UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, DC 20549





FORM 10-K





þANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2010





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





For the transition period from _____________ to _______________.





Commission File No. 000-53463





Covenant Group of China Inc.(Exact Name of Registrant as Specified in Its Charter)





Nevada

68-0677260(State or Other Jurisdiction

of  Incorporation or Organization)

(I.R.S. Employer Identification No.)





Two Bala Plaza, Suite 300


Bala Cynwyd, PA 19004


(Address of Principal Executive Offices, including zip code)





(610) 660-7828


(Registrant’s Telephone Number, Including Area Code)





Securities registered under Section 12(b) of the Exchange Act:  None





Securities registered under Section 12(g) of the Exchange Act:  Common stock, $0.00001 par value





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





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





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





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   ̈    No   ̈










Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ





Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer," "accelerated filer” and "smaller reporting company" in Rule 12b-2 of the Exchange Act (check one):





Large accelerated filer
o
Accelerated filer
oNon-accelerated filer

(Do not check if a smaller reporting company)
o
Smaller reporting company
þ





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  oNo  þ





On March 31, 2011, 9,683,909 shares of the registrant’s common stock were outstanding.





On June 30, 2010, there was no established trading market for our common stock.  We estimate that the aggregate value of our common stock at June 30, 2011 was $27,758,945 based on the “bid” side quotation for our common stock at June 30, 2010.





Documents Incorporated by Reference: None.










TABLE OF CONTENTS





PAGEPART IItem 1.
Business

1Item 1A.
Risk Factors


26Item 1B.
Unresolved Staff Comments.


38Item 2.
Properties


38Item 3.
Legal Proceedings


38Item 4.
[Removed and Reserved]PART IIItem 5.
Market for Registrant’s Common Equity, Related Stockholder Matters  and Issuer Purchases of Equity Securities


38Item 6.
Selected Financial Data


41Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations


41Item 7A.
Quantitative and Qualitative Disclosures About Market Risk


52Item 8.
Financial Statements and Supplementary Data


52Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure


52Item 9A.
Controls and Procedures


52Item 9B.
Other Information


55PART IIIItem 10.
Directors and Executive Officers and Corporate Governance


56Item 11.
Executive Compensation


58Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters


59Item 13.
Certain Relationships, Related Transactions and Director Independence


60Item 14.
Principal Accountant Fees and Services


60PART IVItem 15.
Exhibits and Financial Statement Schedules


62











The statements contained in this Annual Report on Form 10-K that are not historical facts are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to our financial condition, results of operations and business, which can be identified by the use of forward-looking terminology, such as “estimates,” “projects,” “plans,” “believes,” “expects,” “anticipates,” “intends,” “may,” “could,” or the negative thereof or other variations thereon, or by discussions of strategy that involve risks and uncertainties.  Management wishes to caution the reader of the forward-looking statements that such statements, which are contained in this annual report, reflect our current beliefs with respect to future events and involve known and unknown risks, uncertainties and other factors, including, but not limited to, economic, competitive, regulatory, technological, key employee, and general business factors affecting our operations, markets, growth, services, products, licenses and other factors discussed in our other filings with the Securities and Exchange Commission ("SEC"), and that these statements are only estimates or predictions.  No assurances can be given regarding the achievement of future results, as actual results may differ materially as a result of risks facing us, and actual events may differ from the assumptions underlying the statements that have been made regarding anticipated events.





These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. Some of these risks are described in “Risk Factors” in Item 1A of this annual report.





These risk factors should be considered in connection with any subsequent written or oral forward-looking statements that we or persons acting on our behalf may issue. All written and oral forward looking statements made in connection with this annual report that are attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements.  Given these uncertainties, we caution investors not to unduly rely on our forward-looking statements. We do not undertake any obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events. Further, the information about our intentions contained in this document is a statement of our intention as of the date of this document and is based upon, among other things, the existing regulatory environment, industry conditions, market conditions and prices, the economy in general and our assumptions as of such date. We may change our intentions, at any time and without notice, based upon any changes in such factors, in our assumptions or otherwise.





PART I





In this Annual Report on Form 10-K, we will refer to Covenant Group of China Inc., a Nevada corporation, as "Covenant," “the Company,” "our company," "we," "us," and "our."





Item 1.  Business.





Overview





We are a holding company engaged in the business of acquiring equity interests in private companies based and operating in the People’s Republic of China (“PRC” or “China”) and providing value-oriented services in the areas of strategic planning, business development, mergers and acquisitions assistance, and board and/or advisory board service.  As described below, during 2009 we completed the acquisition of two privately held companies based and operating in China.  On April 30, 2010, we terminated our agreements with one of our Chinese subsidiaries and rescinded the exchange of shares for the capital stock of that company.  See “Termination of our Acquisition of Chongqing Sysway.”





We intend to continue to seek to acquire equity interests in privately held companies in China.   We believe that equity investments in China present one of the most attractive global investment opportunities available in the coming five to seven years.  The Company plans to focus on emerging growth company acquisitions generally located in China.  As with our current Chinese subsidiary, we intend to have at least two members of our board of directors and management elected to serve on the board of each company we acquire.  The management and board of the Company intend to take a direct role in monitoring the performance of our operating subsidiaries.





Our initial focus was on Chinese information technology (“IT”) companies that were positioned to capitalize on opportunities created by the government’s new policies or which were serving industrial sectors that were a target of the government’s economic development policies.  The Company intends to broaden its focus to consider other emerging industries, if and when they are discovered, while continuing to focus on the Chinese IT market as its core investment strategy.  In the near-term, the Company will consider investment opportunities in strategic industries that place emphasis on internal markets in agriculture, Chinese medicine, carbon reduction, energy savings, green energy and financial technology and where there is potential for mergers and acquisition activity.




We believe that China presents interesting opportunities for investment for the following reasons:  the volume of its population; a large number and variety of domestic industries; expansive Chinese socialist capitalism; sovereign protection for Chinese operating companies; and the potential increase in value of owned Chinese assets as the RMB appreciates.




1





Our Operating Subsidiaries





Our initial portfolio acquisition of Hainan Jien Intelligent Engineering Co., Inc. (“Hainan Jien” or “JIEN”) was in furtherance of our initial investment focus.  JIEN specializes in the design and installation of security and surveillance systems.   We also entered into acquisition agreements with Chongqing HongSheng Information Industry Co., Inc. (“Chongqing Sysway” or “Sysway”); however, we terminated our agreements with Chongqing Sysway and rescinded our acquisition of its capital stock on April 30, 2010.  See “Termination of our Acquisition of Chongqing Sysway.”





Hainan Jien





Hainan Jien is a hi-tech integrated firm based in Haikou City, Hainan Province.  It is engaged in professional intelligent construction (“IC”) for new buildings and the modernization of existing buildings, which involves the installation of security and surveillance networks and the development and expansion of information and communications technology (“ICT”) for commercial, governmental and residential structures.  JIEN provides security and surveillance systems and IC and ICT services to a variety of market sectors such as manufacturing, finance, securities, hotel, postal services, aviation, government, and residential construction.  Its business currently focuses on providing the following services to its customers: installation of security and surveillance systems (such as monitoring systems, alarm systems, access management, one-card pass technology and visual intercom); TV engineering (cable and satellite television and communal antennae applications); BAS automation and self-control engineering; integrated wiring, IC, ICT and queuing systems; communication engineering (telephone, wireless intercom and computer network systems); and energy-saving city applications (installation of public lighting systems).





As mentioned, Hainan Jien is centrally involved in the implementation of IC projects for commercial customers.  IC construction involves designing and building structures with an integrated technology plan, which includes equipment management automation systems, fire warning systems, communication systems, security systems, and business support systems. IC systems, combined with advanced building structures and internal and external operating systems, make the functionality of buildings more comfortable, safe and energy-efficient.  Moreover, with JIEN’s understanding of IC projects, it embraces the North American concept of “green buildings,” through its implementation of sophisticated communications, network and security systems.





In 2005, China Security and Protection Magazine, published by The Ministry of Public Security of the PRC, ranked Hainan Jien as one of China’s top 100 security and surveillance enterprises.  Since then, JIEN is one of only two companies in Hainan province that hold a 3111 Project Initiative Certification—the "Safe City" Certification issued by the China Security and Protection Industry Association—to participate in the government’s Safe City Projects.  The 3111 Project is the initial phase of the Safe City Project, which is an ongoing nationwide initiative sponsored by the Ministry of Public Security to enhance general security in China’s cities, which includes the implementation of new surveillance cameras in high-traffic areas throughout a total of approximately 660 cities. These security systems will be integrated and networked together both regionally and nationally to ensure safety and security for citizens and to help deploy public services in the most timely and effective manner possible.  Contracts for this project are typically a year or more in duration and are signed and paid for by both the national and local governments.





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Looking to the future, China has a much broader ten-year program to deploy a system of high-tech surveillance and tracking known as “golden shield.” The goal of this program is to deploy a nation-wide system that will enable law enforcement to monitor all highways and streets. It is estimated that the internal-security market will reach $33 billion by 2010. The Left Coaster, Police State 2.0, http://www.theleftcoaster.com/archives/012630.php. Additionally, Hainan Jien is also regionally well positioned to benefit from future growth. Recently, the provincial government of Hainan Island announced a twenty-year construction development plan to build out Hainan as an “International Tourism Island” in accordance with the Chinese Central Government’s strategic vision. See Industry Overview—Hainan Jien.





Hainan Jien is considering opportunities to expand its business into energy savings construction and the installation of “green” lighting applications for the preservation of the environment.  As a result of potential commercial opportunities arising from PRC government policies dating to 2006 that emphasize energy-savings and emissions reduction as a basic national policy, JIEN is investigating the feasibility of performing sales and installation work for a local producer of high efficiency lighting for commercial and residential applications.





Pandaz LLC





On January 13, 2010, the Company acquired the assets of a small technology company under a wholly owned subsidiary, Pandaz LLC, a Delaware limited liability company, in exchange for $25,000.  The assets are intangible in nature and primarily consist of rights to trade names, domain names, and all object code and source code to operate an Internet site deploying automobile search capabilities for consumers. The Pandaz LLC technology is currently in the development stage, and the Company plans to further develop this technology and the Pandaz LLC business model potentially for the emerging Chinese consumer auto market.  See Industry Overview; The China Opportunity, 2011-2015; Growth of Transportation and the Automobile.





Our Business Operations





Hainan Jien – Operations on the International Tourism Island of Hainan





Hainan Jien’s business operations can be separated into two facets:  project implementation and post-installation service.  Project implementation begins with customer interviews by our marketing personnel to ascertain project information and customer demands.   After JIEN completes a full assessment of the customer’s needs, it then designs a project unique to our customer’s application.  Typically, a bidding process results and upon the signing of a contract, JIEN’s implementation team builds out the project at the customer’s facility.





3





Post-installation service primarily involves honoring warranty commitments pursuant to Hainan Jien’s contracts with its customers.  The post-installation service period for work performed under its contracts is usually one to three years, which is consistent with industry standards.  As part of the post-installation service process, JIEN provides a toll-free number available to its customers for consultation with its specialists.  Hainan Jien’s technical support is equipped to respond to both hardware and software malfunctions on both an emergency and normal basis.  Depending on the proximity of the implementation site relative to its Haikou City headquarters, JIEN has the capability to either provide an engineer onsite or provide the customer with long-distance support.  Hainan Jien’s commitment to assisting its customers with any post-installation matters is a key component to its competitive strategy, given its business of introducing and implementing new IC and surveillance technologies to the China market.





JIEN’s location on Hainan Island—an emergent resort destination experiencing a marked buildup of its infrastructure and hospitality industry—is important to the company’s current IC and security and surveillance operations as well as the island’s evolving energy savings industry.  The island province of Hainan, known as “China’s Hawaii,” is the smallest province of the PRC and is located off of the southern coast of the country.  Hainan is the largest island administered by the PRC, having approximately the same land area as the country of Belgium.  On December 31, 2009, the General Office of the State Council, in a proclamation, declared that the island would set as its goal to become a world-renowned resort island by 2020.  See Hainan Jien; Hainan—International Tourism Island.





On June 10, 2010, the National Development and Reform Commission officially approved Hainan’s development into 6 functional areas, focusing on the build out of the island into an international tourist venue.  Subsequently, plans were put into effect to develop Hainan’s high-end real estate market through the construction of commercial and residential buildings and hotels to international standards. See Hainan Jien; Hainan—International Tourism Island.  The management of JIEN anticipates these initiatives will present new opportunities in intelligent and green building construction and security and surveillance.








The China Opportunity, 2011-2015





The Communist Party of China (“CPC”) Twelfth Five-Year Plan (2011-2015) (“Twelfth Plan”)





The Twelfth Plan was offered by the Chinese Premier, Wen Jiabao, in his presentation to the Fifth Plenum of the 17th CPC Central Committee and adopted on October 18, 2010. The Twelfth Plan directs the Central Government’s policy and is important to planning our business strategy.  The Twelfth Plan’s key elements are as follows:





·
The implementation of scientific development should be the key factor employed in all sectors of social reform and economic modernization;





·
The high importance of the needs of human beings and sustainable economic growth;





4





·
“Persever[ance] in keeping economic development as [China’s] central goal;”





·
Narrowing the wealth gap and improving all people’s livelihoods—the ultimate goal of economic development to improve people’s lives—that will be attained by increasing social justice, creating a social security system, instituting medical reforms, expanding the housing system, curbing speculation and promoting the transition of rural populations to urban existence;





·
Emphasis on rural issues—particularly agriculture and farming, which has the responsibility of feeding a population of 1.3 billion—and rural modernization, consisting of new public services, raising incomes and upgrading infrastructure;





·
Putting into action programs that continue to reduce energy consumption and carbon emissions while encouraging global coordination on such matters, but with differentiated responsibility by country;





·
Promoting emerging industries in and related to energy and energy conversion, environmental protection, information technology, advanced manufacturing, new organized markets, communications and internal security; and





·
Sustainable yearly economic growth of 7% over the duration of the Twelfth Plan.





China GDP Growth Rate





The gross domestic product of China has expanded from 1989 to 2010 at an average rate of 9.3%, reaching a high of 14.2% in December 1992 and a low of 3.8% in December of 1990.  Trading Economics, China GDP Growth Rate (1/20/2011).  China’s economy is now the second largest in the world and is expected to eclipse the US economy by 2030 to become the world’s largest economy.  New York Times, China Passes Japan as Second-Largest Economy (8/16/2010).  China’s economic expansion is a recent driver of global growth, and China has emerged as a dominant Asian economy.  As a result, the Chinese are on a course to shape world policy, and the Central Government has asserted that the US dollar be phased out as the world’s only reserve currency.  We anticipate that the Chinese economy will grow faster than that of any other developing country, which in turn will have a significant impact on commodities, imports and exports, energy use, and emerging industries.




Foreign direct investment (“FDI”) in China by FDI enterprises is being encouraged by the creation of new rules instituted by the Ministry of Commerce and the National Development and Reform Commission. In January 2011, China’s FDI increased by 23% to $10.3 billion. In 2010, China received a total of $105.7 billion in FDI, up 17.4% on a year-on-year basis. People’s Daily Online, Officials Say Review of Foreign Takeovers are Good for Chinese and Foreign Firms (2/18/2011).





China’s economy grew at 10.3% to reach $6.1 trillion in 2010.  Correspondingly, China’s consumer price index was up 3.3% and retail sales were up 18.4% as urban residents per capita income grew 7.8%. The economy’s growth was also fueled by fixed-asset investment, which increased by 23.8%.  For 2010, industrial value-added output was up 15.7% and foreign trade grew 34.7%, while China’s trade surplus declined by 6.4%.




5




Amidst China’s growth, inflation pressures are an issue the government is considering seriously.  A trial tax on property speculation is now being employed to discourage housing speculation and land transfer fees are being aggressively collected.  The nation’s central bank is cutting lending targets by 10% for 2011 and has raised the nation’s bank reserve requirements multiple times recently to quell inflation.





China’s outbound direct investments in the non-financial sector were up 36.3% ($59 billion) on a year-to-year basis.  Its trade surplus is predicted to continue to drop as the government redirects the economy toward increased domestic consumption.  In 2010, exports grew 31.3% while imports rose significantly, up 38.7%.  Commerce Minister Chen Deming stated, “Our foreign trade policy principle this year is to stabilize exports, promote imports and reduce the surplus.”  Consistent with these policies, it is the intent of the government to reduce the surplus-to-GDP ratio.





China is currently engaged in cross-border trade using the RMB.  According to HSBC, at least half of China’s trade with emerging countries will be settled in RMB within the next 3 to 5 years, compared with 3% today.  An offshore market for the RMB has developed and is growing in Hong Kong, and at the end of 2010, RMB deposits in Hong Kong reached almost 315 billion RMB ($47.9 billion).  The Central Government and various enterprises are entitled to issue RMB-denominated bonds for overseas investors.  As a result, more than 20 billion RMB ($3 billion) worth of bonds have been issued in Hong Kong as of December 2010.





Urbanization – The Economic Transformation of China





China’s economic and social goals are tied to urbanization and the establishment of the Chinese middle class.  The “middle class” in China is presently defined as those earning 50,000 RMB ($6,300), with different tiers of income necessary to live in megacities such as Shanghai and Beijing as opposed to less-developed, inland urban centers. Disposable income has greater buying power in China than in the western world.  We anticipate emerging opportunities for businesses and investment as the middle class is predicted to expand to over 600 million by 2015, up from 250 million at the end of 2010.  By 2025, half of China’s population should be considered middle class, with the wealthiest consumers in the 25-44 age group—much younger than the analogous group in western countries.  McKinsey & Co. (6/2006).





Consistent with the growth of the Chinese middle class, McKinsey also predicts that more than 20 of the world’s top 50 cities in terms of GDP will be located in Asia by 2025, up from 8 in 2007.  Comparatively, half of Europe’s and 3 of North America’s cities currently on this list will be removed during this period.  McKinsey & Co. (3/2011).





