of Beijing Hua An.

Sureland Industrial Fire Equipment Co., Ltd. (“Sureland Equipment”) was established as a Sino-foreign equity joint venture in Beijing, the People’s Republic of China (the PRC) on April 12, 2006 with a registered capital $660,000. Upon its establishment, 75% and 25% of its registered capital was contributed, in cash, by Sureland Industrial and Vyle Investment Inc., respectively. On June 22, 2006, CFPG signed a sales and purchase agreement with the existing two shareholders, Sureland Industrial and Vyle Investment Inc., to become 100% shareholder of Sureland Equipment. The purchase price was based on the registered capital of Sureland Equipment. On August 4, 2006, this transaction was approved by the Beijing Bureau of Commerce, and the registration with the Beijing State Administration for Industry and Commerce of the People’s Republic of China, (“PRC”) was completed on August 15, 2006.

Tianjin Tianxiao Fire Safety Equipment Co., Ltd. (“Tianxiao Equipment”) was established as a limited liability company in Tianjin, PRC on April 11, 2007 with a registered capital RMB 10,000,000. 100% of its registered capital was contributed, in cash, by Sureland Industrial. Tianxiao Equipment principally engages in the manufacturing 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 its wholly-owned subsidiaries CFPG, Sureland Industrial, Beijing Hua An, Sureland Equipment, and Tianxiao Equipment.

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.

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.
 
6

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 products sales is recognized when the goods are delivered and title has passed. Products sales revenue are presented net of a value-added tax (VAT). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished product.

 
3.
Revenue from the rendering of Maintenance Services is recognized over the service period on a straight line basis.

In accordance with 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.

Almost all of our 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 our three types of products varies significantly from project to project, both in quantity and in dollar amounts. Although we 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 our 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.

Shipping and handling

Costs related to shipping and handlings are included in cost of revenue. The Company accounts for shipping and handling fees and costs in accordance with Emerging Issues Task Force (“EITF”) Issue No. 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 $2,416,008 and $1,065,522 as of September 30, 2007 and December 31, 2006, respectively. Asset and liability accounts at September 30, 2007 were translated at 7.50 RMB to $1.00 USD as compared to 7.80 RMB at December 31, 2006. Equity accounts were stated at their historical rate. The average translation rates applied to income statements accounts for the nine months ended September 30, 2007 and 2006 were 7.65 RMB and 8.02 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.
 
7

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. Depreciation expense amount to $140,393 and $139,845 for the three months ended September 30, 2007 and 2006, respectively and $409,261 and $406,387 for the nine months ended September 30, 2007 and 2006, 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 September 30, 2007, the Company expects these assets to be fully recoverable.

Plant and equipment consist of the following:

   
September 30, 2007
  
December 31, 2006
  
   
Unaudited
      
Buildings and improvements
  
$
2,479,961
  
$
2,393,171
  
Transportation equipment
   
2,092,400
    
1,678,678
 
Machinery
    
936,396
    
579,708
 
Office equipment
    
1,064,067
    
968,213
 
Furniture
    
52,326
    
33,637
 
Totals
    
6,625,150
    
5,653,407
 
Less accumulated depreciation
    
2,568,033
    
2,123,599
 
Totals
  
$
4,057,117
  
$
3,529,808
  
 
8
 
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 Singapore. Total cash (including restricted cash balances) in these banks at September 30, 2007 and December 31, 2006, amounted to $13,817,176 and $11,037,830, respectively of which no deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts.

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

The Company has one major customer which represents approximately 23% of the Company’s sales for the nine months ended September 30, 2007 and 0% of accounts receivable as of September 30, 2007. The Company has two major customers which represents approximately 31% of the Company’s sales for the nine months ended September 30, 2006.

Restricted cash

Restricted cash represents cash required to be deposited in a separate bank account subject to withdrawal restrictions by its system contracting projects and product sales customers to guarantee its contracts will be performed. The deposit cannot be drawn or transferred by the Company until the restriction period has expired. The amounts are $829,534 and $1,622,833 as of September 30, 2007 and December 31, 2006, respectively.

   
September 30, 2007
  
December 31, 2006
  
   
Unaudited
      
Restricted Cash
          
Products sales
  
$
494,914
  
$
1,210,727
  
System contracting projects
    
334,620
    
412,106
  
Total Restricted Cash
  
$
829,534
  
$
1,622,833
  

Inventories

Inventories are stated at the lower of cost or market, using weighted average method. Inventories consisted of the followings at:

   
September 30, 2007
  
December 31, 2006
  
   
Unaudited
      
Raw materials
  
$
326,186
  
$
150,546
  
Finished goods
    
3,198,531
    
3,770,626
  
Work in progress
    
809,527
    
269,658
  
Total
 
$
4,334,244
  
$
4,190,830
  

Raw materials consist primarily of materials used in production. Finished goods consist primarily of equipment used in project contracts. The costs of finished goods include direct costs of raw materials as well as direct labor used in production. Indirect production costs such as utilities and indirect labor related to production such as assembling, shipping and handling costs are also included in the cost of inventory. The Company reviews its inventories periodically to determine if any reserves are necessary for potential obsolescence. As of September 30, 2007 and December 31, 2006, the Company determined no reserves are necessary.
 
9

Accounts receivable

Accounts receivable represents amounts due from customers for products sales, maintenance services and system contracting projects. Overdue balances are reviewed regularly by senior management. Reserves are recorded when collection of amounts due are in doubt.

Accounts receivable consists of the following:
 
   
September 30, 2007
  
December 31, 2006
  
   
Unaudited
  
 
  
Accounts receivable:
          
Products sales
  
$
10,251,974
  
$
6,482,241
  
Maintenance services
   
670,357
    
781,902
 
System contracting projects
   
8,551,530
    
7,583,900
 
Total accounts receivable
    
19,473,861
    
14,848,043
 
Allowance for bad debts
    
(1,779,084
)
  
(1,252,947
)
Accounts receivable, net
    
17,694,777
    
13,595,096
 
Accounts receivable - non-current retentions
    
(564,834
)
  
(383,375
)
Accounts receivable - currents
  
$
17,129,943
  
$
13,211,721
  

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.