China’s Consumption – The Cornerstone of its Economic Policy





A report produced by McKinsey Quarterly in August 2009 (A Consumer Paradigm for China) stated, “[Chinese] consumption has vaulted to the top of national—indeed global—policy agendas.”  As of the date of the McKinsey report, China’s consumption-to-GDP ratio stood at 36%—half that of the US.  China’s policy is to aggressively plan to increase consumption by 2025.  Assuming the Central Government fully implements the policies it has already announced, the McKinsey Global Institute estimates consumption could ultimately account for 45% of GDP, which would place the Chinese economy into a transformative phase.  We believe that the factors necessary for these policies to be effective include successful execution of the Twelfth Plan and a gradual and then accelerated appreciation of the RMB.  McKinsey’s projections related to the expansion of Chinese consumption are as follows:





·
Over 350 million people will be added to the urban population by 2025;





·
The number of people living in cities will approach 1 billion;





·
Migration from rural areas will drive the growth of the urban population, representing nearly 40% of the urban population by 2025;




6




·
New cities will emerge in over 80 different locations by 2025;





·
221 Chinese cities will have 1 million or more people living in them;





·
900 smaller cities outside of the largest 40 cities will generate 54% of the urban GDP and 55% of urban growth;





·
Up to 15 “supercities” with populations greater than 25 million will emerge by 2025;





·
170 new mass-transit systems and up to 50,000 new buildings could be built;




·
Urban centers could produce up to 75% of China’s GDP by 2025 and job creation in cities is estimated to result in 450-500 million urban jobs in 2025, compared to 290 million jobs in 2005 (McKinsey & Co. (3/2009);





·
10 million units of affordable housing for low-income groups in renovated areas that are currently impoverished—an investment of 1.3 trillion RMB ($197.6 billion);





·
The Central Government will raise the threshold of taxable income to assist Chinese households to cope with the rising cost of living; in 2008, this threshold was raised to 2,000 RMB and it is believed it will be raised to as much as 3,000 RMB—this tax relief measure, along with the slow appreciation of the RMB, will enable social stability and further expand domestic consumption;





·
According to China’s Ministry of Commerce, there is an active market for luxury goods in China comprised of wealthy consumers (incomes of 300,000 RMB or more ($45,851)) and an additional 13 million upper-middle class households (incomes of 100,000 to 200,000 RMB ($15,284 to $30,567)), which will account for 20% of global luxury sales by 2015;





·
China’s internet market has more than 450 million users with access to online retailers such as GAP and Wal-Mart; and





·
Online (e-commerce) sales in China increased by 22% in 2010 as internet sales reached 4.5 trillion RMB ($684 billion); e-commerce is expanding in China and is expected, according to the Ministry of Commerce, to reach 5% of retail sales by 2015, up from 2% in 2010.





China Employment





China’s prior reform policies have resulted in a marked labor supply shortage.  This is a direct result of the country’s demography, industrialization and the effect of 30 years of the one-child policy.  Statistics reveal that reserves of migrant workers have dropped by 20 million over the last 3 years.  As a result, the nation’s emerging policy is to encourage persons in less developed areas away from the eastern coastal zone to take advantage of opportunities inland as manufacturers move to the mid-central parts of China as the government promotes industrialization in these areas.  This relocation of the country’s industrial base accelerated in 2010, creating a bigger job market for workers inland.  As a result, wages in the east are less attractive to workers, as the wage gap between east and west is only 5%.  The People’s Daily Online (2/12/2011).





China’s food prices rose 30% in 2010 and thus had a significant impact on lifting incomes for China’s over 600 million farmers.  This price increase is responsible for narrowing the gap in living standards and income levels between the urban and rural population.  As a result, China’s lowest income populations have experienced unprecedented economic benefit as food price inflation provides employment and a transfer of wealth to the rural farm communities, fostering a better standard of living.




7




China is purported to have 200 million migrant workers that move from rural to urban work and back again.  These workers are now being encouraged to settle in smaller towns as the government provides affordable subsidized housing, permanent residency and jobs.





Additionally, retail jobs are expanding throughout China as firms are moving to smaller cities as part of the urbanization process:





·
Adidas AG plans to open 2,500 stores in smaller cities by 2015;





·
Ford Motor Co. is adding 100 dealers to its network in smaller cities;





·
The major electronics producer, Foxxconn Technology Group, is setting up thousands of stores;





·
Tesco, England’s third largest retailer, is planning to open 200 hyper-markets;





·
American retailers, GAP, Morton’s Restaurants Group and Starbucks’s, have expansion plans for second-tier cities.





In total, Chinese retail sales are planned to expand from $2 trillion today to $5-$6 trillion by 2020.





The Manpower Employment Outlook Survey, reviewing China’s employment outlook, stated, “Chinese employers forecast an active labor market in the second quarter of 2011.”  In spite of the shortage of labor and rising wages, China is in a hiring boom.  The clear hiring leaders are in manufacturing and services, followed by finance, insurance and real estate.  Expanding business activities and increased wages are key catalysts in rebalancing the Chinese economy and growing domestic demand.  The Central Government took measures to increase rural incomes by allocating 818.3 billion RMB ($120 billion) to investment in agriculture, farmers and rural areas—135 billion RMB ($20.5 billion) of which was utilized for agricultural production.





Growth of Transportation and the Automobile





The emergence of the Chinese consumer and the urbanization of China have resulted in new demand for transportation and related infrastructure.  The need to connect large urban centers and assure the rapid and efficient movement of manufactured goods between cities and food and produce into cities has resulted in an unprecedented level of investment in transportation infrastructure.  This development of the transportation infrastructure includes 5 main north-south super highways and 4 main east-west superhighways, resulting in 85,000 km of highways in China by the end of 2010, which is 12% longer than the total length of the highways currently in the US.  Rail projects include plans for 280 bullet trains connecting major population centers.  Additionally, China’s domestic production of cars and trucks exceeded US production in 2009, and over 18 million units were sold in 2010.  China AutoWeb (1/27/2011).  In addition, used car sales increased 15% to 3.72 million units in 2010.  The China Automobile Dealers Association predicts used car sales will grow tenfold in the coming decade, reaching 36 million in 2020—close to the predicted 40 million in new car sales in 2020.





China’s Economy, International Trade and the Value of the RMB





The Chinese economy is rapidly and fundamentally transforming itself and the country under the guidance and through the policies of the Chinese Communist Party and the Central Government. Their policies are in pursuit of long-term goals and are not reoriented or refocused in response to short-term issues.  The policies themselves are based on the principle of having a “harmonious society” through developing the health and wealth of the people through “market socialism,” which entails policies to assure market stability and economic growth.  The RMB is central to all policies developed by the politburo dating to the 1970’s.





The political and economic issues that encompass all dialogue on a global basis centers on the RMB, which is the Chinese denomination in the form of bills and is the unit in which all prices are measured.  Before 2009, the RMB had little exposure to international markets due to strict control of the RMB by the government.  China will be resistant to the accelerated appreciation of the RMB.  The RMB rose 23% since 2005 against the US dollar and by 3.72% since China’s exchange rate reform in June 2010.  Over the past 5 years, the US dollar index has depreciated by (15.94)% while foreign countries that are significant trading partners with China rose sharply.  For example, the Australian dollar rose 43.86%, the Japanese Yen rose 38.17% and the Euro rose 18.53% during this period.




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China has questioned whether the RMB’s inexpensiveness relative to the US dollar was responsible for the US-China trade gap.  Instead, China recognizes the dual benefits the US and China receive by China’s exports creating employment and social stability domestically while supplying US consumption, which is funded, in significant part, by China’s purchases of US treasury bonds.





The RMB’s gradual appreciation will benefit the Chinese consumer, decrease the viability of companies competing exclusively on the basis of cost, increase the focus on value-added goods for export, increase outbound acquisition activity and generate greater liquidity in the Chinese capital markets. China’s policymakers indicate they want the RMB to become a component of a new international reserve currency, and the country is seeking alternative investments and bilateral agreements as a precursor to its international plans. To this end, China has established ties with a group of anti-US dollar countries that include Brazil, Russia and India and has further established currency swap agreements with Argentina, South Korea, Hong Kong, Indonesia, Malaysia and Belarus.





China’s policies and the actions of the People’s Bank of China recognize that currency appreciation and a more flexible exchange rate regime serves China’s long-term interests.  In June 2010, China removed the RMB’s peg to the US dollar and allowed it to float in a controlled manner.  By this action, China took steps toward facilitating trade settlement in RMB and the country is expected to expand bilateral trade with emerging markets.  Recently, the RMB appreciated beyond the 6.6 RMB per US dollar threshold and it is predicted the RMB will appreciate 3-5% during 2011.  Since the beginning of 2011, China has liquidated approximately $4.4 billion of its holdings of US treasury bonds, reducing their holdings in these instruments to $763 billion as the dollar continues to decline and thus transferring inflationary liquidity to China.





Key Facts on China’s Economy





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·
China’s economy grew 10.3% in 2010 and is valued at $6 trillion, making it the second largest economy in the world.  GDP growth is forecasted to be at 8.7% for 2011 as China’s authorities adjust the economy to become less export dependent, moving towards a more balanced import and consumer-based economy.  Retail sales increased 18.4% on a year-on-year basis, and urban residents per capita income increased 7.8%.  Tax revenues doubled from 2005 to 2010.





·
China’s CPI increased 3.3% in 2010 and is expected to be higher in 2011 as inflation is expected to be a challenge for the central bank and the economy itself.  The government will embark on combating inflation by tightening liquidity within the banking system, increasing pressure on speculation by severely penalizing speculators, improving distribution efficiency across China, and substantially increasing food available for consumption and agriculture supply through investment and imports.





·
China’s stock market, as defined by i-Shares FTSE, Xinhua and China 25 IDX, rose 91.09% over the last 5 years while the US stock market, as defined by the SPDR S&P 500 ETF, rose only 12.51% during the same period.





·
The Twelfth Plan features an emphasis on boosting domestic consumption—steering the country away from export and investment fueled growth.  China plans to import more technical “know-how” to move its production up in the manufacturing value chain, allowing it to compete in international markets by exporting top grade goods.





·
RMB appreciation is planned to be gradual, which will be utilized to benefit the Chinese consumer as well as serve as a boon to the economy.  Gradual appreciation should provide an increase in consumer purchasing power, lower the cost of domestic consumption, help to neutralize the effect of commodity prices and provide incentive to invest in Chinese businesses and companies.  RMB appreciation is also likely to have a significant impact on global currencies and investments over time.  The recent drop below the historical peg of 6.5885 RMB:$1 indicates China may allow the RMB to become stronger at a faster pace.  Since China de-pegged the RMB from the US dollar in June 2010, the RMB has appreciated 3.3%.




10




·
Chinese companies previously fit into 3 categories:  state-owned enterprises; joint-venture companies between Chinese and foreign entities; and wholly owned private Chinese companies.  There is a new set of companies in China that is emerging out of the activities of innovators and entrepreneurs, which could become a potential source for acquisition candidates and targets for foreign investment.





·
The Chinese government’s intermediate-term economic plan is focused on the reform of income distribution through tax policies favoring the individual and families and increasing wage levels for the low to middle income groups, thereby increasing consumption—an important component of a growing Chinese consumer-based economy.  A recent study of the Chinese consumer by Economic Intelligence Unit and reported by Forbes Online (8/27/10) stated, “[Chinese] retail spending has increased steadily at 15% and more in recent years. . . . China has already become the world’s largest market for automobiles, television sets and cell phones, and the world’s second largest market for luxury goods.”  According to a report by the Boston Consulting Group, China’s economy is growing at a rate of 20 to 30 times the rate of western economies and is expected to consume 14% of the world’s products by 2015.





In light of the foregoing, we intend to pursue our strategy because of the following key macro topics:





·
China’s New Economic Policy.The hallmarks of China’s policy are to: (i) significantly increase spending and implement substantial tax cuts by reducing the value-added tax and adopting preferential tax policies for SMEs; (ii) increase bank liquidity and continue to reduce interest rates; (iii) implement comprehensive industrial restructuring and facilitate the merger and reorganization of enterprises; (iv) promote innovation in science and technology; and move toward a stronger consumer-based economy and away from an economy driven by unskilled manufacturing.





·
Chinese Economy has Significant Reserves.  China has a substantial $2.85 trillion in foreign exchange reserves, up from $2.3 trillion at the beginning of 2010, to keep the economy at its currently planned 8% plus growth level.  In addition, China maintains a significant 35% savings rate, resulting in approximately $3.0 trillion in individual bank savings.  China’s broadly measured money supply is 19.7% higher than a year ago in January 2010.





·
Major International Market Participants are Investing in China.  Warren Buffet, Jim Rogers, the John Templeton Fund, the Carlyle Group, Temasek Holdings and Cargill are investing in China.  Goldman Sachs predicts that China will surpass the U.S. economy by 2027.  Optimism about China stretches across a wide range of American investors.  In a survey by the American Chamber of Commerce and reported by Reuters in December 2009 found that 64% of 369 companies surveyed had plans to increase their investments in China in 2010.





·
Foreign Direct Investment.The Ministry of Commerce stated that foreign direct investment in February 2011 increased 32.2%, to $7.8 billion, compared to February 2010, following a similar increase of 23.4% in January 2011.  In 2010, foreign direct investment inflow reached a record $106 billion, rising 17.4% year-on-year.





·
Current Chinese Business Environment.  Foreign investment is a driver in China’s quest to expand its manufacturing-based economy to include high-end manufacturing, high-tech, clean energy, environmental protection and service-based industries.  According to Huo Jianguo, speaking for the Ministry of Commerce, “China should accelerate its transformation by utilizing the fast growing foreign direct investment to develop its high-tech, service and advanced agricultural industries; all are crucial to our economic development.”





11





Industry Overview





Chinese IT Industry





IT opportunities are abundant in China since the introduction of the PRC government’s adoption of the “scientific concept” policy model. This model features fostering domestic economic growth and social progress. Important to this initiative is the Chinese concept of “informatization,” which centers on the development and expansion of IT in China. Broadly defined, informatization is the transformation of the Chinese economy and society driven by information and communications technology.  Coordinated at China’s highest governmental levels and touching all aspects of society, it is recognized as a key component of the Central Government’s national strategy to transform China’s industrial-based society to a technical and information-based society. Presentation of Xiaofan Zhao, Director General for the Department of IT Application Promotion, State Counsel Informatization Office, PRC. Accordingly, the informatization concept includes plans for the development of e-commerce, e-government, electronic content management, security and industrial IT applications in China.  Informatization is the official is the official term used in China to describe China’s economic development strategy.





Due in part to these government initiatives, information technology investment in China is growing at twice the rate of western countries, and it is estimated that $40 billion of China’s $756 billion economic stimulus package will impact the Chinese IT industry between 2009 and 2013.  According to a press release issued in May 2010 by the research and advisory firm, Gartner Inc., “IT spending in China will reach $216.7 billion in 2010.”  Gartner indicates that this increase in spending offers substantial opportunities for technology and service providers in China, which it attributes to the 5.1% growth in the market during 2010 (up from $205 billion in 2009).  On a worldwide basis, IT spending for 2011 is forecasted to total $3.6 trillion, a 5.1% increase from 2010, continuing a trend from 2009.





Government spending and investment in the expanding potential of the rural market, where approximately 650 million people live, will fuel IT market growth in China.  Other factors driving this market include modernization in sectors such as education, healthcare and manufacturing, as well as the use of consumer credit for purchases.  Consequently, the enterprise software market is forecasted to grow at an estimated 14.6% through 2013 and is expected to surpass the $6 billion spent on enterprise software in 2010.  In viewing the broader software market, China’s share of the Asia/Pacific market by 2013 is expected to reach 30%, or $9.4 billion—3.3% of the worldwide software market.  Gartner Inc., Market Trends:  Software Market, China 2009-2013.





According to the managing director of Research-Works in an article appearing in the Asia Sentinel on 2/11/2011, China has invested heavily in research and development and has completed 60% of a 25-year program to increase research and development expenditures to a level of 2% of GDP; moreover, 75% of research and development spending during this period lies in the current decade.  These initiatives have resulted in industry-specific impacts.  For example, healthcare IT expenditures are projected to reach $4.1 billion by 2013 via a compound annual growth rate of 25%, due in large part to a 2004 government mandate from the health informatization plan that directs 4% of hospital revenues be spent on IT.  Marketwire, Presentation by Scientia Advisors (2/16/2010).  Additionally, IT in agriculture is utilized by agro-scientists, engineers, husbandry students and farmers as stakeholders in the agro business share information on a global basis.





Consequently, China’s IT market is expected to exceed global expectations during 2009-2013, according to the China Information Technology Report Q4 2009 (by Business Monitor International, as published on 10/15/2009 by www.marketresearch.com).  The Chinese stimulus program and the rural electronics subsidiary programs are expected to raise IT spending from $78.0 billion in 2009 to $124.0 billion by 2013.  Computer sales are projected to move from $52.0 billion to $80.0 billion in 2013.  IT services will reach $16.4 billion in 2009, and this sector is expected to achieve a compound annual growth rate (CAGR) of 135% between 2009 and 2013.





12




Special Economic Zones (“SEZs”)





The PRC offers investors a complex system of incentives at the national, regional and local levels.  Party members have great influence at the regional and local levels where they live, impacting regional business activities and seeking employment for locals.  There are special economic zones, hundreds of development zones and designated inland cities that vie for foreign investment.  The most significant benefit of SEZs to businesses and investors is significant tax concessions during the early years of projects within the zone.  SEZs have played a major role in China’s industrial development over the last 20 years.  “Let’s Talk Development,” blog hosted by worldbank.org.  China has more than 1,000 industrial zones that provide basic infrastructure (e.g. roads, water and utilities), security, affordable government land and “plug and play” housing for workers.  The Chinese system of SME-oriented, “plug and play” industrial zones is one of the most important factors in the success of the manufacturing industry.  China’s success with these zones is also based on intense competition between local governments and local private sector developers.





Our subsidiary, JIEN, an SME (see "Government Promotion of Small-to-Medium-Size Enterprises"), is located in an SEZ in Hainan Province, China, where there is access to a large high-tech employee pool. China also has numerous national science parks, many focused on commercializing technology research developed in Chinese universities.  PRC policy is to encourage investors to fund the introduction, innovation and development of technology, and invest in technology intensive projects in order to promote and facilitate technology companies.





Government Promotion of Small-to-Medium-Size Enterprises (“SMEs”)





Chinese SMEs are defined as enterprises with annual business revenue below 300 million RMB ($45.6 million) and employing 300 to 3,000 people.  SMEs, which number over 10 million registered enterprises, account for 99% of all registered companies in China.  These companies contribute to the Chinese economy 60% of GDP, 50% of tax revenues, 68% of foreign trade volume and 75% of urban employment.  The Central Government supports SMEs with wider access to policy and financial support, including the reduction of tax rates.  The government also allows smaller, private companies to compete with larger, government-owned enterprises by opening channels of government funding in a new policy supporting the health of the SME industry.  As a precursor to future policies, the government is also changing the definition of SMEs by narrowing the scope of medium-size companies while expanding the scope of small-size companies and proposing a new category:  micro-size companies.  SMEs are an important source of opportunities for the Company in the execution of our China business strategy.





The SMEs operating environment in China has been historically tougher than the larger government-invested companies because of the lack of financing avenues.  SMEs traditionally depended on commercial loans, which are difficult to obtain, and government subsidies to fund their expansion.  In the past, these companies were too small to list their companies on Chinese national exchanges.  As a result, new exchanges have launched in China, such as ChiNext, an exchange for small companies, and the Growth Enterprise Market of the Honk Kong Stock Exchange, which have enhanced economic growth and increased employment by allowing small companies to raise necessary capital.  During the Twelfth China Hi-Tech Fair, Xiu Xiaoping, director of the High-Technology Development Center of the Ministry of Science and Technology, recommended that venture funds invest in SMEs with growth potential.  China’s policy is to provide assistance to foreign firms with the hope of encouraging investment in small Chinese companies.





SMEs are the backbone of the ASEAN economies, representing 96% of all enterprises in the economic zone.  SMEs are also responsible for 50% to 85% of domestic employment in many of the ASEAN member states.  In addition, their contribution to national GDPs and national exports in this area varies between 30% and 53% and 19% and 31%, respectively.





SMEs were the main driving force of the 2010 Chinese IPO market.  PricewaterhouseCoopers press release, PwC Initial Public Offering Market Review for 2010 and Outlook for 2011.  In 2010, the Shanghai Stock Exchange and the Shenzhen SME Exchange listed 349 IPOs, raising 478.3 billion RMB ($72.7 billion).  Of these listings, 204 were on the Shenzhen SME Exchange.  According to Charles Feng, a Lead Partner at PwC China, “2011 is the first year of China’s Twelfth Five-Year Plan and the government is committed to speeding up the reform of the economic growth model, highlighting technology and innovation as pillars of the reform.”  He added, “I believe small and medium-sized high-tech and growth enterprises will lead the capital market in coming years.”




13




The Company believes that we are positioned to assist private Chinese growth companies in gaining access to international capital markets with the goal of growing such companies’ operations and profits.   In addition to the country’s rapidly expanding consumer base, emergent trends in China indicate there is increasing demand for growth capital for private companies in light of the Chinese government’s recent economic initiatives.  According to the CASS Report (the Chinese Academy of Social Sciences), more than 180 million people worked for privately owned enterprises (“POEs”) by the end of 2010, which is 60 million more than in 2005—an annual increase of 9% over the period.  POEs have an increasing role in innovation and economic restructuring.  The CASS Report indicates that POEs have taken the lead in strategic emerging industries and high tech sectors.  Historically, financing has been difficult to obtain for POEs and SMEs domestically.  As a result, China has removed many of the barriers for POEs and SMEs to enter broader markets, an initiative supported by the 2003 enactment of The Law of Promotion of Small and Medium-Sized Enterprises and the Expansion of Credit.  The People’s Bank of China reported that by the end of 2010, China had more than 2,300 micro-credit companies providing 162 billion Renminbi Yuan (“RMB”) ($24.58 billion) in loans.  In addition, the CASS Report stated that by the end of 2009, more than 5,500 credit guarantee institutions provided 338.9 billion RMB ($51.43 billion) to 370,000 POEs and SMEs.





Hainan Jien





Hainan—International Tourism Island





On February 7, 2010, Hainan Province announced a comprehensive, twenty-year economic and social informatization plan to execute on the Chinese government’s strategic vision to develop the island of Hainan, the country’s major beach holiday destination, as an “International Tourism Island.”  The central goal of this plan is to promote the balanced economic development of the island through urban and rural modernization and improving social welfare programs and infrastructure, while at all times assuring that these development efforts are pursued with care for the environment.  A key element to the execution of this goal, as called for in the plan, will be the utilization of modern and intelligent construction practices to realize the build-out of state-of-the-art road transport infrastructure, housing, leisure, education and medical facilities.  In addition, the province is planning to construct a major rapid transit system linking the four main areas of the island and to invest 2.64 billion RMB ($386 million) in its power grid as part of these initiatives. Source: http://english.bitf.org.cn/node_516350.htm; http://english.bitf.org.cn/2010-02/11/content_3393203.htm.





Surveillance and Security Market





Surveillance and security is homeland security technology in China.  Popular uprisings in various mid-east countries in recent months have underscored for China the need for intensive surveillance to guard against crime, terrorism and upheaval.  This need is therefore consistent with expanding technologies in the surveillance and security market in China, which include video surveillance systems, biometric systems, and facial and behavior recognition software.  The Chinese video surveillance market was $1.4 billion in 2009 and is expected to grow at an annual rate of 20% for the next 4 years and reach $3.5 billion in 2014.





China Security and Protection Industry – 2009-2014





According to the China Security and Protection industry, the market size of the security and protection industry reached 149.6 billion RMB ($22.9 billion) in China.  This market is essentially comprised of entry protection (approximately 33% of the current market space) and electronic security and protection (approximately 67% of the current market space), of which video monitoring is a 58% component.




14




The China video surveillance market is projected to reach $9.5 billion by 2014.  Government regulations and policies, security concerns and international unrest contributed significantly to a compound annual growth rate of 12.1% for this market, which was $5.6 billion in 2005.  Mandatory government regulations cover high-speed railways, universities, financial institutions, residential and commercial areas, and hospitals and health institutions.





The Chinese government’s Eleventh Five-Year Plan (2006-2010) states that a secure and stable society is the number one priority for the government.  Several laws were passed to codify this effort:





·
The Safe City Safety Surveillance Ordinances, requiring the 660 largest cities in China to install surveillance systems in major public areas, such as subway systems, municipal complexes, train stations, airports, major thoroughfares, universities, banks, factories, libraries, border crossings, parks, athletic fields, schools and government facilities;





·
The Safe City Project, which according to the Ministries of Public Safety and Construction requires various commercial buildings to install security and video surveillance systems (See page 2 for a further discussion of the Safe City Project);





·
The 3111 Project, the initial phase of the Safe City Project, which is the program for monitoring and reporting on provincial, city, county and municipal levels;





·
State Ordinance 458 requires surveillance at all entertainment venues in China (e.g. internet cafes, pubs, discos, karaoke parlors and public gathering places);





·
In preparation for the 2010 World's Expo in Shanghai, spending by the PRC government on security and surveillance infrastructure reached approximately $3.0 billion, compared to $300 million spent during the 2008 Olympics; this reflects the government’s reliance on surveillance needed for security in China in view of global travel to the country; and





·
Consistent with the government’s broader informatization policies, the demand for IC; in 2009, commercial property investment was more than 550 billion RMB ($84.1 billion), an increase of 22.8% on a year-on-year basis (ezinemark.com), of which IC costs and security costs could have been as much as 10% and 20%, respectively.




Activity in the IC industry is influenced by annual investment in construction, public infrastructure, and the modernization of existing systems and related hardware.  As new and better technologies are created, the scale of technological improvements and modernization should increase and, as a result, economically feasible break-through designs in IC should have a larger effect in stimulating demand.   This conclusion must be considered in light of broader trends in the Chinese economy and construction industry:





·
In 2010, investment in residential real estate accounted for 12% of China’s GDP (New York Times (3/26/2011)), which, unlike the US, is underpinned by demand and not credit, due to China’s urbanization, rising wages and high savings rate.





·
The share of residential construction in China is significantly lower than the US because of China’s emphasis on infrastructure spending.  However, according to the National Bureau of Statistics, the growth of residential investment on a year-to-year basis has been close to 35%, which is slightly higher than growth of commercial investments.  In this environment, authorities are controlling residential speculation by requiring higher down payments, allowing only residents of an area to purchase in that area, mandating higher mortgage rates and supporting the construction of more affordable housing while reducing the construction of luxury buildings.




15




·
In March 2009, the McKinsey Global Institute reported, “Within 20 years, China will build 40 billion square meters of floor space in 5 million buildings . . . 50,000 of these buildings could be skyscrapers, [which is] equivalent to constructing 10 New York Cities.”





Products





Hainan Jien





Hainan Jien designs and installs security and surveillance infrastructure to protect financial institutions and government agencies and implements systems for IC projects for commercial customers.  JIEN's security and surveillance business is primarily sourced from the Chinese government’s “Safe City Project” 3111 Project initiative.  To this end, the company specializes in the installation of security and surveillance systems in various public areas, from city-wide surveillance systems and traffic surveillance systems to critical government locations, cyber cafes, bars and discotheques. With regard to the IC services offered by Hainan Jien, the company focuses on IC projects in three distinct areas:





·
Intelligent Building (“IBC”): Hainan Jien is one of the largest providers of intelligent building services in Hainan Province. Hainan’s economy has seen rapid growth since the State Council approved Hainan as an “International Tourism Island.” The 2010 provincial GDP was approximately $30 billion, an increase of 15.8% compared with that of 2009. The province’s recent rapid development will be beneficial to the growth of Hainan’s industries and residents and, consequently, for the demand for intelligent buildings. Thus, we estimate that demand for JIEN’s intelligent building services will increase. Source: http://finance.eastmoney.com/news/1350,20110215119687895.html.





·
Intelligent Housing: The development of Hainan as an International Tourism Island will likely promote the development of real estate in the region.  It is predicted that housing opportunities in Hainan will soon open globally. Accordingly, it is estimated that there are currently over 100 nation-wide enterprises specializing in real estate development in Hainan, culminating in an investment total of 100 billion RMB ($15.2 billion).





·
Intelligent Hotel: Hainan, also known as “China’s Hawaii,” is quickly becoming a global tourist destination. Approximately forty internationally and regionally recognized hotel brands have built new hotels in the province, such as Sheraton, Shangri-La, and Hilton. Since the approval of Hainan as an International Tourism Island and in accord with the requirements of the Outline of the Eleventh Five-Year Plan of National Economy and Social Development, Hainan will look to build thirty additional five-star resort hotels in the next three years. With the development and popularization of the Intelligent Hotel systems line, the company hopes to obtain strong market share in this field as it grows.





Below is a graphical representation of a typical IC project performed by Hainan Jien:







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17




Competitive Advantages





Our Investment Strategy and Management Team





At the holding company level, we believe the following strengths will allow us to effectively execute our investment strategy.





We look to invest primarily in “unique growth companies” in China.





Through our research and due diligence, we focus primarily on “unique growth companies” as our potential investment targets. These businesses either participate in or focus on serving industrial sectors that are supported by the PRC’s five and ten year plans for internal economic development. As a result, our operating subsidiaries will operate in business environments supported by the Central and local governments and recognized as important to the economic expansion of China, thereby positioning our subsidiaries for expansive growth upon the successful execution of their business plans.




We will hold significant ownership stakes in our operating subsidiaries.





We intend to hold a significant equity stake in each of our operating subsidiaries. As a result, we will have a vested interest in the successful growth of our operating subsidiaries.  Our management team at the holding company level will lend its expertise and resources to facilitate the sustained growth of our subsidiaries as well as assist these businesses in gaining access to necessary capital for growth.  Moreover, this strategy will allow for centralized control over the reporting obligations of our subsidiaries to ensure their regulatory compliance in the US markets and sound corporate governance.





Our Board and management possess extensive experience both in China and in the U.S. capital markets.





Our subsidiaries will benefit from the guidance and resources available to them at the holding company level.  It is the goal of our Board, management and advisory board to work closely with our operating subsidiaries in assisting them with compliance requirements they will encounter as component parts of a U.S. public company, while simultaneously providing them access to necessary growth capital that will allow them to meet expanding market opportunities in China and ultimately generate a return to our investors.  To this end, members of our Board and senior management are prepared to lend their years of experience with and knowledge of raising funds in the U.S. capital markets as well as their extensive management experience with U.S. public companies.  Beyond this strength, our Board, management and advisory board members bring their experience with and understanding of China, its business culture, its economic opportunities, and its government to the development of the Company and the potential growth of our subsidiaries.  Consequently, through our holding company structure, we are effectively situated as to serve as the key liaison between our subsidiaries and the U.S. investor.





Based on our research and experiences in China and the U.S. capital markets, we have a targeted investment strategy that focuses on quality operating companies.





In light of the vast investment opportunities in a rapidly developing economy such as China’s, we have the opportunity to be selective in the operating companies we choose to invest in.  Consequently, we can utilize our experience in China and in the U.S. capital markets to invest in companies that have the greatest potential to generate sustained growth for the Company and potentially become standalone public entities.  We have established the following investment criteria for our investment in or acquisition of target companies:





·
Focus on “unique growth companies”—i.e. businesses and technologies that participate in, or focus on, serving industrial sectors that are supported by the PRC’s five and ten year plans for internal economic development.




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·
Investment will provide the Company with a substantial position in special growth companies.





·
These special growth companies should also:o
Benefit from the support of both the local and regional government;


o
Be privately owned—i.e. there should not be an ownership stake held by the government;o
Be free from competition with any government enterprise;


o
Have demonstrated profitable organic growth for 2-3 years;o
Exhibit a well established and growing customer base, market penetration and operating infrastructure;


o
Have an effective and proven management team which is willing to make a multi-year contractual commitment to the execution of a business plan;o
Be able to provide comprehensive financial statements;


o
Be willing to commit to a program of establishing a system of sound corporate governance in accordance with U.S. public market standards and comply with all local laws and regulations as well as U.S. securities laws and exchange listing requirements. This will include adopting a code of conduct and U.S. accounting standards.





Our Subsidiary's Competitive Strengths in the IT Industry in China





We believe the following strengths differentiate our operating subsidiary from its competitors, enabling it to attain a leadership position in the IT market in China.





Strong Solution and Service Development Capability





An experienced senior management team, most of whom have computer science and electrification (electrical engineering and electrical generation and distribution systems) backgrounds, leads the solution development efforts of our operating subsidiary. As of September 30, 2009, our operating subsidiary employed 33 software development engineers, or 26.4%, of its work force.  Hainan Jien, in addition to being ranked as a national top 100 security and surveillance provider, is one of three security and surveillance firms that are First Grade National Certified, a certification issued by the Public Ministry Security Bureau that allows Hainan Jien to implement all levels of security projects nationwide.  Hainan Jien also utilizes component-based platforms in the software development process that enable it to redeploy relevant modules for future solutions or repackage them as stand-alone standardized solutions.





The primary goal of the research efforts of our operating subsidiary is to develop solutions that may be strategically implemented and commercialized. As an investment in long-term growth, Hainan Jien funds and operates its own research and development that focuses on core technologies underlying solutions and solution protocols.





Proven Management with a Successful Business Record





The senior management team of our operating subsidiary consists of computer scientists and engineers with extensive management experience in the IT industry ranging from 24 years to 36 years. This management team has complementary skills in the areas of software development, operations, finance, and sales and marketing. Under the leadership of its management team, Hainan Jien has expanded its operations and solution lines and achieved revenue growth.




19




Market Positioning





Hainan Jien is located in a high growth region in China.  Hainan Province, the location of Hainan Jien, recorded 2010 GDP of approximately $30 billion and a year-on-year growth rate of 15.8%. Additionally, the province was approved by the PRC State Council to establish itself as an International Tourism Island, whereby a series of incentive policies will be applied to the region. Such momentum is likely to boost infrastructure investment and property development and, consequently, the service market supporting such initiatives. In working to attain its status as a top security and surveillance firm and IC services leader in the province, it is Hainan Jien’s goal to take a primary role in the Hainan region’s accelerated development.




Recognition within Our Operating Subsidiary’s Industry





In China, recognition by independent public and private industry experts of a firm’s product or service is regarded by commercial, governmental and retail customers as assurance of the quality of a firm’s products and services and is an important basis upon which to compete.  Our operating subsidiary’s certifications and honors are as follows:





HAINAN JIENCertification & Honors
Certification Body
Certification DateSecurity and surveillance certificate level 1
Public security bureau, Hainan Province
October 2009Member of the Procurement Center of the Central People's Government
Procurement Center of the Central People's Government
March 2008Computer Information System Integration Level 2
Hainan Development Bureau
April 2007

(valid for 3 years)Certificate in intelligent construction design and installation level 2
Department of Construction, Hainan Province
April 2007Member of Hainan Software Industry Association
Hainan Software Industry Association
2007Commercial Credit Qualification Certificate
Hainan Guoli Credit Certification Center
June 2007Quality Certification of IS09001:2000
China Quality Certification Centre
April 2007

(valid for 3 years)Authentication Certificate of Commercial Credit AAA
Commercial Credit Administration of Hainan Province
August 2006Greatest Grow Up of 100 Enterprise for China Public Security & Safety Industry
A Subordinate of The Ministry of Public Security of PRC
January 2005








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Project Implementation





Hainan Jien





JIEN implements a dual phase project support and implementation process for its surveillance and IC services.  The cornerstone of the project support phase is the accurate design of projects tailored to customer specifications in advance of project implementation.  After a customer submits a project request, JIEN validates the request to ensure it is in accordance with its capacity and capabilities, with the goal of assigning the proposal to one of its project designers.  Once the proposal is submitted to a project designer, the designer is then responsible for developing a written and graphical design plan for submission to JIEN’s customer.  After second level review of the design and internal approval, the final project design proposal is submitted to the customer for review.





Upon acceptance of the project proposal by the customer and entry into a written contract setting forth the scope of work to be performed, the implementation phase begins with Hainan Jien’s management appointing a project manager to oversee preparation for the project both internally and with the customer, allocation of staff to the project worksite and construction.  Once onsite, the project staff receives, inspects and lays all necessary wiring, followed by their receipt, inspection and installation of all required equipment.  The project manager also works with the customer to assess the need for additional sub-projects tangential to the installation.  To the extent such additional projects are required, the original contract is modified accordingly and the project manager oversees such further projects’ development and installation onsite.  After all installation work is complete and the project staff performs a thorough inspection of the system, JIEN ensures the installation is in accord with the customer’s specifications, making any required adjustments, and finally assisting the customer with the data transfer into the new system, if necessary.




Sales and Marketing





Hainan Jien





Hainan Jien’s Marketing Department is divided according to business scope among the following five industry sales centers:  finance, government, real estate, hotel and small projects.





JIEN’s marketing program is centered on a general-manager-responsibility system. Originally, JIEN’s Deputy General Manager was responsible for the overall marketing for the company, having jurisdiction over the five industry sales centers. However, over the past two years of operations, the company has experienced rapid market growth.  As a result, the company’s General Manager is now responsible for the government industry while its Deputy General Manager is responsible for the financial industry.  JIEN’s Marketing Director is in charge of the real estate industry while its Deputy Marketing Director heads the company’s hotel sales division. Hainan Jien’s general marketing staff manages sales for all small projects. Advertising is primarily accomplished through face-to-face meetings with potential customers, Internet and e-mail communications, government conferences and scheduled meetings with JIEN’s independent contractors.





With regard to approximately 20% to 30% of JIEN’s new contracts, the company utilizes a partnership-sale method, whereby the company works with independent contractors who assist it with negotiations with potential customers on projects.  JIEN has a profit sharing relationship with its independent contractors based on the success of negotiations.  The company’s independent contractors are located in all of the company’s sales centers.  There is currently a ten contractor marketing staff in JIEN’s three sales centers, with its Haikou Center having six people, its Sanya Center having two people and its Hubei Province Center having two people.  All other contracts are obtained and serviced by JIEN’s own internal marketing staff.





Hainan Jien’s Post-Sale Service Department specializes in customer service.  JIEN has established a 7-day, 24-hour service system where customers can communicate with its Post-Sale Service Department through mobile phone, telephone, Tencent QQ and E-mail.  As an added redundancy, the company’s Marketing and General Office Departments also have the capabilities of carrying out customer support functions.





21




Suppliers





Hainan Jien





JIEN’s 5 largest suppliers during 2010 are as shown in the chart below:





Supplier
$
000's


% of Total PurchasesHainan Shengyi Systems Engineering Co., Ltd.