   
September 30, 2007
  
December 31, 2006
  
   
Unaudited
  
 
  
           
Contracts costs incurred plus recognized profits less recognized losses to date
  
$
48,915,397
  
$
25,378,764
  
Less progress billings
    
37,338,574
    
16,358,642
 
Costs and estimated earnings in excess of billings
  
$
11,576,823
  
$
9,020,122
  

10
 
Billings in excess of costs and estimated earnings

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

   
September 30, 2007
  
December 31, 2006
  
 
  
Unaudited
  
 
  
Progress billings
  
$
10,189,678
  
$
23,129,942
  
Contracts costs incurred plus recognized  profits estimated less recognized losses
    
5,746,222
    
14,262,318
 
Billings in excess of costs and estimated  earnings
  
$
4,443,456
  
$
8,867,624
  

At September 30, 2007 and December 31, 2006, retentions held by customers of system contracting projects included in the Company’s accounts receivable as following:
 
   
September 30, 2007
  
December 31, 2006
  
   
Unaudited
  
 
  
Retentions
          
Current
  
$
1,752,017
  
$
2,135,753
  
Non-current
    
564,834
    
383,375
 
Total retentions
  
$
2,316,851
  
$
2,519,128
  

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.

Research and development

Research and development expenses include salaries, consultant fees, supplies and materials, as well as costs related to other overhead such as depreciation, facilities, utilities and other departmental expenses. The costs we incur with respect to internally developed technology and engineering services are included in research and development expenses as incurred as they do not directly relate to any particular licensee, license agreement or licenses fee.

Warranties

Generally, our products are not covered by specific warranty terms. However, our policy is to replace parts if they become defective within one year after deployment at no additional charge. Historically, failure of product parts due to materials or workmanship is rare. Therefore, at September 30, 2007 and December 31, 2006, we made no provision for warranty claims for our products. We continuously evaluate our potential warranty obligation. We will record the expenses related to the warranty obligation when the estimated amount become material at the time revenue is recorded.

Financial instruments

Statement of Financial Accounting Standards No. 107 (SFAS 107), “Disclosures about Fair Value of Financial Instruments” requires disclosure of the fair value of financial instruments held by the Company. SFAS 107 defines the fair value of financial instruments as the amount at which the instrument could be exchanged in a current transaction between willing parties. The Company considers the carrying amount of cash, accounts receivable, other receivables, accounts payable, accrued liabilities and other payables to approximate their fair values because of the short period of time between the origination of such instruments and their expected realization and their current market rate of interest. Derivative instruments are carried at fair value, estimated using the Black-Scholes option model.
 
11

Intangible assets

Land use rights - All land in the People’s Republic of China is owned by the government and cannot be sold to any individual or company. However, the government grants the user “land use rights” to use the land. The Company acquired land use rights in 2001 for a total amount of $635,757. The land use rights expire in 2051. The costs of these rights are being amortized over fifty years using the straight-line method. As of September 30, 2007 and December 31, 2006, accumulated amortization amounted to $130,400 and $115,332, respectively. Amortization expense amounted to $3,392 and $3,254 for the three months ended September 30, 2007 and 2006, respectively and $10,174 and $6,490 for the nine months ended September 30, 2007 and 2006, respectively.

Technology rights - In May 2007, the Company acquired two technology rights to manufacturing fire protection products for $608,745. The costs of these rights are being amortized over ten years using the straight-line method. As of September 30, 2007, accumulated amortization amounted to $25,365. Amortization expense amounted to $15,219 for the three months ended September 30, 2007 and $25,365 for the nine months ended September 30, 2007.

Intangible assets of the Company are reviewed annually to determine whether their carrying value has become impaired. The Company considers assets to be impaired if the carrying value exceeds the future projected cash flows from related operations. The Company also evaluates the periods of amortization to determine whether subsequent events and circumstances warrant revised estimates of useful lives. As of September 30, 2007, the Company expects these assets to be fully recoverable.

Income taxes

The Company adopted Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (SFAS 109). SFAS 109 requires the recognition of deferred income tax liabilities and assets for the expected future tax consequences of temporary differences between income tax basis and financial reporting basis of assets and liabilities. Provision for income taxes consist of taxes currently due plus deferred taxes. There are no deferred tax amounts at September 30, 2007 and December 31, 2006.

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 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 principle, 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.
 
12

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 $4,313,715 and $3,397,843 for the nine months ended September 30, 2007 and $2,501,949 and $3,258,567 for the nine months ended September 30, 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 Statement of Financial Accounting Standards No. 123R “Accounting for Stock-Based Compensation” (“SFAS 123R”) at the beginning of 2006, which defines a fair-value-based method of accounting for stock based employee compensation and transactions in which an entity issues its equity instruments to acquire goods and services from non-employees. Stock compensation for stock granted to non-employees has been determined in accordance with SFAS 123R and the Emerging Issues Task Force consensus Issue No. 96-18, "Accounting for Equity Instruments that are issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services" ("EITF 96-18"), as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

Recently issued accounting pronouncements

In June 2006, the Emerging Issues Task Force (EITF) reached a consensus on EITF No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (EITF No. 06-3). EITF No. 06-3 permits that such taxes may be presented on either a gross basis or a net basis as long as that presentation is used consistently. The adoption of EITF No. 06-3 on January 1, 2007 did not impact our consolidated financial statements. We present the taxes within the scope of EITF No. 06-3 on a net basis.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which addresses the measurement of fair value by companies when they are required to use a fair value measure for recognition or disclosure purposes under GAAP. SFAS No. 157 provides a common definition of fair value to be used throughout GAAP which is intended to make the measurement of fair value more consistent and comparable and improve disclosures about those measures. SFAS No. 157 will be effective for an entity's financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effect SFAS No. 157 will have on its consolidated financial position, liquidity, or results of operations.

In June 2007, the FASB issued FASB Staff Position No. EITF 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services Received for use in Future Research and Development Activities” (“FSP EITF 07-3”), which addresses whether nonrefundable advance payments for goods or services that used or rendered for research and development activities should be expensed when the advance payment is made or when the research and development activity has been performed. FSP EITF 07-3 will be effective for an entity’s financial statements issued for fiscal years beginning after than December 15, 2007. The Company is currently evaluating the effect of this pronouncement on financial statements.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications have no effect on net income or cash flows.
 
13

Note 3 - Earnings per share

The Company reports earnings per share in accordance with the provisions of SFAS No. 128, “Earnings per Share.” SFAS No. 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 three months ended September 30, 2007 and 2006:

   
2007
  
2006
  
   
Unaudited
  
Unaudited
  
Net income for earnings per share
  
$
4,392,035
  
$
1,531,325
  
               
Weighted average shares used in basic computation
    
27,026,221
    
24,000,000
  
Diluted effect of stock options and warrants
    
799,221
    
-
  
Weighted average shares used in diluted computation
    
27,825,442
    
24,000,000
  
               
Earnings per share:
              
Basic
  
$
0.16
  
$
0.06
  
Diluted
  
$
0.16
  
$
0.06
  

At September 30, 2007, all stock options outstanding and warrants were included in the calculation of diluted earnings per share for the three months ended September 30, 2007.
 
The following is a reconciliation of the basic and diluted earnings per share computation for the nine months ended September 30, 2007 and 2006:

   
2007
  
2006
  
   
Unaudited
  
Unaudited
  
Net income for earnings per share
  
$
12,764,675
  
$
7,349,361
  
               
Weighted average shares used in basic computation
    
26,649,859
    
24,000,000
  
Diluted effect of stock options and warrants
    
786,836
    
-
  
Weighted average shares used in diluted computation
    
27,436,695
    
24,000,000
  
               
Earnings per share:
              
Basic
  
$
0.48
  
$
0.31
  
Diluted
  
$
0.47
  
$
0.31
  
 
14
 
At September 30, 2007, all stock options outstanding and warrants were included in the nine months ended September 30, 2007 calculation of diluted earnings per share.

Note 4 - Supplemental disclosure of cash flow information

For the nine months ended September 30, 2007 and December 31, 2006, the Company has disclosed cash flow information as following:

   
2007
  
2006
  
   
Unaudited
  
Unaudited
  
Interest paid
  
$
-
  
$
79,025
  
               
Income tax paid
  
$
-
  
$
137,439
  
               
Non-cash transactions investing and financing activities:
              
Reclassification of warrants liability to paid-in capital
              
upon modification of warrants agreement
  
$
1,475,020
  
$
-
  

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 $1,284,242 and $903,425 as of September 30, 2007 and December 31, 2006, 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 $3,066,828 and $2,396,571 as of September 30, 2007 and December 31, 2006, respectively.
 
Note 7 - Investment in joint ventures

During the second quarter of 2007, the Company invested $152,076 for a 19% interest in Hubei Shou An Changjiang Fire Protection Co., Ltd., located in China Hubei, PRC. Investment is recorded under cost method.

During the third quarter of 2007, the Company also invested $1,000,000 for a 5% interest in King Galaxy Investments Limited. King Galaxy Investment 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. Investment was recorded under cost method.

The Company has not consolidated the financial statements of these two joint ventures into its financial statements as the Company does not have the ability to exercise significant influence over the joint ventures companies.
 
15

Note 8 - Customer deposits

Customer deposits represent amounts advanced by customers on products orders, 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. As of September 30, 2007 and December 31, 2006, customer deposits amounted to $4,937,818 and $2,713,451, respectively.

Note 9 - Accrued liabilities 

Accrued liabilities represent subcontractors’ expenses incurred as of period end for system contracting projects. As of September 30, 2007 and December 31, 2006, accrued liabilities amounted to $2,502,714 and $1,891,628, respectively.

Note 10 - Income taxes

Under the Income Tax Laws of PRC, the Company’s subsidiaries are generally subject to an income tax at an effective rate of 33% (30% state income taxes plus 3% local income taxes) 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%.

On July 19, 2006, Sureland Industrial became a wholly owned subsidiary of the Company, a foreign enterprise, and will start enjoying the exemption from January 1, 2007 to December 31, 2008, and is entitled to a 50% deduction of the special income tax rate of 24%, which is a rate of 12% from January 2009 to December 31, 2011.

On August 4, 2006, Sureland Equipment became a wholly owned subsidiary of the Company, a foreign enterprise, and was granted income tax exemption from April 2006 to December 31, 2007, and is entitled to a 50% deduction of the special income tax rate of 24%, which is a rate of 12% from January 2008 to December 31, 2010.

Beijing Hua An were established and registered in the New Technology Enterprise Development Zone, Beijing, PRC and are subject to the rate of 15% and have been certified by the relevant PRC authorities high technology enterprises. However pursuant to approval documents issued by the relevant tax bureau, Beijing Hua An obtained additional tax benefits. Beijing Hua An is exempt from income taxes from January 2006 to December 31, 2008 and is entitled to a 50% deduction of the special income tax rate of 15% which is a rate of 7.5% from January 2009 to December 31, 2011.

Tianxiao Equipment has no income tax exemption and therefore it has an income tax rate of 33% from its establishment.

Beginning January 1, 2008, the new Enterprise Income Tax (“EIT”) law will replace the existing 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.
 
16
 
The Company and its subsidiaries were established before March 16, 2007 and therefore are qualified to continue enjoying the reduced tax rate as described above. Since the detailed guidelines of the new tax law is not publicized yet, the Company can not determined what the new tax rate (15% or 25%) will be applicable to the Company and its subsidiaries after the end of their respective tax holiday terms.

The provision for income taxes for the three months ended September 30 consisted of the following:

   
2007
  
2006
  
   
Unaudited
  
Unaudited
  
Provision for China Income Tax
  
$
-
  
$
(16,376
)
Provision for China Local Tax
    
-
   
(1,243
)
Total provision for income taxes
  
$
-
  
$
(17,619
)
 
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the three months ended September 30:

   
2007
  
2006
  
   
Unaudited
  
Unaudited
  
U.S. Statutory rates
    
34.0
%
  
34.0
%
Foreign income not recognized in USA
    
(34.0
)
  
(34.0
)
China income taxes
    
33.0
   
33.0
 
China income tax exemption
    
(33.0
)
  
(32.0
)
Total provision for income taxes
    
-
%
  
1.0
%

The estimated tax savings for the three months ended September 30, 2007 and 2006 amounted to $1,648,501 and $736,491, respectively. The net effect on basic earnings per share if the income tax had been applied would decrease basic earnings per share for the three months ended September 30, 2007 and 2006 by $0.06 and $0.03, respectively.