3,514



63.00
%Haikou Jiachuang Electronic Company


258



4.87
%Haikou Hongjie Construction Material Company


253



4.76
%Haikou Kalai Lighting Decoration Company


152



2.86
%Hainan Mingyuan Lighting Construction Engineering Co., Ltd.


149



2.80
%Total


4,326



81.46
%





JIEN purchases its products based on customer demand, product performance and brand. Suppliers for the company’s project implementations vary due to different systems and the products demanded by its customers. Based on the size of a given project, some of JIEN’s suppliers for large-size equipment will send their technical staff to the project site to support the company during the installation according to the company’s specifications. If quality problems occur, JIEN’s suppliers generally assess the seriousness of the problem based on the difficulties communicated by JIEN’s on-site technical staff. Generally, the company’s suppliers are available for technical guidance to assist its technicians with troubleshooting customers’ systems. If hardware problems occur with the company’s projects, suppliers normally provide on-the-spot support or spare products. Consistent with the company’s own warranty commitments to its customers, JIEN’s suppliers normally provide free maintenance or replacement for their products within JIEN’s warranty periods (1 to 3 years).





Customers





Hainan Jien





Hainan Jien’s 10 largest customers during 2010 are as shown in the chart below:





Customer

$
000s


RateHainan Modern Trade Co., Ltd.


771



10.62
%Haikou Central Government Service Hall


733



10.10
%Haikou Central Government Governor's office


582



8.02
%Hainan Jingrui Real Estate Co., Ltd


564



7.76
%Hainan South Sea Information Technology Company


562



7.75
%Hainan Jingrui Real Estate Co., Ltd


499



6.87
%Accountingcenter,Gongan County, Hubei Province


462



6.36
%Hainan Medical College


420



5.79
%Provincial Department of Land and Resources


415



5.73
%Haikou Prison


415



5.71
%Total


5,423



74.70
%




22




Hainan Jien’s customers are from various areas of Hainan Province and parts of Hubei Province.  The company has no business overseas.  JIEN’s largest customers are primarily from the government sector, the financial industry and real estate.





Research and Development





Hainan Jien





Hainan Jien’s research and development staff has developed a proprietary software system: Information Management System (“IMS”).  The IMS system assists companies with the management of the exploration of market opportunities, production, logistics and internal project approval.  IMS is currently in the technology solution stage.  Once Hainan Jien completes its technology solution analysis, it plans to do further software coding and software testing, with the goal of submitting a report of software property to the State Intellectual Property Office for property registration.  Related to the development of solutions for the IMS technology, JIEN has recently signed a contract to work on an integrated circuit card network communication system.





JIEN is also considering opportunities in the growing Internet of Things industry in China.  As a result, the company’s research and development staff is focused on developing an Internet of Things service system in 2011, primarily for Hainan’s logistics information service market and network construction security industry.





Intellectual Property





Hainan Jien





JIEN currently has intellectual property rights to an automatic spit plate machine.  In 2011, JIEN plans to apply for one additional patent through the State Intellectual Property Office for its IMS system.





Employees





At December 31, 2010, we employed approximately 75 full time employees. Our holding company employed 2 full time employees and 2 part-time employees.  Our operating subsidiary, Hainan Jien, employed 73 full time employees.





Covenant Employee BreakdownDepartment

Holding Company


Hainan Jien


TOTALManagement


2



6



8All administration


0



3



3Sales/Post-Sale Service


0



14



14Design/Implementation


0



50



50Total


2



73



75




23




Government and Environmental Regulation





Hainan Jien





Previously, the Hainan government has given Hainan Jien preferential tax treatment due to its industry.   However, a unified taxation policy has since been implemented throughout the nation, eliminating any tax reduction benefits for the company.





Hainan Province’s "Intelligence Island Plan" is the provincial government’s primary source of guidance and planning for Hainan’s information technology industry.  In the plan, the Hainan government indicates it is actively promoting information intelligence systems and improving the province’s information service system to increase speeds, with the goal of enhancing the overall strength and competitiveness of its SMEs.




Hainan Province has also indicated it is going to establish a software and information services industrial park.  Hainan Jien anticipates this park will introduce large enterprises and new software technology to the province, aiming to enhance the competitiveness of SMEs and thereby increasing competition.  However, Hainan Jien anticipates new opportunities will arise as the government emphasizes the replacement and renovation of intelligence software applications in e-commerce, e-government, telecommunications, finance, taxation, transportation, medical care and other key sectors.




The planning of Hainan’s provincial government also incorporates the construction of a "Digital Safety Green Island," which consists of enhancing intelligence security systems, including systems related to population information, traffic management, integrated public security and integrated public security communication networks.  This plan also calls for building and improving global satellite positioning systems and focuses on enhancing vital components of the province’s video surveillance system.




The province also supports the wide use of information technology to improve transportation infrastructure and the movement of goods into and off of the island.  With regard to improving the transportation infrastructure, the province supports the improvement of IT associated with traffic and communication systems, which entails implementing a new traffic management system, electronic license program, internet-based intelligent traffic management system and sensing information systems.  Additionally, the government aims to strengthen the joint cooperation of customs, banking, quality inspection, insurance, the tax department and other private and public bodies to promote collaboration and improve customs clearance for international shipping.  It plans to accomplish this through coordinating and strengthening information sharing between different departments and promoting multiple forms of transport.




Competition





There are currently two US listed companies in China’s security and surveillance service sector recognized as leaders due to their size and financial strength, thereby posing competition to our operating subsidiaries.  Those companies are China Security and Surveillance Technology, Inc. and China Information Technology, Inc.  Both of these companies have extensive market presence and resources in China. In addition, these companies are well-financed and have valuable enterprise values.





·
China Security and Surveillance Technology, Inc.  (NYSE Symbol:  CSR):  CSR has a market capitalization of $354 million, revenues of $685 million and net income of $78 million for the year ended December 31, 2010.  CSR is the largest company in China in the security and surveillance industry and operates an extensive sales and service network that includes 150 branch offices and distribution points throughout China.





·
China Information Technology, Inc.  (NASDAQ Symbol:  CNIT):  CNIT has a market capitalization of $124 million, revenues of $163 million and net income of $34.4 million for the year ended December 31, 2010.  CNIT specializes in geographic information systems, digital public security technology and hospital information systems.





24




History





We were incorporated in the State of Nevada on November 8, 2006 under the name Everest Resources Corp. (“Everest”) as an exploration stage corporation that intended to engage in the exploration of gold.  On December 24, 2009 we changed our name to Covenant Group of China Inc. and acquired all of the outstanding capital stock of Covenant Group Holdings Inc. (“Covenant Holdings”), a privately held company incorporated under the laws of the State of Delaware and engaged in the business of acquiring equity interests in private Chinese operating companies and providing these companies with strategic support.  The acquisition of Covenant Holdings was accomplished on December 24, 2009, pursuant to the terms of a share exchange in which each of the Covenant Holdings shareholders exchanged their respective shares of Covenant Holdings, on a one-for-one basis, for 9,380,909 shares of the Company's common stock.  As a result of the share exchange, Covenant Holdings became a wholly-owned subsidiary of Covenant.





Prior to our acquisition of Covenant Holdings, we were in the development stage and had minimal business operations.  We had no interest in any property, but had the right to conduct mineral exploration activities on 471 acres in southern British Columbia, Canada.  In connection with the acquisition of Covenant Holdings, the Company’s former majority shareholder, terminated the Company’s mineral exploration rights, and he agreed to surrender 5,000,000 shares of the Company’s common stock in exchange for $100,000 and a promissory note from the Company in the principal amount of $190,000, $90,000 of which the Company prepaid.  The shareholder surrendered 4,500,000 shares of our common stock and agreed to surrender his remaining 500,000 shares upon full payment of the promissory note by the Company.  On March 25, 2010, the shareholder and the Company entered into an agreement pursuant to which the shareholder agreed to cancel the promissory note and surrender his remaining 500,000 shares in exchange for the Company issuing to him 300,000 shares of common stock of the Company.   On May 13, 2010, the shareholder and the Company entered into an agreement pursuant to which the shareholder agreed to reduce the number of shares that he will receive from 300,000 to 70,000.





On June 24, 2009, Covenant Holdings entered into a stock acquisition and reorganization agreement with Hainan Jien and its stockholders.  Pursuant to the terms of this agreement, Covenant Holdings acquired 100% of the capital stock of Jien, representing 100% of the company’s outstanding equity interests, in exchange for 1,350,000 shares of a public shell’s common stock.  For purposes of this acquisition, the common stock of the shell company that would acquire all of the rights and obligations of Covenant Holdings was valued at $1.76 per share, which was determined by the volume weighted average stock price for the first day of trading of the Company’s common stock plus all private sales of Covenant Holdings’ common stock prior to the completion of the reverse merger with the Company.  Jien was incorporated in Hainan Province, China in 1999.  Jien specializes in the design and installation of security and surveillance infrastructure to protect financial institutions and government agencies, and it also implements “intelligent construction” projects for commercial customers.





On June 24, 2009, Covenant Holdings entered into a stock acquisition and reorganization agreement with Chongqing Sysway and its stockholders. Pursuant to the terms of this agreement, Covenant Holdings acquired 100% of the capital stock of Sysway, representing 100% of the company’s outstanding equity interests, in exchange for 1,400,000 shares of a public shell’s common stock. For purposes of this acquisition, the common stock of the shell company that would acquire all of the rights and obligations of Covenant Holdings was valued at $1.76 per share, which was determined in the same manner as in the acquisition of Hainan Jien. Chongqing Sysway was incorporated in 1999 in Chongqing City, Sichuan Province, PRC, as a state owned enterprise. Since 2005 Chongqing Sysway has operated as a private enterprise mainly engaged in systems integration services, including computer systems installation, website design, and system firewall setup, particularly for the tobacco industry.





Under the stock acquisition and reorganization agreements with Chongqing Sysway and Hainan Jien, we agreed to contribute $2,500,000 in capital to each of these companies.  Because the government of China would not permit the ownership of the stock of Chongqing Sysway and Hainan Jien to be registered in the name of the Company until the companies’ existing registered capital requirements were satisfied, the Company entered into share entrustment agreements with each of these companies and their former shareholders pursuant to which the shares of stock of each company and the shares of common stock of the Company to be issued in exchange for such shares were held in trust until the ownership of the stock of each company was registered in the name of the Company on the records of the Chinese government.





25




On August 27, 2010, the Company entered into an agreement with Hainan Jien and its former shareholders pursuant to which Hainan Jien and such shareholders agreed to arrange for the official transfer of the shares of Hainan Jien from such shareholders to the Company in the PRC.  The Company paid $150,000 to such shareholders on October 21, 2010 and invested $350,000 in Hainan Jien upon completion of the registration of Hainan Jien's shares in the name of the Company in China on November 17, 2010.  In addition, the Company has agreed to use its best efforts to invest an additional $825,000 in Hainan Jien on or before October 31, 2010 and another $1,175,000 on or before January 31, 2011.  The parties have agreed that in the event the Company fails to make such capital contributions to Hainan Jien, the former shareholders will have no right to have the shares of stock of Hainan Jien returned to them.  As of March 31, 2011, the Company has not made any further investment in Hainan Jien.





Termination of our Acquisition of Chongqing Sysway





On April 30, 2010, the Board of Directors of the Company voted to terminate and rescind the stock acquisition and reorganization agreement with Chongqing Sysway due to several breaches of such agreement by Chongqing Sysway, including the failure of the prior owners of Chongqing Sysway to repay a dividend paid to them by Chongqing Sysway in excess of that permitted under the agreement and under China law and the failure of Chongqing Sysway and its prior owners to cooperate with the Company in the preparation of the financial statement disclosures required under United States securities laws.





As a result of the termination and rescission of the agreement, the Company has transferred all of the shares of capital stock of Chongqing Sysway to the prior owners of Chongqing Sysway and the 1,400,000 shares of common stock of the Company issued in exchange for the shares of capital stock of Chongqing Sysway have been returned to the Company and treated as treasury shares.  This transaction returned the Company, Chongqing Sysway, and the prior owners of the capital stock of Chongqing Sysway to their status prior to the completion of the acquisition by the Company of the capital stock of Chongqing Sysway on December 24, 2009.





Item 1A.  Risk Factors.





You should carefully consider the risks described below before making an investment decision. The risks described below are not the only ones facing the Company and some risks and uncertainties are inherent in our business. Additional risks not presently known to us or that we currently believe are immaterial may also impair our business operations. Our business could be harmed by any of these risks. The following sets forth factors related to our business, operations, financial position or future financial performance or cash flows which could cause an investment in our securities to decline and result in a loss. In assessing these risks, you should also refer to the other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes.





Risks Related to Our Business.





Our operating subsidiary may not be able to adapt to rapid changes in the dynamic Chinese IT industry, thereby losing market share and revenue opportunities.The Chinese IT industry is extremely dynamic, characterized by rapid changes in technology and the frequent introduction of new and more advanced equipment and software applications.  Our subsidiary will be subject to the general risks, uncertainties and problems frequently encountered by similar companies operating in the Chinese IT industry. These include, among others, the following:





·
the failure to anticipate and adapt to developing market trends;·
the failure to identify, develop and market services and products that respond to changing client needs and changing technological standards;


·
the inability to maintain, upgrade and improve our current services and products;·
the inability to attract and retain skilled personnel, relevant to our company’s service and product offerings; and


·
the failure to manage our currently expanding operations.





If our subsidiary is unable to meet these challenges and any others that it may encounter, it is possible that it will lose market share and revenue opportunities and that our growth will be slowed.





26




There exists substantial and increasing competition with which our business must compete in service offerings and pricing, and if our subsidiary is not successful in addressing those issues, it may lose market share and revenue potential.In general, the level of competition in the PRC market for IT services and solutions to the construction sector is intense. We face competition from both local and international companies. Some of our competitors have longer operating histories, larger clientele, more varied service and product offerings and more extensive personnel and financial resources which place them in a better position than our subsidiary to develop and expand its range of services and market share. It is also expected that there will be competition from new entrants into the industry. Current or future competitors may develop or offer services that are comparable or superior to ours at a lower price. In addition, only some of the products and services of our company are protected by intellectual property rights, therefore competitors would not be prevented from copying our business techniques. If we fail to successfully compete against our current and future competitors, our business, financial condition and operating results will be adversely affected.





In some service areas of the IT business, prices are decreasing and adversely affecting margins; if our subsidiary does not meet the resulting pricing structure or shifts away from those areas of business to more profitable services, they may lose business opportunities and may experience losses.There has been increasing competition in some areas of IT consulting services, resulting in more competitive pricing and falling margins. Customers may elect to engage competitors who offer better pricing rather than use our subsidiary. If our subsidiary does not successfully manage its business and competes in these areas for engagements, it will suffer financial losses. Our subsidiary may also address the competitive situation by shifting to other service areas where margins are better or it may provide extra services or enhancements that result in different pricing. If it is not successful in implementing new or differentiating services, it may suffer losses in particular segments of its business.





IT infrastructure components are obtained from selected suppliers; if the ability to obtain needed items is disrupted, our subsidiary's businesses would be adversely affected.Many of the IT consulting services and system infrastructure installations conducted by our subsidiary depends on the availability of the necessary hardware equipment and software applications from third parties. Our subsidiary has established relations with selected suppliers. There is no assurance that these vendors/distributors will continue to offer needed items or not terminate their relationship with our subsidiary. Although there are alternative suppliers for most of the needs, if our subsidiary is unable to obtain the necessary IT infrastructure components from these or comparable vendors/distributors on a timely basis, our business, financial condition and results of operation would be adversely affected.




If the senior management team and critical staff are not retained, our subsidiary would suffer a loss of reputation and an inability to manage its commitments and expand its operations as planned.In a service-oriented business, personal relationships, goodwill and networks are critical in obtaining and maintaining customer engagements. The ability to successfully complete engagements depends on a trained, knowledgeable and stable staff. The success of our subsidiary depends on the continued efforts of its senior management team in building good relationships with existing and potential customers and in the implementation of its growth and business strategy and its ability to retain and replace its staff. Our subsidiary’s senior management team has experience in the services offered by the company and has been instrumental in its past growth and expansion. The loss of any member of the senior management team and critical staff could, without adequate replacement, result in an adverse impact on its businesses, financial conditions and results of operations.




27




If our subsidiary is unable to protect its proprietary technology and other rights, it may be unable to effectively compete.Our subsidiary relies on a combination of patent, copyright, trademark and anti-competition laws, as well as licensing agreements, third-party nondisclosure agreements, internal confidentiality policies and other contractual provisions and technical measures to protect its intellectual property rights. There can be no assurance that these protections will be adequate to prevent competitors from copying or reverse-engineering our subsidiary’s products, or that competitors will not independently develop technologies that are substantially equivalent or superior to our technology.  Although our subsidiary holds registered rights covering certain aspects of its technology, there can be no assurance of the level of protection that these registrations will provide. Our subsidiary may have to resort to litigation to enforce intellectual property rights, to protect the trade secrets or know-how, or to determine their scope, validity or enforceability. Enforcing or defending intellectual property rights is expensive, could cause diversion of our resources and may not prove successful.





If our subsidiary's proprietary rights infringe on those of other persons, they could be required to redesign those products, pay royalties or enter into license agreements with third parties or cease offering the infringing products or services, any of which could have an adverse impact on the business and revenues and profits of our subsidiary.There can be no assurance that a third party will not assert that the intellectual property rights and services of our subsidiary violates such third party’s intellectual property rights. To some extent, the law of the PRC is not extensively developed in the area of enforcement. Any claims, whether with or without merit, could:





·
be expensive and time consuming to defend or prosecute;


·
divert management's attention and resources; and


·
require our companies to pay royalties or enter into licensing agreements in order to obtain the right to use necessary technologies.





Security breaches could have a material adverse effect on our business and the business reputations of our subsidiary.Computer systems may be vulnerable to computer viruses, hackers, and other disruptive problems caused by unauthorized access to, or improper use of, systems by third parties or employees. Although our subsidiary intends to continue to implement security measures, computer attacks or disruptions may jeopardize the security of information stored in and transmitted through computer systems of the clients and their end-users.





Our subsidiary's business uses internally developed software and systems as well as third-party products, any of which may contain errors and bugs, the effect of which could cause our subsidiary to spend additional money and time to correct, cause a breach of services agreements and/or pay damages.Our subsidiary'sproducts may contain undetected errors, defects or bugs that may or may not be correctable. The products involve integration with products and systems developed by third parties. Complex software programs of third parties may contain undetected errors or bugs when they are first introduced or as new versions are released. There can be no assurance that errors will not be found in existing or future products or third-party products upon which our subsidiary'sproducts are dependent, which could result in delays, loss of market acceptance of its solutions, diversion of resources, injury to its reputation, and increased expenses and potentially the payment of damages.