The provision for income taxes for the nine months ended September 30 consisted of the following:

   
2007
  
2006
  
   
Unaudited
  
Unaudited
  
Provision for China Income Tax
  
$
-
  
$
35,619
  
Provision for China Local Tax
    
-
   
3,562
 
Total provision for income taxes
  
$
-
  
$
39,181
 

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the nine months ended September 30:

   
2007
  
2006
  
   
Unaudited
  
Unaudited
  
U.S. Statutory rates
    
34.0
%
  
34.0
%
Foreign income not recognized in USA
    
(34.0
)
  
(34.0
)
China income taxes
    
33.0
   
33.0
 
China income tax exemption
    
(33.0
)
  
(32.0
)
Total provision for income taxes
    
-
%
  
1.0
%
 
17
 
The estimated tax savings for the nine months ended September 30, 2007 and 2006 amounted to $4,124,617 and $2,239,826, respectively. The net effect on basic earnings per share if the income tax had been applied would decrease basic earnings per share for the nine months ended September 30, 2007 and 2006 by $0.15 and $0.09, respectively.

China Fire & Security Group, Inc. was incorporated in the United States and has incurred net operating losses of $47,945 for income tax purposes for the nine months ended September 30, 2007. The net operating loss carry forwards for United States income taxes amounted to $1,004,413 which may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, beginning in 2005 and continue through 2027. Management believes that the realization of the benefits from these losses appears uncertain due to the Company’s limited operating history and continuing losses for United States income tax purposes. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero. The valuation allowance for the nine month period ended September 30, 2007 was increased $16,301 and the accumulated valuation allowance as of September 30, 2007 amounted to $341,500. Management will review this valuation allowance periodically and make adjustments as warranted.

Taxes payable

Taxes payable as of September 30, 2007 and December 31, 2006 consisted of the following:

   
 September 30, 2007
  
December 31, 2006
  
   
 Unaudited
  
 
  
VAT taxes payable (credit)
  
$
(380,375
)
$
47,211
  
Income taxes payable (refund)
    
-
    
(13,317
)
Sales taxes
   
974,549
    
541,486
 
Other taxes payable
    
32,898
    
44,569
 
Total
  
$
627,072
  
$
619,949
  

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 2007 and 2006. 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 $134,147 and $36,512 for the nine months ended September 30, 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.
 
18

Surplus reserve fund

The Company is required to transfer 10% of its net income, as determined in accordance with the PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital.

The transfer to this reserve must be made before distribution of any dividend to shareholders. The company did not make any contribution to this fund for the nine months ended September 30, 2007 and 2006. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.

On May 17, 2007, the Beijing Shunyi District Business Administration approved the Company to increase registered capital from RMB 50,000,000 to RMB 100,000,000. $605,000 or RMB 5,000,000 was approved by the Beijing Shunyi District Business Administration to be transferred out from this surplus reserve fund as an increase of registered capital.

Enterprise fund

The enterprise fund may be used to acquire plant and equipment or to increase the working capital to expend on production and operation of the business. No minimum contribution is required and the Company did not make any contribution to this fund for the nine months ended September 30, 2007.

Note 13 - Commitments and contingencies

The Company’s office lease is under a one year term expiring in December 15, 2007. It is cancelable with three months prior notice. At September 30, 2007, total future minimum lease payments under these operating leases were as follows:

Year Ended December 31,
  
Amount
  
2007
  
$
6,707
  
Thereafter
    
-
 

Rent expense amounted to $22,200 and $22,072 for the three months ended September 30, 2007 and 2006, respectively and amounted to $102,099 and $99,961 for the nine months ended September 30, 2007 and 2006, respectively.

Note 14 - Shareholders’ equity

On October 27, 2006, pursuant to a Securities Purchase Agreement dated October 27, 2006 (“SPA”), the Company issued 1,538,600 units of common stock at $3.25 per share, Series A warrants expiring on October 27, 2011 to acquire 307,723 shares at $3.58 per share and Series B warrants expiring on October 27, 2011 to acquire 307,723 shares at $4.88 per share.

On December 5, 2006, under the SPA, the Company issued 923,078 units of common stock at $3.25 per share, Series A warrants expiring on December 5, 2011 to acquire 184,617 shares at $3.58 per share and Series B warrants expiring on December 5, 2011 to acquire 184,617 shares at $4.88 per share.
 
19

Warrants

In order for the warrants to be accounted for as equity, the warrants must comply with FAS 133 and EITF 00-19. Under the original terms, the Series A and Series B warrant agreements, the warrant holders under certain circumstances, at their option, could elect to receive an amount in cash equal to the fair value of the warrant calculated in accordance with the Black-Scholes formula. Thus, the warrant holders had rights to a cash payment that are not available to other common stockholders, which failed the test in paragraph 27 of EITF 00-19. The failure of this test therefore resulted in classification of the warrants as derivative instrument liabilities, rather than as equity instruments. The Company allocated the proceeds received between the common stock and warrants based upon the fair values on the dates the proceeds were received. The value of the warrants was determined using the Cox-Ross-Rubinstein binomial model using the following assumptions: volatility 75%; risk free interest rate 4.64%; dividend yield of 0% and expected term of 5 years. Net proceeds were allocated as the follows:


Warrants
  
$
1,110,236
  
Common stock
    
6,030,602
 
Total Net Proceeds
  
$
7,140,838
  

Subsequent to the initial recording, the change in the fair value of the warrants, determined under the Cox-Ross-Rubinstein binomial model, at each reporting date was recorded as a gain or loss on derivative instruments.

On April 26, 2007, the Company amended its Series A Warrants and Series B Warrants issued to certain investors on October 27 and December 5, 2006 pursuant to the Securities Purchase Agreement in connection with a private placement (the “Amendment”). The Amendment eliminates the right of the warrant holders to be paid in cash in the event of a merger or other types of reorganization. The warrants no longer need to be accounted for as derivative instrument liabilities.  The fair value of the warrants should be transferred to equity on the signing date and no further accounting (i.e., no mark-to-market) is required going forward. As of December 31, 2006, the fair value of the derivative instrument totaled $2,680,811. At April 26, 2007, the Company determined the fair value of the warrants was $1,475,020 using the Cox-Ross-Rubinstein binomial model with the following assumptions: volatility 25%; risk free interest rate 4.59%; dividend yield of 0% and expected term of 4.5 years. A gain of $1,205,791 was recognized in the accompanying income statement based on the decrease in fair value since prior period ended December 31, 2006. On April 26, 2007, the fair value of the warrants was transferred to additional paid-in capital.

During the third quarter of 2007, a total of 492,340 warrants exercised at $3.58 and 384,645 warrants exercised at $4.88 for a total of 876,985 shares of common stock. The Company received a total of $3,639,645 from various warrant holders.

On February 1, 2007, CFPG issued 50,000 warrants to Hayden Communication, the Company’s investor relations consultant, as part of its compensation. These warrants meet the conditions for equity classification pursuant to FAS 133 and EITF 00-19. Therefore, the warrants were classified as equity and accounted as compensation expenses. The warrants vest one year from the grant date. The Company used the Black Sholes model to value the options at the time they were issued, based on the exercise price of $4.25 and expiration dates of the instruments and using a risk-free rate of 4.84% and the volatility at 50% that was estimated by analyzing the trading history of the Company’s stock. At that market price, the 50,000 warrants had a fair value of approximately $94,274. The service that the investor relation consultant provides started from the second quarter of 2007; the related compensation expense is recognized on a straight-line basis over the total service period. The compensation expense for the three months and nine months ended September 30, 2007 are $94,274 and $94,274, respectively.

20
 
As of September 30, 2007, the Company has warrants as following:

           
Weighted
  
Average
  
   
Warrants
  
Warrants
  
Average
Exercise
  
Remaining Contractual
  
   
Outstanding
  
Exercisable
  
Price
  
Life
  
Outstanding, December 31, 2005
    
-
   
-
 
$
-
    
-
 
Granted
    
1,169,306
   
1,169,306
 
$
4.08
    
5.00
 
Forfeited
    
-
   
-
 
$
-
    
-
 
Exercised
    
-
   
-
 
$
-
    
-
 
Outstanding, December 31, 2006
    
1,169,306
   
1,169,306
 
$
4.08
    
4.58
 
Granted
    
50,000
   
-
 
$
4.25
    
-
 
Forfeited
    
-
    
-
 
$
-
    
-
 
Exercised
    
(1,030,813
)
  
(1,030,813
)
$
4.02
    
-
 
Outstanding, September 30, 2007
    
188,493
   
138,493
 
$
4.45
    
3.58
 

Note 15 - 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 (discussed in Note 14) 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. The expense recognized for the three months and nine months ended September 30, 2007 was $34,000 and $146,000, respectively.

On April 20, 2007, CFPG issued 9,500 options to the Company’s four independent directors as part of their compensation. The options will vest immediately after one year from the issuance date. The fair value of these warrants was determined at $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 service that independent directors provide started from the second quarter of 2007 and will last for one year, the related compensation expense was recognized on a straight-line basis over the total service period. The compensation expense for the three months and nine months ended September 30, 2007 are $9,714 and $9,714, respectively.

On July 1, 2007, CFPG issued 20,000 options to Mr. Yuan Xiaoyuan, who joined the Company as Chief Accounting Officer on the same day. The options will vest evenly each quarter over the following four years, starting from the third quarter of 2007. The Company used the Black Sholes model to value the options at the time they were issued, based on the exercise price of $6.70, which was the close price of the Company’s stock on June 30, 2007 and expiration dates of the instruments and using a risk-free rate of 4.84% and the volatility of 40% that was estimated by analyzing the trading history of the Company’s stock. At that market price, the 20,000 employee options had a fair value of $57,178. Because the options vested each quarter over the following four years, the related compensation expense is recognized on a straight-line basis over the total vesting period. The expense recognized for the three months and nine months ended September 30, 2007 are $3,574 and $3,574, respectively.
 
21

As of September 30, 2007, the Company has stock options as following:

       
Weighted
    
   
Options
  
Average Exercise
  
Aggregate
Intrinsic
  
   
Outstanding
  
Price
  
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, September 30, 2007
    
779,500
 
$
1.43
    
8,356,380
 

Following is a summary of the status of options outstanding at September 30, 2007:

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
   
3.75
   
562,500
   
1.25
   
3.75
 
9,500
 
  
4.51
    
4.58
   
-
   
4.51
   
4.58
 
20,000
   
6.70
   
4.75
   
1,250
   
6.70
   
4.75
 
 
Note 16 - 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 of the net assets of Beijing Zhong Xiao as of March 31, 2007 and received 100% ownership of Beijing Zhong Xiao.
 
After the restructuring of Beijing Zhong Xiao, the Company still has significant continuing involvement in the historical operations of the manufacturing of fire safety and protection products through Sureland Equipment, which fail 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 restructuring of Beijing Zhong Xiao as discontinued operations.
 
Note 17 - Subsequent event
 
In October 2007, the Company issued 107,695 shares of common stock for warrants exercised.
 
22
 
Item 2. Management's Discussion and Analysis or Plan of Operation
 
The following discussion and analysis provides information which the management of China Fire & Security Group, Inc., (the "Company" or "CFSG") believes to be relevant to an assessment and understanding of the Company's results of operations and financial condition. This discussion should be read together with the Company's financial statements and the notes to financial statements, which are included in this report.
 
Overview

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

Reorganization

We were organized as a Florida corporation on June 17, 2003.
 
On September 1, 2006, we entered into a share exchange agreement, pursuant to which we acquired all of the outstanding capital shares of China Fire Protection Group Inc. in exchange for a controlling interest in our common shares. The transaction was completed on Oct 27, 2006.