28




Part of the business plan in the future is to seek additional services and clients and business opportunities through the acquisition of related service and product providers; in such acquisitions, we will have to manage the integration of the acquired business operations, systems and personnel, which may be disruptive to ongoing business, not successful, or more costly than estimated.Part of our business plan for our subsidiary is to acquire additional businesses. To achieve the anticipated benefits of these acquisitions, our subsidiary will need to successfully integrate the acquired employees, products and services, data and business methods of operations.  In addition, our subsidiary may also have to consolidate certain functions and integrate procedures, personnel, product lines and operations in an efficient and effective manner. The integration process may be disruptive to, and may cause an interruption of, business as a result of a number of potential obstacles, such as:





·
the loss of key employees or customers;·
the need to coordinate diverse organizations;


·
difficulties in integrating administrative and other functions;·
the loss of key members of management following the acquisition; and


·
he diversion of management's attention from our day-to-day operations.





We have not entered into definitive negotiations with any other target Chinese operating companies at this time, and therefore we cannot provide further specific information to you. In this regard, we are not dissimilar from a blank check company whereby the success of the Company will be predicated upon finding suitable acquisition target companies, successfully purchasing them at a fair and economical price, and integrating them into our operations.  Consistent with these objectives, the Company would also need to raise additional capital to execute these strategies and grow the business of our subsidiary, which we may not be able to do.





To the extent an acquisition is integrated into the business of our subsidiary, there could be significant costs and our business could be adversely affected if our subsidiary is not successful in integrating such business or if the integration takes longer than expected.





We will incur costs as a result of being a public company, and the requirements of being a public company may divert management’s attention from our business and adversely affect our financial results.As a public company, we are subject to a number of requirements, including the reporting requirements of the Exchange Act and the requirements of Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). These requirements will cause us to incur costs and might place a strain on our systems and resources. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and financial condition. Sarbanes-Oxley requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, significant resources and management oversight will be required. As a result, our management’s attention might be diverted from other business concerns, which could have a material adverse effect on our business, results of operations and financial condition. Furthermore, we might not be able to retain our independent directors or attract new independent directors for our committees.





If we fail to establish and maintain an effective system of internal control, we may not be able to report our financial results accurately or to prevent fraud.  Any inability to report and file our financial results accurately and timely could harm our business and adversely impact the trading price of our common stock.We are required to establish and maintain internal control over financial reporting, disclosure controls, and to comply with other requirements of Sarbanes-Oxley and the rules promulgated by the SEC thereunder.  Our management, including our President, cannot guarantee that our internal controls and disclosure controls will prevent all possible errors or all fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  In addition, the design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be relative to their costs.  Because of the inherent limitations in all control systems, no system of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake.  Further, controls can be circumvented by individual acts of some persons, by collusion of two or more persons, or by management override of the controls.  The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.  Over time, a control may become inadequate because of changes in conditions or the degree of compliance with policies or procedures may deteriorate.  Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.





29





All of Covenant Holdings' liabilities survived its acquisition by the Company and there may be undisclosed liabilities that could have a negative impact on our financial condition.Before the share exchange, certain due diligence activities on the Company and Covenant Holdings were performed.  The due diligence process may not have revealed all liabilities (actual or contingent) of the Company and Covenant Holdings that existed or which may arise in the future relating to the Company's activities before the consummation of the acquisition.  Notwithstanding that Mr. Sidhu agreed to release and indemnify the Company of all liability related to the Company’s ownership interest in the mineral exploration rights in Canada, it is possible that claims for such liabilities may still be made against us, which we will be required to defend or otherwise resolve.  The provisions and terms of the termination agreement may not be sufficient to protect us from claims and liabilities and any breaches of related representations and warranties.  Any liabilities remaining from the Company's pre-closing activities could harm our financial condition and results of operations.





New accounting standards could result in changes to our methods of quantifying and recording accounting transactions, and could affect our financial results and financial position.Changes to United States generally accepted accounting principles, or GAAP, arise from new and revised standards, interpretations, and other guidance issued by the Financial Accounting Standards Board, or FASB, the SEC, and others.  The effects of such changes may include prescribing an accounting method where none had been previously specified, prescribing a single acceptable method of accounting from among several acceptable methods that currently exist, or revoking the acceptability of a current method and replacing it with an entirely different method, among others.  Such changes could result in unanticipated effects on our results of operations, financial position, and other financial measures.





Risks Related to Doing Business in China.





We may have difficulty establishing adequate management, legal and financial controls in China.Historically, China has not adopted a Western style of management and financial reporting concepts and practices, as well as modern banking, computer and other control systems.  We may have difficulty in hiring and retaining a sufficient number of qualified employees to work in China.  As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data and preparing financial statements, books of account and corporate records and instituting business practices that meet Western standards.





In December 2009, the board of directors of Chongqing Sysway, one of our wholly owned Chinese subsidiaries, declared and paid a $322,061 dividend to the original shareholders and management of the company without the authorization of Covenant’s board of directors.  In a December 2009 meeting of the Chongqing Sysway board, the board resolved to declare a dividend payment to the original shareholders and management of the company based on 2007 earnings on the assumption that it was permissible.  Upon our receipt of a report from our independent accountants, we determined that this payment was outside the parameters of our acquisition agreement with Chongqing Sysway and had to be reversed.  Moreover, the dividend exceeded the amount that Chongqing Sysway was permitted to pay under PRC law. The original shareholders and management of Chongqing Sysway executed a promissory note to repay the full $322,061 dividend to Chongqing Sysway by April 15, 2010.   Due to the failure of the original shareholders and management to repay the dividend and the refusal of its prior owners to cooperate with the Company in the preparation of the financial statement disclosures required under the United States securities laws, the Company terminated its agreements with Chongqing Sysway and rescinded the Company’s acquisition of Chongqing Sysway.  See "Termination of our Acquisition of Chongqing Sysway."





30




Recent Chinese regulations relating to the establishment of offshore special purpose companies by Chinese residents and registration requirements for employee stock ownership plans or share option plans may subject our Chinese resident shareholders to personal liability and limit our ability to acquire companies in China or to inject capital into our subsidiaries in China, limit our Chinese subsidiary's ability to distribute profits to us, or otherwise materially and adversely affect us.The Chinese State Administration of Foreign Exchange ("SAFE") issued a public notice in October 2005, requiring Chinese residents, including both legal persons and natural persons, to register with the competent local SAFE branch before establishing or controlling any company outside of China established for the purpose of acquiring any assets of or equity interest in companies in China and raising funds from overseas (referred to as an “offshore special purpose company”).  In addition, any Chinese resident that is a shareholder of an offshore special purpose company is required to amend his or her SAFE registration with the local SAFE branch in the event of any increase or decrease of capital, transfer of shares, merger, division, equity investment or creation of any security interest over any assets located in China with respect to that offshore special purpose company.  To further clarify the implementation of Circular 75, the SAFE issued Circular 124 and Circular 106 on November 24, 2005 and May 29, 2007, respectively. Under Circular 106, PRC subsidiaries of an offshore special purpose company are required to coordinate and supervise the filing of SAFE registrations by the offshore holding company’s shareholders who are Chinese residents in a timely manner. If these shareholders fail to comply, the Chinese subsidiary is required to report to the local SAFE authorities.  If the Chinese subsidiary of the offshore parent company do not report to the local SAFE authorities, they may be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to their offshore parent company, and the offshore parent company may be restricted in its ability to contribute additional capital into its Chinese subsidiary.  Moreover, failure to comply with the above SAFE registration requirements could result in liabilities under China law for evasion of foreign exchange restrictions. The failure or inability of these Chinese resident beneficial owners to comply with the applicable SAFE registration requirements may subject these beneficial owners or us to the fines, legal sanctions and restrictions described above.





On March 28, 2007, SAFE released detailed registration procedures for employee stock ownership plans or share option plans to be established by overseas listed companies and for individual plan participants. Any failure to comply with the relevant registration procedures may affect the effectiveness of our employee stock ownership plans or share option plans and subject the plan participants, the companies offering the plans or the relevant intermediaries, as the case may be, to penalties under PRC foreign exchange regime. These penalties may subject us to fines and legal sanctions, prevent us from being able to make distributions or pay dividends, as a result of which our business operations and our ability to distribute profits to our shareholders could be materially and adversely affected.





In addition, the National Development and Reform Commission ("NDRC") promulgated a rule in October 2004, or the NDRC Rule, which requires NDRC approvals for overseas investment projects made by PRC entities. The NDRC Rule also provides that approval procedures for overseas investment projects of PRC individuals must be implemented with reference to this rule. However, there exist extensive uncertainties in terms of interpretation of the NDRC Rule with respect to its application to a PRC individual’s overseas investment, and in practice, we are not aware of any precedents that a PRC individual’s overseas investment has been approved by the NDRC or challenged by the NDRC based on the absence of NDRC approval. Our current beneficial owners who are PRC individuals did not apply for NDRC approval for investment in us. We cannot predict how and to what extent this will affect our business operations or future strategy. For example, the failure of our shareholders who are PRC individuals to comply with the NDRC Rule may subject these persons or our PRC subsidiary to certain liabilities under PRC laws, which could adversely affect our business.





Chinese regulation of loans and direct investment by offshore holding companies to Chinese entities may delay or prevent us from making loans or additional capital contributions to our operating subsidiary, which could materially and adversely affect our liquidity and our ability to fund and expand our business.  We may make loans to our subsidiary, or we may make additional capital contributions to our subsidiary.  Any loans to our subsidiary are subject to Chinese regulations.  For example, loans by us to our subsidiary in China, which are foreign-invested enterprises, to finance its activities cannot exceed statutory limits and must be registered with SAFE.





We may also decide to finance our subsidiary by means of capital contributions. The Ministry of Foreign Commerce or its local counterpart and SAFE must approve these capital contributions. We cannot assure you that we will be able to obtain these government approvals on a timely basis, or if at all, with respect to future capital contributions by us to our subsidiary. Furthermore, we cannot assure you that once necessary approvals are obtained, that we will be able to maintain them. If we fail to receive such approvals or maintain them, our ability to capitalize our Chinese operations may be negatively affected, which could adversely affect our subsidiary’s liquidity and our ability to fund and expand our business.





31




A return to profit repatriation controls may limit the ability to expand business and reduce the attractiveness of investing in Chinese business opportunities.PRC law allows enterprises owned by foreign investors to remit their profits, dividends and bonuses earned in the PRC to other countries, and the remittance does not require prior approval by SAFE. SAFE regulations required extensive documentation and reporting, some of which was burdensome and slowed payments. If there is a return to payment restrictions and reporting, the ability of a Chinese company to attract investors will be reduced. Also, current investors may not be able to obtain the profits of the business in which they own for other reasons. Relevant PRC law and regulation permit payment of dividends only from retained earnings, if any, determined in accordance with PRC accounting standards and regulations. It is possible that the PRC tax authorities may require changes in the income of the company that may limit its ability to pay dividends and other distributions to shareholders. PRC law requires companies to set aside a portion of net income to fund certain reserves, which amounts are not distributable as dividends. These rules and possible changes could restrict our subsidiary from repatriating funds to us, and ultimately, our shareholders as dividends.





The economy of China has been experiencing unprecedented growth and this has resulted in some inflation.If the Chinese government tries to control inflation by traditional means of monetary policy or returns to planned economic techniques, our business will suffer a reduction in sales growth and expansion opportunities.  The rapid growth of the Chinese economy has resulted in higher levels of inflation. If the government tries to control inflation, it may have an adverse effect on the business climate and growth of private enterprise in the PRC. An economic slow down will have an adverse effect on our sales and may increase costs. On the other hand, if inflation is allowed to proceed unchecked, our subsidiary’s costs would likely increase, and there can be no assurance that it would be able to increase its prices to an extent that would offset the increase in its expenses.





As we have limited business insurance coverage in China, any loss that we suffer in China may not be insured or may be insured to only a limited extent.  The insurance industry in China is still in an early stage of development and insurance companies located in China offer limited business insurance products. In the event of damage or loss to our properties in China, our insurance may not provide adequate coverage in the event of loss or damage to our property.





We are subject to international economic and political risks over which we have little or no control and may be unable to alter our business practice in time to avoid the possibility of reduced revenues.Our business is conducted in China.  Doing business outside the United States, particularly in China, subjects us to various risks, including changing economic and political conditions, major work stoppages, exchange controls, currency fluctuations, armed conflicts and unexpected changes in United States and foreign laws relating to tariffs, trade restrictions, transportation regulations, foreign investments and taxation.  We have no control over most of these risks and may be unable to anticipate changes in international economic and political conditions and, therefore,  we may be unable to alter our business practice in time to avoid the possibility of reduced revenues.





China's economic policies could affect our business.Substantially all of our assets are located in China and all of our revenue is derived from our operations in China.  Accordingly, our results of operations and prospects are subject, to a significant extent, to the economic, political and legal developments in China.





While China's economy has experienced significant growth in the past twenty years, such growth has been uneven, both geographically and among various sectors of the economy.  The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources.  Some of these measures benefit the overall economy of China, but they may also have a negative effect on us.  For example, operating results and financial condition may be adversely affected by government control over capital investments or changes in tax regulations.  The economy of China has been changing from a planned economy to a more market-oriented economy.  In recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform and the reduction of state ownership of productive assets, and the establishment of corporate governance in business enterprises; however, a substantial portion of productive assets in China are still owned by the Chinese government.  In addition, the Chinese government continues to play a significant role in regulating industry development by imposing industrial policies.  It also exercises significant control over China's economic growth through the allocation of resources, the control of payment of foreign currency-denominated obligations, the setting of monetary policy and the provision of preferential treatment to particular industries or companies.





32




China could change its policies toward private enterprise or even nationalize or expropriate private enterprises.Our business is subject to significant political and economic uncertainties and may be affected by political, economic and social developments in China.  Over the past several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activity and greater economic decentralization. The Chinese government may not continue to pursue these policies or may significantly alter them to our detriment from time to time with little, if any, prior notice.





Changes in policies, laws and regulations or in their interpretation or the imposition of confiscatory taxation, restrictions on currency conversion, restrictions or prohibitions on dividend payments to stockholders, or devaluations of currency could cause a decline in the price of our common stock. Nationalization or expropriation could even result in the total loss of an investment in our stock.





The nature and application of many laws of China create an uncertain environment for business operations and they could have a negative effect on us.The legal system in China is a civil law system. Unlike the common law system, the civil law system is based on written statutes in which decided legal cases have little value as precedents. In 1979, China began to promulgate a comprehensive system of laws and has since introduced many laws and regulations to provide general guidance on economic and business practices in China and to regulate foreign investment. Progress has been made in the promulgation of laws and regulations dealing with economic matters such as corporate organization and governance, foreign investment, commerce, taxation and trade. The promulgation of new laws, changes of existing laws and the abrogation of local regulations by national laws could cause a decline in the price of our common stock.  In addition, as these laws, regulations and legal requirements are relatively recent, their interpretation and enforcement involve significant uncertainty.





The PRC legal system has inherent uncertainties that could limit the legal protections available to you.Most of the Company assets and all of our operations are in the PRC. The Chinese legal system is based on written statutes. Prior court decisions may be cited for reference but are not binding on subsequent cases and have limited precedential value. Since 1979, the Chinese legislative bodies have promulgated laws and regulations dealing with such economic matters as foreign investment, corporate organization and governance, commerce, taxation and trade. However, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their non-binding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. The laws in the PRC differ from the laws in the United States and may afford less protection to our shareholders. Unlike laws in the United States, the applicable laws of China do not specifically allow shareholders to sue the directors, supervisors, officers or other shareholders on behalf of the company to enforce a claim against these parties that the company has failed to enforce itself. Therefore, any action brought against the company or its officers and directors or its assets may be very difficult to pursue if not impossible. It is unlikely that any suit in the PRC would be able to be based on theories common in the United States or based on United States securities laws.





It will be extremely difficult to acquire jurisdiction and enforce liabilities against any officers, directors, advisory board members and assets based in China.  As our executive officers, advisory board members and directors may be Chinese citizens, it may be difficult, if not impossible, to acquire jurisdiction over these persons in the event a lawsuit is initiated against us and/or our officers and directors by a shareholder or group of shareholders in the United States.  Also, because our operating subsidiaries and assets are located in China, it may be extremely difficult or impossible for you to access those assets to enforce judgments rendered against us or our executive officers, advisory board members or directors by U.S. courts.  In addition, the courts in China may not permit the enforcement of judgments arising out of U.S. federal and state corporate, securities or similar laws.  Accordingly, U.S. investors may not be able to enforce judgments against us for violation of U.S. securities laws.





33




We may face judicial corruption in China.Another obstacle to foreign investment in China is corruption. There is no assurance that we will be able to obtain recourse in any legal disputes with suppliers, customers or other parties with whom we conduct business, if desired, through China's poorly developed and sometimes corrupt judicial systems.





If relations between the United States and China worsen, investors may be unwilling to hold or buy our stock and our stock price may decrease. At various times during recent years, the United States and China have had significant disagreements over political and economic issues. Controversies may arise in the future between these two countries. Any political or trade controversies between the United States and China, whether or not directly related to our business, could reduce the price of our common stock.





Restrictions on currency exchange may limit our ability to receive and use our revenues effectively. The RMB is currently convertible under the “current account,” which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment and loans. Currently, our Chinese subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, without the approval of SAFE. However, the relevant Chinese government authorities may limit or eliminate their ability to purchase foreign currencies in the future. Since a significant amount of our future revenues will be denominated in RMB, any existing and future restrictions on currency exchange may limit our ability to utilize revenues generated in RMB to fund our business activities outside China that are denominated in foreign currencies.





Foreign exchange transactions by our Chinese subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of or need to register with Chinese governmental authorities, including SAFE. In particular, if our Chinese subsidiaries borrow foreign currency loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance our Chinese subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the NDRC, the Ministry of Commerce, or MOFCOM, or their respective local counterparts. These limitations could affect the ability of our Chinese subsidiaries to obtain foreign exchange through debt or equity financing.





Fluctuation in the value of the RMB may reduce the value of your investment.The change in value of the RMB against the U.S. dollar, Euro and other currencies is affected by, among other things, changes in China’s political and economic conditions.  On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the US dollar.  Under the current policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in a greater fluctuation range between RMB and the U.S. dollar.  There remains significant international pressure on China to adopt a more flexible and more market-oriented currency policy that allows a greater fluctuation in the exchange rate between the RMB and the US dollar. Accordingly, we expect that there will be increasing fluctuations in the RMB exchange rate against the US dollar in the near future.  Any significant revaluation of the RMB may have a material adverse effect on the value of, and any dividends paid on, our common stock in US dollar terms.




34




We face risks associated with currency exchange rate fluctuations; any adverse fluctuation may adversely affect our operating margins.  Almost all of our revenues are denominated in Renminbi. Conducting business in currencies other than US dollars subjects us to fluctuations in currency exchange rates that could have a negative impact on our reported operating results. Fluctuations in the value of the US dollar relative to other currencies impact our revenues, cost of revenues and operating margins and result in foreign currency translation gains and losses. If the exchange rate of the Renminbi is affected by lowering its value as against the US dollar, our reported profitability when stated in US dollars will decrease. Historically, we have not engaged in exchange rate hedging activities and have no current intention of doing so.