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

On February 9, 2007, Unipro changed its name to China Fire & Security Group, Inc. (CFSG) and started trading on OTC Bulletin Board under its new ticker symbol CFSG. On July 16, 2007, China Fire & Security Group, Inc. began trading on Nasdaq Capital Market and retained the ticker symbol CFSG.
 
CFSG owns, through its wholly owned subsidiary China Fire Protection Group, Inc., Sureland Industrial and Sureland Equipment (jointly “Sureland”). Sureland is engaged primarily in the design, development, manufacture and sale in China of a variety of fire safety products for the industrial fire safety market and of design and installation of industrial fire safety systems in which it uses its own fire safety products. To a minor extent, it provides maintenance services for customers of its industrial fire safety systems. Its business is primarily in China, but it has recently begun contract manufacturing products for the export market and it has begun to provide a fire safety system for a Chinese company operating abroad.
 
Sureland markets its industrial fire safety products and systems primarily to major companies in the iron and steel, power and petrochemical industries in China. It has also completed projects for highway and railway tunnels, wine distilleries, tobacco warehouses and a nuclear reactor. It is developing its business in the transportation, wine and tobacco, vessels, nuclear energy, and public space markets. Its products can be readily adapted for use on vessels and in exhibition halls and theatres. It plans to expand its marketing efforts to secure business in these industries.

23
 
Sureland has internal research and development facilities engaged primarily in furthering fire safety technologies. It believes that its technologies allow it to offer cost-effective and high-quality fire safety products and systems. It has developed products for industrial fire detecting and extinguishing. It believes that it is the only manufacturer in China which has successfully developed a comprehensive line of linear heat detectors.
 
By the end of third quarter 2007, Sureland operates more than 30 sales and liaison offices in China.
 
Sureland has been ranked as the leading Chinese industrial fire safety company two times by the China Association for Fire Prevention based on six major factors including total revenue, growth rate, net profit, return on assets, investment in research and development and intellectual property. Its key products include linear heat detectors and water mist extinguishers, whose sales volumes are the largest in China. Its products have been used by its customers in more than 20 provinces throughout China.
 
Critical Accounting Policies and Estimates
 
While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements appearing at the end of this form, 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 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 represents the invoiced value of goods, net of a value-added tax (VAT). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17 percent of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished product.
 
3.
Revenue from the rendering of Maintenance Services is recognized when such services are provided.
 
4.
Interest income is recognized on a time proportion basis taking into account the principal outstanding and the effective interest rate applicable.
 
5.
Dividend income is recognized when the shareholders’ right to receive payment has been established.
 
6.
Provision is made for foreseeable losses as soon as they are anticipated by management.
 
7.
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.
 
24
 
Foreign currency translation
 
The reporting currency of the Company is the US dollar. The Company uses their local currency, Renminbi (RMB), as their functional currency. Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. Historically, the Company has not entered any currency trading or hedging, although there is no assurance that the Company will not enter into such activities in the future.
 
Plant and equipment
 
Plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets with 5 percent residual value.
 
Use of estimates
 
The preparation of financial statements in conformity with generally accepted accounting principles of the United States of America requires management to make estimates and assumptions that affect the amounts reported in the combined financial statements and accompanying notes. Management believes that the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results could differ from these estimates.
 
25
 
Certain of the Company’s accounting policies require higher degrees of judgment than others in their application. These include the recognition of revenue and earnings from system contracting projects under the percentage of completion method and the allowance of doubtful accounts. Management evaluates all of its estimates and judgments on an on-going basis.
 
Inventories
 
Inventories are stated at the lower of cost or market, using the weighted average method. Inventories consist of raw materials, work in progress, finished goods and consumables. Raw materials consist primarily of materials used in production. Finished goods consist primarily of equipment used in project contracts. The cost of finished goods included direct costs of raw materials as well as direct labor used in production. Indirect production costs such as utilities and indirect labor related to production such as assembling, shipping and handling costs are also included in the cost of inventory. The Company reviews its inventory annually for possible obsolete goods or to determine if any reserves are necessary for potential obsolescence.
 
Accounts receivable
 
Accounts receivable represents the products sales, maintenance services and system contracting projects with its customers that were on credit. The credit term is generally for a period of three months for major customers. Each customer has a maximum credit limit. The Company seeks to maintain strict control over its outstanding receivables. Overdue balances are reviewed regularly by senior management.
 
Results of Operations

The following is a schedule showing results of our business.

Three Months Financial Results

Comparison of the Three Months Ended September 30, 2007 and 2006:
 
 
  
Three months ended
September 30, 
  
 
  
2007
  
2006
  
Revenues
  
$
11,596,970
  
$
8,042,200
  
Cost of revenues
    
4,729,538
    
4,218,005
  
Gross Profits
    
6,867,432
    
3,824,195
  
Operating expenses
    
2,769,996
    
2,663,346
  
Income From Operations
    
4,097,436
    
1,160,849
  
Other income(expense)
    
294,599
    
352,857
  
Income Before Income Taxes
    
4,392,035
    
1,513,706
  
Income taxes
    
-
    
(17,619
)
Net profit (Loss)
    
4,392,035
    
1,531,325
  
Foreign exchange adjustment
    
540,152
    
210,268
  
Comprehensive income
    
4,932,187
    
1,741,593
  
weighted average number of shares-basic
    
27,026,221
    
24,000,000
  
weighted average number of shares-diluted
    
27,825,442
    
24,000,000
  
earning per share-basic
    
0.16
    
0.06
  
earning per share-diluted
    
0.16
    
0.06
  
 
26
 
Total revenues were approximately $11.6 million for the three months ended September 30, 2007 as compared to approximately $8.0 million for the three months ended September 30, 2006, which represent an increase of approximately $3.6 million or 44.2 percent. This increase was mainly attributable to an increase in our product sales and the execution of contracts at a bigger value in the period. During the period, the Company performed 104 total solution and product sales contracts as compared to 120 contracts for the three months ended September 30, 2006. The revenues from total solution contracts increased by 7.8 percent to $6.1 million, compared to $5.7 million for the same period of last year; while the revenues from product sales increased by 133.1 percent to $5.2 million, compared to $2.2 million in the same period of last year. In particular, the three largest customers were Maanshan Iron and Steel Group, Sichuan Dongfang Electronic Equipment and PetroChina, who collectively contributed approximately $4.9 million of the revenues, representing 43.0 percent of our total revenues for this period.

27
 
Cost of revenues for the three months ended September 30, 2007 was approximately $4.7 million or 40.8 percent of revenues, as compared to $4.2 million or 52.4 percent of revenue for the three months ended September 30, 2006. Gross margin during this period was 59.2 percent, which is higher than the gross margin of 47.6 percent for the same period of 2006. The increase in the gross margin was mainly attributable to a higher percentage of revenue contribution from the sales of the Company’s proprietary products which enjoy higher margins.
 
Operating expense were approximately $2.8 million for the three months ended September 30, 2007, as compared to approximately $2.7 million for the three months ended September 30, 2006, which represent an increase of approximately $0.1 million or 4.0 percent. During this period, the Company increased its expenditures in sales-related activities and raised the compensation for the management to be in line with other US public companies. This increase is also attributable to the increased expenses related to being listed as a public company in the United States.
 
Operating income was approximately $4.1 million for the three months ended September 30, 2007 as compared to approximately $1.2 million for the three months ended September 30, 2006, representing a 253.0 percent increase. The improvement in operating income was mainly attributable to the increase in revenue and gross margin and the efficient cost control.

Total other income was approximately $0.3 million for the three months ended September 30, 2007 as compared to approximately $0.4 million for the three months ended September 30, 2006.

Our net income was approximately $4.4 million for the three months ended September 30, 2007 as compared to approximately $1.5 million net income for the three months ended September 30, 2006, which represent an increase of $2.9 million or 186.8 percent. This was attributable to the fact that the net income as a % of sales for this period was 37.9 percent, which was higher than the net income as a % of sales of 19.0 percent for the same period of 2006. The higher net income as a % of sales was mainly attributable to the higher gross margin that the Company enjoyed and the lower operating expenses as a result of our successful cost control in the period.

Currency translation adjustments resulting from RMB appreciation process amounted to $540,152 and $210,268 for the three months ended September 30, 2007 and 2006, respectively. The balance sheet amounts with the exception of equity at September 30, 2007 were translated at 7.50 RMB to 1.00 USD as compared to 7.80 RMB at December 31, 2006. The equity accounts were stated at their historical rate. The average translation rates applied to income statement accounts for the three months ended September 30, 2007, and 2006 were 7.57 RMB and 7.98 RMB, respectively.

The comprehensive income, which adds the currency adjustment to the net income, were approximately $4.9 million for the three months ended September 30, 2007 as compared to approximately $1.7 million comprehensive income for the three months ended September 30, 2006, which represent an increase of $ 3.2 million or 183.2 percent.
 
28
 
Nine Months Financial Results

Comparison of the Nine Months Ended September 30, 2007 and 2006

 
  
Nine months ended
September 30,
  
 
  
2007
  
2006
  
Revenues
  
$
32,643,617
  
$
23,068,283
  
Cost of revenues
    
14,450,765
    
10,943,005
  
Gross Profits
    
18,192,852
    
12,125,278
  
Operating expenses
    
7,294,318
    
5,278,138
  
Income From Operations
    
10,898,534
    
6,847,140
  
Other income(expense)
    
1,866,141
    
541,402
  
Income Before Income Taxes 
    
12,764,675
    
7,388,542
  
Income taxes
    
-
    
39,181
  
Net profit (Loss)
    
12,764,675
    
7,349,361
  
Foreign exchange adjustment
    
1,350,486
    
330,945
  
Comprehensive income
    
14,115,161
    
7,680,306
  
weighted average number of shares-basic
    
26,649,859
    
24,000,000
  
weighted average number of shares-diluted
    
27,436,695
    
24,000,000
  
earning per share-basic
    
0.48
    
0.31
  
earning per share-diluted
    
0.47
    
0.31
  
 
Total revenues were approximately $32.6 million for the nine months ended September 30, 2007 as compared to approximately $23.1 million for the nine months ended September 30, 2006, which represent an increase of approximately $9.6 million or 41.5 percent. This increase was mainly attributable to the further penetration of the Company’s customer base in the iron and steel, power, and petrochemical industries and the execution of more contracts in the period. During the period, the Company performed 186 total solution and product sales contracts as compared to 181 contracts for the nine months ended September 30, 2006. The three largest customers were Maanshan Iron and Steel, Sichuan Dongfang Electronic Equipment, and Jiuquan Iron and Steel, who collectively contributed approximately $12.3 million of the revenues, representing 37.7 percent of our total revenues for this period.

Cost of revenues for the nine months ended September 30, 2007 was approximately $14.5 million or 44.3 percent of revenues, as compared to $10.9 million or 47.4 percent of revenues for the nine months ended September 30, 2006. Gross margin during this period was 55.7 percent, which is higher than the gross margin of 52.6 percent for the same period of 2006. The increase in the gross margin was mainly attributable to a higher percentage of revenue contribution from the sales of the Company’s proprietary products which enjoy higher margins.

Operating expenses were approximately $7.3 million for the nine months ended September 30, 2007 as compared to approximately $5.3 million for the nine months ended September 30, 2006, which represent an increase of approximately $2.0 million or 38.2 percent. During the period, the Company increased expenditures in sales-related activities and raised the compensation for the management to be in line with other US public companies. This increase is also attributable to the increased expenses related to being listed as a public company in the United States.

Operating income was approximately $10.9 million for the nine months ended September 30, 2007 as compared to approximately $6.8 million for the nine months ended September 30, 2006, which represent an increase of $4.1 million or 59.2 percent. The increase was mainly due to the increase in our revenues and higher gross margin in this period even though we had a significant increase in our operating expenses related to being a public company and related to increasing our sales activities.
 