Risks Related to Our Securities





We need additional capital to execute our business plan and fund operations and may not be able to obtain such capital on acceptable terms or at all.Capital requirements are difficult to plan in our rapidly changing industry. We expect that we will need additional capital to fund our future growth.





Our ability to obtain additional capital on acceptable terms or at all is subject to a variety of uncertainties, including:





·
Investors' perceptions of, and demand for, companies in our industries;·
Investors' perceptions of, and demand for, companies operating in the PRC


·
Conditions of the US and other capital markets in which we may seek to raise funds;·
Our future results of operations, financial condition and cash flows;


·
Governmental regulation of foreign investment in companies in particular countries;·
Economic, political and other conditions in the US, the PRC, and other countries; and


·
Governmental policies relating to foreign currency borrowings.





We may be required to pursue sources of additional capital through various means, including joint venture projects and debt or equity financings. There is no assurance that we will be successful in locating a suitable financing transaction in a timely fashion or at all. In addition, there is no assurance that we will be successful in obtaining the capital we require by any other means. Future financings through equity investments are likely to be dilutive to our existing shareholders. Also, the terms of securities we may issue in future capital transactions may be more favorable for our new investors. Newly issued securities may include preferences, superior voting rights, the issuance of warrants or other derivative securities, and the issuances of incentive awards under equity employee incentive plans, which may have additional dilutive effects. Further, we may incur substantial costs in pursuing future capital and/or financing, including investment banking fees, legal fees, accounting fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible notes and warrants, which will adversely impact our results of operations or financial condition.





If we cannot raise additional funds on favorable terms or at all, we may not be able to carry out all or parts of our strategy to maintain our growth and competitiveness or to fund our operations. If the amount of capital we are able to raise from financing activities, together with our revenues from operations, is not sufficient to satisfy our capital needs, even to the extent that we reduce our operations accordingly, we may be required to cease operations.





The market price of our common stock may be volatile, which could cause the value of your investment to decline or could subject us to securities class action litigation.Many factors could cause the market price of our common stock to rise and fall, including the following:





·
variations in our or our competitors’ actual or anticipated operating results;·
variations in our or our competitors’ growth rates;


·
recruitment or departure of key personnel;·
changes in the estimates of our operating performance or changes in recommendations by any securities analyst that follows our stock;


·
substantial sales of our common stock; or·
changes in accounting principles.




35




Market volatility, as well as general economic, market or potential conditions, could reduce the market price of our common stock in spite of our operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation often has been brought against that company. Due to the potential volatility of our stock price, we therefore may be the target of securities litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and resources from our business.





Shares of our common stock lack a significant trading market.Shares of our common stock are not eligible as yet for trading on any national securities exchange.  Our common stock may be quoted in the over-the-counter market on the OTC Bulletin Board, the OTC Markets OTCQB or in what are commonly referred to as "pink sheets."  These markets are highly illiquid.  Although we intend to apply for listing of our common stock on an exchange, there can be no assurance if and when the initial listing criteria could be met or if such application would be granted, or that the trading of the common stock will be sustained.  There is no assurance that an active trading market in our common stock will develop, or if such a market develops, that it will be sustained.  In addition, there is a greater chance for market volatility for securities that are quoted on the OTC Markets OTCQB as opposed to securities that trade on a national exchange.  This volatility may be caused by a variety of factors, including the lack of readily available quotations, the absence of consistent administrative supervision of "bid" and "ask" quotations and generally lower trading volume.  As a result, an investor may find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, the common stock or to obtain coverage for significant news events concerning us, and the common stock would become substantially less attractive for margin loans, for investment by financial institutions and as consideration in future capital raising transactions or other purposes.





Future sales of shares of our common stock by our shareholders could cause our stock price to decline.We cannot predict the effect, if any, that market sales of shares of our common stock or the availability of shares of common stock for sale will have on the market price prevailing from time to time.  If our stockholders sell substantial amounts of our common stock in the public market upon the effectiveness of a registration statement, or upon the expiration of any holding period under Rule 144, such sales could create a circumstance commonly referred to as an "overhang" and in anticipation of which the market price of our common stock could fall.  The existence of an overhang, whether or not sales have occurred or are occurring, also could make more difficult our ability to raise additional financing through the sale of equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate.  Our outstanding shares of common stock will be freely tradable upon the earlier of (i) effectiveness of a registration statement covering such shares; and (ii) the date on which such shares may be sold without registration pursuant to Rule 144 under the Securities Act and the sale of such shares could have a negative impact on the price of our common stock.





We may issue additional shares of our capital stock or debt securities to raise capital or complete acquisitions, which would reduce the equity interest of our shareholders.Our articles of incorporation authorize the issuance of up to 100,000,000 shares of common stock, par value $.00001 per share, and up to 100,000,000 shares of preferred stock, par value $.00001 per share.  There are approximately 90,316,091 authorized and unissued shares of our common stock and 100,000,000 shares of our preferred stock that have not been reserved and are available for future issuance.  Although we have no commitments as of the date of this offering to issue our securities, we may issue a substantial number of additional shares of our common stock, to complete a business combination or to raise capital.  The issuance of additional shares of our common stock:





·
may significantly reduce the equity interest of our existing shareholders; and·
may adversely affect prevailing market price for our common stock.




36




We currently do not intend to pay dividends on our common stock and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.We do not expect to pay dividends on shares of our common stock in the foreseeable future. In addition, because we are a holding company, our ability to pay cash dividends on shares of our common stock may be limited by restrictions on our ability to obtain sufficient funds through dividends from our subsidiaries. Subject to these restrictions, the payment of cash dividends in the future, if any, will be at the discretion of our Board of Directors and will depend upon such factors as earnings levels, capital requirements, our overall financial condition and any other factors deemed relevant by our Board of Directors. Consequently, your only opportunity to achieve a return on your investment in the Company will be if the market price of our common stock appreciates.





Risks Related to the Organization and Operations of the Company.





Revenues of the Company.  The Company is a holding company and does not conduct any business operations. The Company must rely on capital that it raises from the sale of stock and dividends paid by its Chinese subsidiary to fund the Company’s operating expenses. Therefore, there can be no assurances that the Company will have the funds available to satisfy its obligations. We currently expect that the earnings and cash flow of our subsidiary will primarily be retained and used by us in its operations.  Therefore, it is unlikely that the Company will declare or pay cash dividends or make distributions to our shareholders. See “Risks Related to our Securities—We currently do not intend to pay dividends on our common stock, and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.”




Risks Related to Acquisition of Chinese Companies.





Risks attendant to acquisitions.The Company has acquired Hainan Jien, a Chinese company.  Other companies will be sought as investment targets, and there is no limit as to the number of companies that we may acquire. Because the Company has yet to engage in any definitive negotiations with any such target companies, there is no available information regarding these companies.  Acquisitions involve a number of special risks, including: failure of the acquired business to achieve expected results; diversion of management’s attention; failure to retain key personnel of the acquired business; the need by the acquired business to obtain additional financing which if necessary and available, could increase leverage, dilute equity, or both; the potential negative effect on the financial statements of the Company from the increase in goodwill and other intangibles; and the high cost and expenses of completing acquisitions and risks associated with unanticipated events or liabilities.  These risks could have a material adverse effect on the business, results of operations and financial condition of the Company.  The Company expects to face competition for acquisition candidates, which may limit the number of opportunities to acquire companies and may lead to higher acquisition prices.  The Company cannot assure investors that it will be able to identify, acquire, or manage profitably additional businesses or to integrate successfully any acquired businesses into its existing business without substantial costs, delays or other operational or financial difficulties.  In addition, the Company may inadvertently assume unknown liabilities in acquisitions that it has completed or plans to complete. The Company’s assumption of unknown liabilities in acquisitions may harm the financial condition and operating results of the Company. Acquisitions may be structured in such a manner that would result in the assumption of unknown liabilities not disclosed by the seller or not discovered during pre-acquisition due diligence. These obligations and liabilities could harm the financial condition and operating results of the Company.





Market risks.An investor in a private equity transaction (such as the Company's acquisition of Hainan Jien) generally determines the terms of the investment based upon financial projections for the target company. Projected operating results for such companies will normally be based primarily on judgments of the management of those companies. In all cases, projections are only estimates of future results based upon assumptions made at the time the projections are developed. There can be no assurance that the projected results will be obtained, and actual results may vary significantly from the projections. General economic conditions or other factors that are not predictable and can have a material adverse impact on the reliability of projections.  For any given investment, total loss of invested capital is possible.





37




Item 1B. Unresolved Staff Comments.





None.





Item 2.  Properties.





Our properties are located primarily in Haikou City in Hainan Province, PRC as described below.





Hainan Jien





JIEN’s headquarters and manufacturing facilities are located in the Northern part of Hainan Province, Haikou City.  On November 9, 2009, the company signed a lease contract with Hainan North Star Information Service Company.  The lease term is for 36 months, expiring on November 7, 2012.  The total area of our facility is approximately 1,100 square meters and our monthly rent is 21 RMB per square meter ($3,552 total per month), payable in monthly installments.





Item 3.  Legal Proceedings.





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








PART II





Item 5.  Market for Common Equity, Related Stockholder Matters and Issuer Repurchases of Equity Securities.





Market Information





Through February 10, 2010, our common stock was quoted on the OTC.BB under the symbol “EVRS.” Our common stock was quoted on the OTC.BB under the symbol CVGC.OB until September 3, 2010. Our common stock ceased quotation on the OTC.BB because, pursuant to Rule 15c2-11 promulgated under the Exchange Act, September 3, 2010 was the conclusion of a four consecutive business day period where a broker or dealer did not maintain bid and ask quotations in our common stock within the OTC.BB interdealer quotation system. Currently, our common stock is quoted on the OTC Markets OTCQB middle-tier exchange for reporting companies. We intend to resume quotation on the OTC.BB. The following table sets forth, for the periods indicated, the quarterly high “bid” and low “ask” quotations for our common stock as reported by the OTC.BB and OTCQB. These quotations represent inter-dealer prices and may not represent actual transactions.




38




For the Year Ended December 31,2010


2009High


Low


High


LowFirst Quarter


2.70



1.10



n/a



n/aSecond Quarter


3.10



2.25



n/a



n/aThird Quarter


2.80



2.60



n/a



n/aFourth Quarter


2.60



1.50



n/a



n/a





During the prior two most recent fiscal years there was an absence of an established trading market for our stock.  On March 31, 2011, the closing price of our common stock as reported on the OTCQB was $1.50.





Holders





As of March 31, 2011, there were 9,683,909 shares of our common stock outstanding held by approximately 75 shareholders of record.  The number of our shareholders of record excludes any estimate by us of the number of beneficial owners of shares held in street name, the accuracy of which cannot be guaranteed.





Dividend Policy





We have not paid any cash dividends on our common stock and we have no intention of paying cash dividends in the foreseeable future. Whether we will declare and pay dividends in the future will be determined by our board of directors at their discretion, subject to certain limitations imposed under Nevada corporate law. In addition, our ability to pay dividends may be affected by the foreign exchange controls in the PRC. The timing, amount and form of dividends, if any, will depend on, among other things, our results of operations, financial condition, cash requirements and other factors deemed relevant by our board of directors.





Securities Authorized for Issuance under Equity Compensation Plans





We adopted the Covenant Group of China Inc. Long-Term Incentive Plan in April 2010 by majority written consent of our shareholders.  Prior to that time, we did not have a formal equity compensation plan in effect for our employees or directors.





Outstanding Equity Awards at December 31, 2010





The following table sets forth information with respect to holdings of stock options and restricted stock awards by the named executives officers at December 31, 2010:




39




Option Awards

Stock AwardsName

Number of

Securities Underlying Unexercised

Options

(#)

Exercisable

Number of

Securities Underlying Unexercised

Options

(#)

Unexercisable

Option

Exercise

Price

($)

Number of

Shares or Units of Stock that Have Not Vested (1)

(#)

Market Value of Shares or Units of Stock That Have Not

Vested (2)

($)Fredric W. Rittereiser


—



—



—



—



—K. Ivan F. Gothner


—



—



—



—



—Kenneth Wong


—



—



—



—



—Justin D. Csik


—



—



—



50,000



75,000
  (1)
Restricted stock vests over a period of three years: 20% on the first anniversary of the date of grant, and 25% on the second anniversary and 55% on the third anniversary.(2)
The market value is based on the closing price of our common stock on December 31, 2010 of $1.50 multiplied by the number of outstanding shares.




40




Repurchases of Equity Securities





None.





Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities





On February 23, 2011, the Company entered into a bridge loan agreement for short-term financing with Walston Dupont Global Advisors LLC.  As additional consideration for entering into the bridge loan agreement, the Company agreed to issue a warrant to purchase up to 18,000 shares of the Company’s common stock at a $2.00 strike price over a 2-year term. The issuance of such warrant was exempt from the registration requirements of the Securities Act pursuant to the exemption provided under Section 4(2) of the Securities Act.





On November 24, 2010, the Company entered into a bridge loan agreement for short-term financing with Sui Generis Capital Partners LLC.  As additional consideration for entering into the bridge loan agreement, the Company agreed to issue a warrant to purchase up to 6,000 shares of the Company’s common stock at a $2.50 strike price over a 2-year term. The issuance of such warrant was exempt from the registration requirements of the Securities Act pursuant to the exemption provided under Section 4(2) of the Securities Act.





On November 15, 2010, the Company’s board authorized the issuance of 200,000 restricted shares of the Company’s common stock to our employees and advisory board members.  These shares are subject to a 3-year vesting schedule, whereby 20% of the shares shall vest on the first anniversary of the date of grant, 25% shall vest on the second anniversary and 55% shall vest on the third anniversary.  The issuance of such shares was exempt from the registration requirements of the Securities Act pursuant to the exemption provided under Section 4(2) of the Securities Act.




Item 6.  Selected Financial Data.





Not required.





Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.





Safe Harbor Declaration





This Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  We have based these forward-looking statements on our current expectations and projections about future events.  These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions about us that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements.  In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” anticipate,” believe,” estimate,” continue,” or the negative of such terms or other similar expressions.  Factors that might cause or contribute to such a discrepancy include, but are not limited to, those listed under the heading “Risk Factors” and those listed in our other Securities and Exchange Commission filings.  The following discussion should be read in conjunction with our Financial Statements and related Notes thereto included elsewhere in this report. Throughout this Annual Report we will refer to Covenant Group of China Inc. as "Covenant Group," the "Company," "we," "us," and "our."





41




Overview





We are a holding company engaged in the business of acquiring equity interests in private companies based and operating in the PRC and providing value-oriented services in the areas of strategic planning, business development, mergers and acquisitions assistance, and board and/or advisory board service.  We believe that equity investments in China present one of the most attractive global investment opportunities available in the coming four to seven years.  We plan to focus on growth company acquisitions located in China.





We were incorporated in the State of Nevada on November 8, 2006 under the name Everest Resources Corp. as a development stage corporation that intended to engage in the exploration of gold.  On December 24, 2009, we changed our name to Covenant Group of China Inc. and acquired all of the capital stock of Covenant Holdings, a privately held company incorporated under the laws of the State of Delaware and engaged in the business of acquiring equity interests in private Chinese operating companies and providing these companies with strategic support. The acquisition of the capital stock of Covenant Holdings was accomplished on December 24, 2009, pursuant to the terms of a share exchange agreement by and among the Company, Covenant Holdings and all of the shareholders of Covenant Holdings. Upon the closing of the share exchange, each of the Covenant Holdings shareholders exchanged their respective shares of Covenant Holdings, on a one-for-one basis, for 9,380,909 shares of the Company’s common stock. As a result of the share exchange, Covenant Holdings became a wholly owned subsidiary of the Company.





Prior to our acquisition of Covenant Holdings, we were in the development stage and had minimal business operations. We had no interest in any property, but had the right to conduct mineral exploration activities on 471 acres located in southern British Columbia, Canada pursuant to an agreement with the former majority shareholder of the Company.  In connection with the acquisition of Covenant Holdings, the shareholder terminated the Company’s mineral exploration rights, and he agreed to surrender 5,000,000 shares of the Company’s common stock in exchange for $100,000 and a promissory note from the Company in the principal amount of $190,000, $90,000 of which the Company has prepaid.  The shareholder surrendered 4,500,000 shares of our common stock and agreed to surrender his remaining 500,000 shares upon full payment of the promissory note by the Company.  On March 25, 2010, the shareholder and the Company entered into an agreement pursuant to which the shareholder agreed to cancel the promissory note and surrender his remaining 500,000 shares in exchange for the Company issuing to him 300,000 shares of common stock of the Company.  On May 13, 2010, the shareholder and the Company entered into an agreement pursuant to which the shareholder agreed to reduce the number of shares that he will receive from 300,000 to 70,000.  See “History”.





There was no significant activity from June 10, 2009 through December 31, 2009, except for the acquisitions of our two operating subsidiaries, Hainan Jien and Chongqing Sysway. On June 24, 2009, Covenant Holdings entered into a stock acquisition and reorganization agreement with Hainan Jien and its stockholders.  Pursuant to the terms of this agreement, Covenant Holdings acquired 100% of the capital stock of Jien, representing 100% of the company’s outstanding equity interests, in exchange for 1,350,000 shares of a public shell’s common stock.  For purposes of this acquisition, the common stock of the shell company that would acquire all of the rights and obligations of Covenant Holdings was valued at $1.76 per share, which was determined by the volume weighted average stock price for the first day of trading of the Company’s common stock plus all private sales of Covenant Holdings’ common stock prior to the completion of the reverse merger with the Company.  Jien was incorporated in Hainan Province, China in 1999.  Jien specializes in the design and installation of security and surveillance infrastructure to protect financial institutions and government agencies, and it also implements “intelligent construction” projects for commercial customers.





42




On June 24, 2009, Covenant Holdings entered into a stock acquisition and reorganization agreement with Chongqing Sysway and its stockholders.  Pursuant to the terms of this agreement, Covenant Holdings acquired 100% of the capital stock of Sysway, representing 100% of the company’s outstanding equity interests, in exchange for 1,400,000 shares of a public shell’s common stock.  For purposes of this acquisition, the common stock of the shell company that would acquire all of the rights and obligations of Covenant Holdings was valued at $1.76 per share, which was determined in the same manner as in the acquisition of Hainan Jien.   Chongqing Sysway was incorporated in 1999 in Chongqing City, Sichuan Province, PRC, as a State Owned Enterprise (“SOE”).  Since 2005 Chongqing Sysway has operated as a private enterprise mainly engaged in systems integration services, including computer systems installation, website design, and system firewall setup, particularly for the tobacco industry.





Under the stock acquisition and reorganization agreement between the Company and Hainan Jien, the Company agreed to make a capital contribution of $2,500,000 to Hainan Jien. On August 27, 2010, the Company entered into an agreement with Hainan Jien and its former shareholders pursuant to which Hainan Jien and such shareholders agreed to arrange for the official transfer of the shares of Hainan Jien from such shareholders to the Company in the PRC.  The Company paid $150,000 to such shareholders on October 21, 2010 and invested $350,000 in Hainan Jien upon completion of the registration of Hainan Jien's shares in the name of the Company in China on November 17, 2010.  In addition, the Company has agreed to use its best efforts to invest an additional $825,000 in Hainan Jien on or before October 31, 2010 and another $1,175,000 on or before January 31, 2011.  The parties have agreed that in the event the Company fails to make such capital contributions to Hainan Jien, the former shareholders will have no right to have the shares of stock of Hainan Jien returned to them.  As of March 31, 2011, the Company has not made any further investment in Hainan Jien.





The Company intends to rely on a private placement of convertible preferred stock and other private offerings to provide the funding for the remaining $2,000,000 that the Company has agreed to contribute to Hainan Jien. Additionally, to the extent the Company has the ability to sell shares under its Equity Credit Agreement with Southridge Partners II, LP at or prior to the time that any obligation to make capital contributions to Jien remains outstanding, the Company may use the sale of shares under the Equity Credit Agreement to provide such funding, though it is too early for the Company to determine how much, if any, funds will be accessed via the Equity Credit Agreement for this purpose.








Rescission of our Acquisition of Chongqing Sysway





On April 30, 2010, the Board of Directors of the Company voted to terminate and rescind the stock acquisition and reorganization agreement with Chongqing Sysway due to several breaches of such agreement by Chongqing Sysway, including the failure of the prior owners of Chongqing to repay a dividend paid to them by Chongqing Sysway in excess of that permitted under the agreement and under China law and the failure of Chongqing Sysway and its prior owners to cooperate with the Company in the preparation of the financial statement disclosures required under United States securities laws.





As a result of the termination and rescission of the agreement, the Company has transferred all of the shares of capital stock of Chongqing Sysway to the prior owners of Chongqing Sysway and the 1,400,000 shares of common stock of the Company issued in exchange for the shares of capital stock of Chongqing Sysway have been returned to the Company and treated as treasury shares.  This transaction returned the Company, Chongqing Sysway, and the prior owners of the capital stock of Chongqing Sysway to their status prior to the completion of the acquisition by the Company of the capital stock of Chongqing Sysway on December 24, 2009.





The assets and liabilities of Chongqing Sysway and the results of operations of Chongqing Sysway are reflected in the consolidated financial statements of the Company as discontinued operations. As a result, the consolidated results of operations of Covenant Group of China from inception (June 10, 2009) through December 31, 2009 reflect the results of operations of Jien but exclude the results of operations of Chongqing Sysway as if the rescission of Chongqing Sysway acquisition occurred on July 1, 2009.




43




Critical Accounting Policies





While our significant accounting policies are more fully described in Note 2 of our 2010 consolidated audited annual financial statements, we believe the following accounting policies are the most critical to aid you in fully understanding and evaluating this management discussion and analysis.





Basis of Presentation





The Company’s financial statements are prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”).





Principle of Consolidation





The consolidated financial statements include the accounts of Covenant Holdings, Covenant Group of China, Pandaz Delaware and Hainan Jien and all intercompany transactions and account balances are eliminated in consolidation.





Use of Estimates





In preparing the financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting year.  Significant estimates, required by management, include the recoverability of long-lived assets and the valuation of inventories.  Actual results could differ from those estimates.





Accounts Receivable and Retentions Receivable





The Company’s policy is to maintain reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. We record retentions receivable to reflect payments withheld by customers for product quality assurance. The retention rate under such contracts is predominantly 5% of the sales price with retention periods that vary from 1 year to 3 years, though some contracts have a 3% or a 10% retention rate.





Inventories





The Company’s inventory is valued at the lower of cost or market with cost determined on a first in, first out basis.





Property and Equipment





Property and equipment are stated at cost, net of accumulated depreciation.  Expenditures for maintenance and repairs are expensed as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations.  Depreciation of property and equipment is provided using the straight-line method for substantially all assets with 5% salvage value and estimated lives ranging from 3 to 25 years as follows:





Buildings
20-25 yearsLeasehold improvements
Shorter of lease term or 10 yearsVehicles
5-10 yearsOffice Equipment
3-5 years





44




Goodwill





Goodwill represents the excess of the fair value of the consideration transferred over the net of the acquisition date amount of identifiable assets acquired and the liability assumed.  In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“Statement No. 142”), codified in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, goodwill is not amortized but is tested for impairment annually, or when circumstances indicate a possible impairment may exist.  Impairment testing is performed at a reporting unit level.  An impairment loss generally would be recognized when the carrying amount of the reporting unit exceeds the fair value of the reporting unit, with the fair value of the reporting unit determined using a discounted cash flow (DCF) analysis.  A number of significant assumptions and estimates are involved in the application of the DCF analysis to forecast operating cash flows, including the discount rate, the internal rate of return, and projections of realizations and costs to produce.  Management considers historical experience and all available information at the time the fair values of its reporting units are estimated.





Revenue Recognition





The Company's revenue recognition policies are in compliance with Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 104 (codified in FASB ASC Topic 605).  Revenue is recognized when services have been rendered or product delivery has occurred, a formal arrangement exists, the price is fixed or determinable, no other significant obligations of the Company exist and collectability is reasonably assured.  Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue.




The Company derives the majority of its revenue from the supply and installation of surveillance and security equipment and systems under fixed price contracts.  The Company recognizes revenue based on the percentage of completion method as work on the contract progresses, in accordance with Statement of Position (SOP) 81-1 (codified in FASB ASC Topic 605-35).  The Company measures progress on a contract using the input method based on the ratio of costs incurred to total estimated costs.  The revenue recognized is the percentage of total estimated income that incurred costs to date bear to estimated total costs.




Most of the major contracts are bundled with a post-installation service for duration of 1 to 3 years depending on customers’ requests. There is no general right of return. During this period, customers are entitled to exchange defective parts for a new part, but are not entitled to a refund.




The Company subcontracts most of its major projects to third party subcontractors who supply both the equipment and parts and provide installation service. The Company is the primary obligator in the arrangement, takes title to the equipment and has the general inventory risk; thus the Company is considered the principal and the revenue is recorded gross in accordance with FASB ASC 605-45.  The Company provides its customers with warranties for both the products and the services; however, this warranty obligation is mitigated by warranties to the Company from the product manufacturers and warranties to the Company from the third party service providers. Thus the Company has no substantial performance obligation once the installation is completed and accepted by the customers. Accordingly, the earnings process is considered completed upon completion of the project.  In cases where the subcontractors provide a shorter warranty period than that requested by the customers, the Company will service the customers itself, as the Company has a core team of engineers and technicians to handle this part of the service.  In such cases, the warranty service is inconsequential to the contract as a whole and the estimated potential warranty cost is accrued.




Sales revenue represents the invoiced value of goods and services, net of value-added tax (VAT).  Jien became a general tax payer on February 1, 2010, and as of this date, all of the Company’s products sold in the PRC are subject to a fixed VAT rate of 17% of the gross sales price, which can be offset by VAT incurred by the Company on its purchases. Prior to February 2010, the Company was a small business and subject to a fixed VAT rate of 4% in 2008 and 3% in 2009, which cannot be offset by VAT incurred on purchases. Only sales of goods are subject to VAT. Revenue from installation contracts is subject to a 3% business tax, which is reflected in the cost of goods sold.





45




Cost of Revenue





Cost of goods sold consists primarily of material costs, labor costs, and related overhead that are directly attributable to the production of the service. Write-down of inventory to lower of cost or market is also recorded in cost of goods sold.





Foreign Currency Translation and Transactions and Comprehensive Income (Loss)





The accompanying consolidated financial statements are presented in United States Dollars (“USD”). The Company’s functional currency is the USD, while the Company’s wholly owned Chinese subsidiary’s functional currency is the Renminbi (“RMB”). The functional currencies of the Company’s foreign operations are translated into USD for balance sheet accounts using the current exchange rates in effect as of the balance sheet date and for revenue and expense accounts using the weighted-average exchange rate during the fiscal year. The translation adjustments are recorded as a separate component of stockholders’ equity, captioned accumulated other comprehensive income (loss). Gains and losses resulting from transactions denominated in foreign currencies are included in other income (expense) in the consolidated statements of operations. There have been no significant fluctuations in the exchange rate for the conversion of RMB to USD after the balance sheet date.





Comprehensive Income (Loss)





The Company uses SFAS No. 130, “Reporting Comprehensive Income” (codified in FASB ASC Topic 220). Comprehensive income is comprised of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders.








Segment Reporting





SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (codified in FASB ASC Topic 280), requires use of the “management approach” model for segment reporting. The management approach model is based on the way a company’s management organizes segments within the company for making operating decisions and assessing performance.  Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.





SFAS 131 has no effect on the Company’s financial statements as substantially all of the Company’s operations are conducted in one industry segment. The Company consists of one reportable business segment.  Most of the Company’s assets are located in the PRC, except US bank accounts for Covenant Holdings, Covenant Group of China, and Pandaz Delaware, and $25,000 of intangible assets that belong to Pandaz Delaware.





RESULTS OF OPERATIONS





For the years ended December 31, 2010 and 2009





The following table presents the actual consolidated results of operations of Covenant Group of China for the year ended December 31, 2010 as compared to the pro forma consolidated results of operations of Covenant Group of China for the year ended December 31, 2009 as if the acquisition of Hainan Jien occurred on January 1, 2009, indicated as a percentage of net sales.  The pro forma consolidated results of operations of Covenant Group of China for the year ended December 31, 2009 exclude the results of operations of Chongqing Sysway.





2010


2009 (Pro Forma)$



% of Sales


$



% of SalesSales


7,190,215






6,758,243Cost of sales


5,575,183



78
%


5,239,587



78
%Gross Profit


1,615,032



22
%


1,518,656



22
%Operating Expenses


1,289,331



17
%


992,829



15
%Income from Operations


325,701



5
%


525,827



7
%Other Expenses, net


(190,742)



(3)
%


(291,422)



(4
)%Net Income


134,959



2
%


234,405



3
%





46




NET REVENUES





Net revenues for 2010 were $7,190,215, as compared to net revenues of $6,758,243 for 2009, an increase of $431,972, or approximately 6%. The increase was mainly attributable to the new contracts obtained by Jien in 2010, such as for the Baishamen Holiday Village, Jingrui Real Estate Development Company, the General Office of the Peoples Government of Haikou Municipality, the Government Affairs Center, Hainan Province National Security Department and Haikou City Prison.  We recognize revenue by using the percentage of completion method for each project, which is determined based on actual cost incurred in proportion to the total estimated cost to complete.  In relation to our revenue recognition policy, progress on our projects typically proceeds faster during the beginning stages of projects than during later stages.





COST OF REVENUES





Cost of revenues included material costs, labor costs and related overhead, which are directly attributable to our provided services. For 2010, cost of revenues amounted to $5,575,183, or approximately 78% of net revenues, as compared to cost of revenues of $5,239,587, or approximately 78% of net revenues for 2009. The cost of revenue as a percentage of net revenue stayed the same primarily due to our continued efficient control and allocation of labor costs and the selective outsourcing of certain projects, despite an increase in the cost of materials and labor during 2010.





GROSS PROFIT





Gross profit for 2010 was $1,615,032 as compared to $1,518,656 for 2009, an increase of $96,376 or approximately 6%. Gross profit margin was 22% for both 2010 and 2009. This was mainly due to the Company’s cost control efforts.





OPERATING EXPENSES





Operating expenses consisted of selling, general and administrative expenses totaling $1,289,331 for 2010, compared to $992,829 for 2009, an increase of $296,502 or 30%.  The increase in operating expenses was primarily due to increased expenses in audit, legal and consulting fees arising from the Company being a public company as a result of the share exchange at the end of 2009.





Hainan Jien’s operating expense was approximately $574,541 for 2010 as compared to $592,105 for 2009, a decrease of $ 17,564 or 3%. This decrease was mainly attributable to cost savings on travel, rental and advertisement expenses incurred by Jien’s management, as well as a decrease of the tax rate on net sales from 3% in 2009 to 1.76% in 2010.





NET INCOME





For 2010, the Company had net income of $134,959 as compared to net income of $234,405 for 2009, a decrease of $99,446, or approximately 42%. This decrease in net income was mainly due to increased expenses in audit, legal, and consulting fees arising from the Company being a public company, a bad debt allowance expense of $79,000, a one-time, non-cash expense of approximately $23,200 resulting from the settlement of a note payable to the Company’s former majority shareholder in exchange for the issuance of 70,000 shares of the Company’s common stock and non-cash interest expense of approximately $136,000 resulting from amortization of the fair value of warrants that were attached to short term loans. In addition, the Company recorded $46,000 of stock-based compensation to vendors of outsourced services and $55,000 of stock-based compensation to an officer and members of the Company’s advisory board under the Company’s Long-Term Incentive Plan. These expenses were partially offset by the forgiveness of a $130,000 short-term loan.




47




For year ended December 31, 2010 and from inception (June 10, 2009) to December 31, 2009





The following table presents the actual consolidated results of operations of Covenant Group of China for the year ended December 31, 2010 as compared to the consolidated results of operations of Covenant Group of China for the period from inception (June 10, 2009) through December 31, 2009, indicated as a percentage of net sales.  The consolidated results of operations of Covenant Group of China for the period from inception to December 31, 2009 included the results of operations of Chongqing Sysway as discontinued operations.








2010


2009 (Since inception)$



% of Sales


$



% of SalesSales


7,190,215






3,732,408Cost of sales


5,575,183



78
%


2,938,921



79
%Gross Profit


1,615,032



22
%


793,487



21
%Operating Expenses


1,289,331



17
%


763,329



20
%Income from Operations


325,701



5
%


30,158



1
%Other Expenses, net


(190,742)



(3)
%


(286,910)



(8
)%Income from discontinued operations, net of tax


-



-



324,053



9
%Net Income


134,959



2
%


67,301



2
%








NET REVENUES





Net revenues for 2010 were $7,190,215, as compared to net revenues of $3,732,408 for the period from inception (June 10, 2009) through December 31, 2009, an increase of $3,457,807, or approximately 93%. The increase was mainly attributable to the recognition of a full year of revenues during 2010 and new contracts obtained by Jien in 2010, such as for the Baishamen Holiday Village, Jingrui Real Estate Development Company, the General Office of the Peoples Government of Haikou Municipality, the Government Affairs Center, Hainan Province National Security Department and Haikou City Prison.  Revenues from inception through December 31, 2009 were attributable to the recovery of China’s economy as a result of effective economic stimulus by the Central Government as well as the growth and strengthening of our own sales force and our building good government relations.





COST OF REVENUES





Cost of revenue included material costs, labor costs and related overhead, which are directly attributable to our provided services. For 2010, cost of revenues amounted to $5,575,183 or approximately 78% of net revenues, as compared to cost of revenues of $2,938,921, or approximately 79% of net revenues for the period from inception (June 10, 2009) through December 31, 2009. The decrease of cost of revenue as a percentage of net revenue was mainly due to our efficient control and allocation of labor costs and the selective outsourcing of certain projects, despite an increase in the cost of materials and labor during 2010.





GROSS PROFIT





Gross profit for 2010 was $1,615,032 as compared to $793,487 for the period from inception (June 10, 2009) through December 31, 2009, an increase of $821,545, or approximately 104%. Gross profit margin was 22% and 21% for 2010 and the period from inception through December 31, 2009, respectively. This was mainly due to the recognition of a full year of gross profit during 2010 and the Company’s cost control efforts.




48




OPERATING EXPENSES





Operating expenses consisted of selling, general and administrative expenses totaling $1,289,331 for 2010, compared to $763,329 for the period from inception (June 10, 2009) through December 31, 2009, an increase of $526,002 or 69%. The increase in operating expenses was primarily due to the recognition of a full year of operating expenses during 2010 and increased expenses for audit, legal, and consulting services arising from the Company being a public company as a result of the share exchange at the end of 2009.





JIEN’s operating expense was approximately $574,541 for 2010 as compared to $362,605 for the period from inception (June 10, 2009) through December 31, 2009, an increase of $ 211,936, or 58%.





NET INCOME





For the year ended December 31, 2010, the Company had net income of $134,959 as compared to net income of $67,301 for the period from inception (June 10, 2009) through December 31, 2009, an increase of $67,658, or approximately 101%. This increase in net income was mainly due to the recognition of a full year of net income during 2010 and the growth in revenue. Net income as a percentage of net revenue was 2% for both 2010 and the period of 2009 from inception through December 31, 2010.





LIQUIDITY AND CAPITAL RESOURCES





For the years ended December 31, 2010 and 2009





As of December 31, 2010, we had cash and cash equivalents of $2,559,528, of which $2,534,161 was held by JIEN. Other current assets were $2,996,547 and current liabilities were $3,277,806.  Working capital was $2,278,269. The ratio of current assets to current liabilities was 1.70:1 at December 31, 2010.





The following table presents the actual summary of cash provided by or used in each of the indicated types of activities of Covenant Group of China for 2010 as compared to the pro forma summary of cash provided by or used in each of the indicated types of activities of Covenant Group of China for 2009 as if the acquisition of Hainan Jien occurred on January 1, 2009.





2010


(Pro Forma)

2009Cash provided by (used in):Operating Activities

$
658,811


$
(36,670
)Investing Activities


(35,218
)


68,101Financing Activities


912,036



937,493





Net cash flow provided by operating activities was $658,811 during 2010, as compared to net cash flow used in operating activities of $36,670 for 2009. The increase in net cash flow generated in operating activities during 2010 was mainly due to a decrease in retention receivable and other receivables outstanding, a decrease in inventory and an increase in unearned revenue.  Due to an increasingly competitive business environment, Hainan Jien has extended more favorable payment terms to its customers while simultaneously managing the strict credit terms of its suppliers.  JIEN plans to address this difficult business environment through continued cost reduction and negotiating better payment terms with its materials suppliers.





Net cash flow used in investing activities was $35,218 in 2010, compared to net cash generated by investing activities of $68,101 in the comparative period of 2009. The cash used in 2010 was mainly for the acquisition of fixed assets and the cash generated in 2009 was primarily due to cash acquired from the acquisition of Hainan Jien by the Company.





Net cash flow provided by financing activities was $912,036 in 2010 as compared to net cash provided by financing activities of $937,493 in the comparative period of 2009.  In 2010, the Company obtained four bridge loans of $950,000 and repaid a short-term bank loan of $37,964. In 2009, the Company had cash proceeds of $799,870 from the issuance of stock and $137,623 from short-term loans.




49




For the year ended December 31, 2010 and from inception (June 10, 2009) to December 31, 2009





The following table presents the actual summary of cash provided by or used in each of the indicated types of activities of Covenant Group of China for 2010 as compared to the summary of cash provided by or used in each of the indicated types of activities of Covenant Group of China from inception (June 10, 2009) through December 31, 2009.