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Total other income was approximately $1.9 million for the nine months ended September 30, 2007 as compared to approximately $0.5 million for the nine months ended September 30, 2006. This increase in total other income is primarily due to the increase from the change in fair value of derivative. On May 3, 2007, the Company and warrant holders agreed to make an amendment to the Securities Purchase Agreement. As a result, we will not have the entry of “Change in fair value of derivative” on the income statements for the third quarter of 2007 and onwards.

Our net income was approximately $12.8 million for the nine months ended September 30, 2007 as compared to approximately $7.3 million net income for the nine months ended September 30, 2006, which represent an increase of 5.4 million or 73.7 percent. Net income margin for the nine months ended September 30, 2007 was 39.1 percent, which is higher than the net income as a % of sales of 31.9 percent for the same period of 2006. The reason for the increase in the net income was mainly due to the increase in the revenues and operating margin and the non-cash credit of $1.2 million related to the change in fair value of derivative instruments. Excluding the one-time credit of approximately $1.2 million from the change in fair value of derivatives, our pro forma net income is $11.6 million for the nine months ended September 30, 2007.

Currency translation adjustments resulting from RMB appreciation process amounted to $1,350,486 and $330,945 as of the nine months ended September 30, 2007 and 2006, respectively.

The comprehensive income, which adds the currency adjustment to the net income, were approximately $14.1 million for the nine months ended September 30, 2007 as compared to approximately $7.7 million comprehensive income for the nine months ended September 30, 2006, which represent an increase of $6.4 million or 83.8 percent.

Liquidity and Capital Resources
 
As of September 30, 2007, we had working capital of $35.1 million including cash and cash equivalents of $13.0 million. The following table sets forth a summary of our cash flows for the periods indicated:
 
 
Nine Months Ended
September 30,
  
 
  
2007
  
2006
  
 
  
   
  
  
  
Net cash provided by (used in) operating activities
  
$
3,236,930
  
$
8,368,333
  
Net cash used in investing activities
    
(3,484,254
)
  
(731,523
)
Net cash provided by (used in) financing activities
    
3,387,848
    
(7,927,645
)
Effect of foreign currency translation on cash and cash equivalents
    
412,282
    
108,216
  
Net cash flow
  
$
3,552,806
  
$
(182,619
)
 
Operating Activities
 
Net cash provided by operating activities was approximately $3.2 million for the nine months ended September 30, 2007 as compared to approximately $8.4 million net cash provided by operating activities for the same period in 2006. Net cash provided by operating activities in the nine months ended September 30, 2007 was mainly due to net income of $12.8 million, a $2.1 million increase in customer deposits, a $0.6 million increase in accrued liabilities and a $0.6 million increase in account payable offset by a $3.4 million increase in account receivable, a $2.1 million increase in costs and estimated earnings in excess of billings, a $4.7 million decrease in billings in excess of costs and estimated earnings and a $1.1 million increase in prepayments and deferred expenses. The increase of a $2.1 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 a $4.7 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.
 
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On a quarterly basis, the operating cash flow for the third quarter of 2007 is approximately positive $3.3 million as compared to approximately positive $0.2 million for the second quarter of 2007, which is the result of better management of our working capital during the period.
 
Investing Activities
 
Net cash used in investing activities in the nine months ended September 30, 2007 was $3.5 million, which is an increase of $2.8 million from net cash used in investing activities of $0.7 million in the same period of 2006. Net cash used in investing activities was mainly attributable to a $1.0 million used to purchase equipment, a $2.3 million used to purchase building, a $0.6 million used to purchase intangible asset, and $1.0 million used to invest in King Galaxy Investment Limited offset by a $0.5 million proceeds from the sale of investment in Tianjin Fire Safety Equipment Co. Ltd. and a $1.1 million proceeds from the restructure in Beijing Zhong Xiao.

Financing Activities
 
Net cash provided by financing activities in the nine months ended September 30, 2007 totaled $3.4 million as compared to $7.9 million used in financing activities in the same period of 2006. The increase of the cash provided by financing activities was attributable to a $0.8 million decrease in restricted cash, which represents the cash required to be deposited in the bank to guarantee the execution of signed contracts, and a $1.4 million payment from Beijing Zhong Xiao to clear the balance between Beijing Hua An and Beijing Zhong Xiao, and a $3.6 million proceeds from the issuance of common stock for the exercise of warrants offset by a $2.4 million payment 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 $3.6 million from December 31, 2006 to September 30, 2007.  We believe that our currently available working capital of $35.1 million including cash and cash equivalents of $13.0 million should be adequate to sustain our operations at our current level and our anticipated expansion through at least the next twelve months.
 
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Off-Balance Sheet Arrangements

We do not have any off-balance sheet financing arrangements.  
  
Item 3. Controls and Procedures.

a)   Evaluation of Disclosure Controls. Brian Lin, our Chief Executive Officer and Robert Yuan, our Chief Accounting Officer evaluated the effectiveness of our disclosure controls and procedures as of the end of our second fiscal quarter 2007 pursuant to Rule 13a-15(b) of the Securities and Exchange Act. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, as appropriate to allow timely decisions regarding required disclosure. Based on their evaluations, Mr. Lin and Mr. Yuan concluded that our disclosure controls and procedures were effective as of September 30, 2007.

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

  (b)   Changes in internal control over financial reporting. There have been no changes in our internal control over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Our management team will continue to evaluate our internal control over financial reporting in 2007 as we implement our Sarbanes Oxley testing.

32
 
PART II - OTHER INFORMATION
 
Item 1. Legal Proceedings

None
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders.

None

Item 5. Other Information.

None

Item 6.  Exhibits
 
The following exhibits are hereby filed as part of this Quarterly Report on Form 10-QSB.
 
Exhibit
Number: 
 
 
Description
31.1
 
Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of Principal Accounting Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1
 
Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
     
33.2
  
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350

33

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-QSB to be signed on its behalf by the undersigned, thereunto duly authorized, in Beijing, on November 13, 2007.
     
 
CHINA FIRE & SECURITY GROUP, INC.
 
 		  
 		  
 
By:  
/s/ Brian Lin
 
Brian Lin
 
Chief Executive Officer, Principal Accounting Officer
 
 
34