2010


2009 (Since inception)Cash provided by (used in):Operating Activities

$
658,811


$
72,397Investing Activities


(35,218
)


330,565Financing Activities


912,036



565,805





Net cash flow provided by operating activities was $658,811 during 2010, as compared to net cash flow provided by operating activities of $72,397 for the period from inception through December 31, 2009. The increase in net cash flow generated by operating activities during 2010 was mainly due to a decrease in retention receivable and other receivables outstanding, a decrease in inventory and an increase in unearned revenue and accounts payable outstanding. For the period from inception through December 31, 2009, the cash outflow from continued operations was $646,994; the cash inflow of discontinued operations was $719,391.




Net cash flow used in investing activities was $35,218 in 2010, compared to net cash generated by investing activities of $330,565 in the period of 2009 from inception through December 31, 2010. The cash used in 2010 was mainly for the acquisition of fixed assets, and the cash generated for the period from inception through December 31, 2009 was mainly attributable to $710,552 in cash acquired from the acquisition of JIEN, offset by $413,093 of cash disposed through discontinued operations. For the period from inception through December 31, 2009, cash inflow from continued operations was $297,459; the cash inflow from discontinued operations was $33,106




Net cash flow provided by financing activities was $912,036 in 2010 as compared to net cash provided by financing activities of $565,805 in the period from inception through December 31, 2009. In 2010, the Company obtained four bridge loans of $950,000 and repaid a short-term bank loan of $37,964. In 2009, the Company had cash proceeds of $799,870 from the issuance of stock and $137,623 from short-term loans. For the period from inception through December 31, 2009, the cash inflow from continued operations was $905,433; the cash outflow of discontinued operation was $339,628.








New Accounting Pronouncements





Recently Issued Accounting Pronouncements Not Yet Adopted





In April 2010 the FASB issued Accounting Standards Update (ASU) No. 2010-13, Compensation – Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades. This Update provides amendments to Accounting Standards Codification (ASC) Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency  of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The amendments in this Update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. The cumulative-effect adjustment should be calculated for all awards outstanding as of the beginning of the fiscal year in which the amendments are initially applied, as if the amendments had been applied consistently since the inception of the award. The cumulative-effect adjustment should be presented separately. Earlier application is permitted. This standard will be adopted effective January 1, 2011.




50




In December 2010, FASB issued ASU No. 2010-28, Intangibles – Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.The amendments in this Update affect all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. The amendments in this Update modify Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. Upon adoption of the amendments, any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of an adoption. Any goodwill impairments occurring after the initial adoption of the amendments should be included in earnings. This standard will be adopted effective January 1, 2011.




In December 2010, FASB issued ASU No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this Update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company intends to adopt the disclosure requirements for any business combinations in 2011.




As of December 31, 2010, there are no other recently issued accounting standards not yet adopted which would have a material effect on the Company’s financial statements.




Recently Adopted Accounting Pronouncements




In January 2010, FASB issued ASU No. 2010-05, Compensation – Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. This update codifies Emerging Issues Task Force D-110. This standard is not currently applicable to the Company.




In January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update provides amendments to ASC Topic 820 that will provide more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. This standard is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.




In January 2010, FASB issued ASU N0. 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash. The update clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected prospectively in earnings per share and is not considered a stock dividend for purposes of ASC Topic 505 and Topic 260, Earnings Per Share. This standard is effective for interim and annual periods ending on or after December 15, 2009, and should be applied on a retrospective basis. The adoption of this standard did not have a material impact to the Company’s financial position or results of operations.




51





Off-Balance Sheet Arrangements





We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties.  We have not entered into any derivative contracts that are indexed to our shares and classified as stockholder’s equity or that are not reflected in our consolidated financial statements.  Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity.  We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.





Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.





We are exposed to market risks related to changes in interest rates and foreign currency exchange rates.  However, we believe those risks to be not material in relation to our operations. We are not a party to any derivative financial instruments.





Interest Rate Risk





As of December 31, 2010, we held no money market securities or short term available for sale marketable securities. Accordingly, an immediate 10% change in interest rates would not have a material effect on the fair market value of our portfolio. Therefore, we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio.





Foreign Currency Exchange Risk





All of our revenues are denominated in RMB and, as a result, we have certain exposure to foreign currency exchange risk with respect to current revenues. A majority of our expenses are payable in foreign currency. We do not use forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. The effect of an immediate 10% change in exchange rates would not have a material impact on our future operating results or cash flows.





Credit Risk





We have exposure to the normal credit risk of customers failing to pay their obligations when due.





Item 8.  Financial Statements and Supplementary Data.





PageReport of Independent Registered Public Accounting Firm
F-1Financial Statements:Consolidated Balance Sheet as of December 31, 2010
F-2Consolidated Statements of Income and Other Comprehensive Income for the year ended December 31, 2010
F-3Consolidated Statement of Stockholders’ Equity for the year ended December 31, 2010
F-4Combined Statements of Cash Flows for the year ended December 31, 2010
F-5Notes to Combined Financial Statements
F-6 to F-18





Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.





None





Item 9A.  Controls and Procedures.





52




Disclosure Controls and Procedures





Our management, under the supervision and with the participation of our president and chief financial officer, has performed an evaluation of the effectiveness of the design and operation ofour disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this report, as required by Rule 13a-15(b) under the Exchange Act. Disclosure controls and procedures are those controls and procedures that are designed to provide reasonable assurance that the information required to be disclosed in our Exchange Act filings is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules, regulations and related forms, and (2) accumulated and communicated to management, including our president and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.  Based on that evaluation, our president and chief financial officer concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this Annual Report on Form 10K.





With respect to ineffective disclosure controls and procedures, the board and management of the Company determined that engaging an independent, third-party consultant to evaluate the internal controls of the Company’s Chinese operating subsidiary was necessary to assist management with performing its 2010 assessment on internal control over financial reporting.  Accordingly, because it required additional time to evaluate and select a third party consultant to review the internal controls of our operating subsidiary, management was unable complete its 2010 assessment on internal control over financial reporting and finalize the Company’s financial statements by the required deadline to file our Annual Report on Form 10K.  In addition, the material weaknesses in our internal control over financial reporting identified during the year ended December 31, 2010 and discussed below contributed to the ineffectiveness of our controls and procedures as of such date.





Management’s Annual Report on Internal Control over Financial Reporting.





Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act).  Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles of the United States (“ US GAAP”).  Internal control over financial reporting includes policies and procedures that:





1)
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;





2)
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with US GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and/or our board of directors; and





3)
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the interim or annual consolidated financial statements.





Under the supervision and with the participation of our president and chief financial officer, management conducted an evaluation of the effectiveness of Covenant’s (comprised of our US holding company and our operating subsidiary, Hainan Jien) internal control over financial reporting as of December 31, 2010.  Based on this evaluation, our management concluded that our internal control over financial reporting was not effective due to the material weaknesses described below.




53




Material Weaknesses and Remediation





A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.  The material weaknesses identified are:





1)
Inconsistencies between established policies and procedures and actual practices by employees of operating subsidiary that relate to the provision for doubtful debt/bad debt write-off, cost recognition, quotation and supplier selection, invoice management, and contract management;





2)
Too few adequately trained financial management staff to follow-up on established policies and procedures and to ensure the accurate, contemporaneous and complete recordation of complex financial transactions without outside assistance;





3)
Ineffective controls over segregation of key duties to reduce the likelihood of errors; and





4)
Ineffective controls concerning access rights to and authorization rights within our operating subsidiary’s accounting system.





With respect to the control deficiencies noted above, a material misstatement to our financial statements could result.  Accordingly, management has determined that the four control deficiencies described above constitute material weaknesses.





As part of its remediation plan, the Company anticipates working further with its independent third-party consultants to conduct regular internal control audits and to seek consultation on the improvement of the Company’s internal controls. Additionally, the Company utilizes an outside CPA firm to assist the Company with the preparation of its financial statements in accordance with US GAAP.  As a result, the Company plans to further utilize its outside CPA firm to assist it with the improvement of the accounting practices, policies and procedures of our operating subsidiary. With regard to the specific material weaknesses stated above, the following remediation measures are planned:





1)
Review and enhance existing policies and procedures to ensure consistency and educate employees as to stated policies to improve implementation and compliance, namely:





·
Establish a month-end closing checklist to ensure all responsible employees are aware of their responsibilities and to track the completion of required tasks;





·
Continue to work with the Company’s outside CPA firm to further formalize our operating subsidiary’s regular assessment and review of uncollectible accounts receivable as it relates to the Company’s policy for doubtful debt/bad debt write-off;





·
With the assistance of the Company’s outside CPA firm, better establish more formalized procedures for the collection of all project cost information;





·
Standardize procurement procedures to ensure quotation and supplier/sub-contractor selection procedures follow our operating subsidiary’s stated policies;





·
Ensure the strict enforcement of operating subsidiary policy to request tax invoices for all purchases from suppliers and maintain purchase and tax invoices for all purchases;





·
Execute our operating subsidiary’s contract management system in accordance with its stated contract management policies;





2)
Support financial management of operating subsidiary with additional competent staff, maintain further cooperation of financial management with the Company’s outside CPA firm and encourage additional training of financial management on US GAAP and IFRS concepts;




54




3)
Ensure proper segregation of duties within operating subsidiary with regard to the custody of assets, the authorization of related transactions affecting those assets, and the recordation and reporting of the related transactions; and





4)
Reassign access and authorization rights in operating subsidiary’s accounting system and employ system security measures to restrict access to non-authorized employees and others.





Inherent Limitations Over Internal Controls





Because of its inherent limitations, internal control over financial reporting may not prevent or detect all errors or misstatements and all fraud. Therefore, even those systems determined to be effective can provide only reasonable, not absolute, assurance that the objectives of the policies and procedures are met. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.





This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which permits the Company to discuss only management’s report in this annual report.





Changes in Internal Control Over Financial Reporting





As a result of the termination of our acquisition of Chongqing Sysway on April 30, 2010, there were changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the second quarter of 2010 that are reasonably likely to materially affect our internal control over financial reporting.   See “Termination of our Acquisition of Chongqing Sysway.”  Since the Company had two Chinese operating subsidiaries prior to the termination of the Chongqing Sysway acquisition (the assets and liabilities of Chongqing Sysway were reflected as discontinued operations of the Company as of December 31, 2009), our internal control framework as well as the scope of management’s assessment of internal control over financial reporting was reduced as a result of the termination to comprise only that of the Company’s US holding company and its sole Chinese operating subsidiary, Hainan Jien.





Item 9B.  Other Information.





None.





55




PART III





Item 10.  Directors, Executive Officers and Corporate Governance.





Executive Officers and Directors





As of December 31, 2010, the directors and executive officers of Covenant were:





Name

Age

PositionFredric W. Rittereiser

74

Chairman of the Board of DirectorsKenneth Wong

55

President and DirectorK. Ivan F. Gothner

52

DirectorJustin D. Csik

28

General Counsel, Chief Financial Officer and Secretary





Our directors hold office for one-year terms and until their successors have been elected and qualified.  Our officers are elected annually by the board of directors and serve at the discretion of the board. Messrs. Rittereiser, Wong and Gothner were appointed as directors on December 24, 2009.





Biographies





Fredric Rittereiser, Chairman of the Board of Directors





Mr. Rittereiser was a founder of Covenant Holdings in 2009.  He has over 40 years of capital markets experience as a senior executive at various Wall Street firms, and he has extensive experience working with US public companies with China-based operations.  From 2007 to 2009, he served on the Board of Directors of AgFeed Industries, Inc., one of the largest hog producers in the PRC, and he is currently Chairman of the Strategic Affairs Committee for AgFeed Industries, a non-board position.  From October 1996 until retiring in 2002, Mr. Rittereiser served as Chairman of the Board and Chief Executive Officer of Ashton Technology Group, Inc., a company specializing in development and commercialization of online transaction systems for the financial industry.  He was also a founder of Ashton Technology.





Prior to his principal role at Ashton Technology, Mr. Rittereiser served as a special consultant to Booz Allen and Hamilton, a global strategy and technology-consulting group, from 1991 to 1993.  Previously, he was the former President and Chief Operating Officer of Instinet Corporation since 1983, which became one of the world’s leading electronic securities trading firms. Under his leadership, the company evolved into a highly efficient continuous electronic communications network or ECN that allowed institutions and dealers to negotiate securities trades anonymously.  Mr. Rittereiser successfully negotiated the sale of Instinet to the Reuters Group in 1987.  From 1973 until 1980, he served as the NASD representative on the National Market System Committee responsible for negotiated rates, developing market linkages in the U.S., promoting price competition and endorsing NASDAQ as the electronic market for growth companies and new issues.





Mr. Rittereiser was also a founder of Gomez Advisors, Inc., TH Lehman Inc., and he was a member of the board of directors of the International Heritage Mutual Fund.





Kenneth Wong, President and Director.





Mr. Wong was a founder of Covenant Holdings in 2009. He is also President, owner and founder of CIG Asia, Ltd., a Philadelphia, Pennsylvania-based national property and casualty insurance brokerage firm.  From 2004-2007, Mr. Wong, as an appointee of President George W. Bush, served as a commissioner on the President’s Advisory Commission for Asian Americans and Pacific Islanders.  In 2010, Mr. Wong was appointed to the Chairmanship of the National U.S. Hong Kong Business Association (“NUSHKBA”). NUSHKBA is a member of the Hong Kong Business Association Worldwide, which is affiliated with the Hong Kong Trade and Development Council.  Mr. Wong also serves on the Executive Board of Directors of the Hong Kong Business Association Worldwide. Mr. Wong received a BA from Pennsylvania State University in sociology and political science.





56




K. Ivan F. Gothner, Director.





Mr. Gothner was a founder of Covenant Holdings in 2009. In 1993, he founded Adirondack Partners, LLC, a private merchant-banking firm that focuses on serving small and mid-size growth companies, and has since served as Adirondack Partners’ Managing Director.  Prior to founding Adirondack Partners, Mr. Gothner was Senior Vice President of Barclays Bank from 1990 to 1992, responsible for establishing an investment banking unit to serve small and mid-sized companies.  Mr. Gothner joined Kleinwort Benson Limited in 1986, and from 1987 to 1990 he served as a Senior Vice President of the firm and General Manager of the KB Mezzanine Fund, L.P., a specialized fund which invested in equity and junior capital of small and mid-sized businesses.  Currently, Mr. Gothner serves on the Board of Directors of ArtID, LLC and AgFeed Industries, Inc. (where he is also Chairman of the Audit Committee and Compensation Committee and a member of the Nominating and Corporate Governance Committee).  Mr. Gothner received a Bachelor’s of Art from Columbia College in political science and economics and a MIA from Columbia University’s School of International Affairs in international economic policy and finance.





Justin D. Csik, General Counsel, Chief Financial Officer and Corporate Secretary.





Mr. Csik joined Covenant Holdings in October 2009.  Mr. Csik is a practicing attorney with a background in accounting and economics.  Upon being admitted to the state bars of Pennsylvania and New Jersey in 2008, Mr. Csik was a corporate finance associate with Buchanan Ingersoll & Rooney PC from 2008 to 2009.  While at Buchanan Ingersoll, he worked on a variety of securities regulatory, transactional and corporate governance matters.  He was also a member of his firm’s China practice group, where he assisted clients with legal issues unique to U.S. public companies with primarily China-based operations.  Prior to joining Buchanan Ingersoll, Mr. Csik worked for Deloitte & Touche LLP for an extended audit and assurance internship in 2004.  During his time with Deloitte, he worked on the major phases of financial statement audits for a variety of public and privately-held clients, which included substantive account testing and SEC reporting.   Mr. Csik received his Bachelor of Science in accountancy and economics from Villanova University in 2005, graduating magna cum laude.  In 2008, Mr. Csik received his Juris Doctor degree from Rutgers School of Law—Camden.





The Board of Directors and Committees





Currently, Messrs. Rittereiser and Gothner qualify as “independent” directors, but Mr. Wong does not qualify as an “independent” director, as that term is defined by the listing standards of The NASDAQ Stock Market and SEC rules.  The Company intends to maintain a majority of independent directors.  The board’s composition (and that of its eventual committees) will be subject to the corporate governance provisions of its primary trading market, including the requirements related to independent directors in accordance with the Sarbanes-Oxley Act of 2002, and regulations adopted by the SEC pursuant thereto.





Audit Committee





We intend to establish an audit committee of the board of directors, which will consist of independent directors, of which at least one director will qualify as a qualified financial expert as defined in Item 407(d)(5)(ii) of Regulation S-K.  The audit committee’s duties would be to recommend to our board of directors the engagement of independent auditors to audit our financial statements and to review our accounting and auditing principles.  The audit committee would review the scope, timing and fees for the annual audit and the results of audit examinations performed by the internal auditors and independent public accountants, including their recommendations to improve the system of accounting and internal controls. The audit committee would at all times be composed exclusively of directors who are, in the opinion of our board of directors, free from any relationship which would interfere with the exercise of independent judgment as a committee member and who possess an understanding of financial statements and generally accepted accounting principles.





57





Compensation Committee





We intend to establish a compensation committee of the board of directors.  The compensation committee would review and approve our salary and benefits policies, including compensation of executive officers. The compensation committee would also administer our stock option plans and recommend and approve grants of stock options under such plans.





Nominating and Corporate Governance Committee





We intend to establish a nominating and corporate governance committee of the board of directors to assist in the selection of director nominees, approve director nominations to be presented for shareholder approval at our annual general meeting and fill any vacancies on our board of directors, consider any nominations of director candidates validly made by shareholders, and review and consider developments in corporate governance practices.





Director Compensation





The following table provides information concerning the compensation of our non-executive directors for the period from January 1, 2010 through December 31, 2010.





Name

Fees

Earnedor

Paid in

Cash ($)


Option

Awards ($)


Total ($)Fredric W. Rittereiser

$
0


$
0


$
0K. Ivan F. Gothner


0



0



0





Our directors hold office for one-year terms and until their successors have been elected and qualified.  Our officers are elected annually by the board of directors and serve at the discretion of the board. Messrs. Rittereiser, Wong and Gothner were appointed as directors on December 24, 2009.





Corporate Governance





Code of Conduct





Our board of directors plans to adopt a Code of Conduct, which will apply to all directors, officers and employees. The purpose of the Code would be to promote honest and ethical conduct.





Section 16 Beneficial Ownership Reporting Compliance





Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires our officers and directors and persons who own more than ten percent (10%) of our common stock to file with the SEC initial reports of ownership and reports of changes in ownership of our common stock. Such officers, directors and ten percent (10%) shareholders are also required by applicable SEC rules to furnish to us copies of all forms filed with the SEC pursuant to Section 16(a) of the Exchange Act. Based solely on our review of copies of forms filed pursuant to Section 16(a) of the Securities Exchange Act of 1934, as amended, and written representations from certain reporting persons, we believe that during 2010 all reporting persons timely complied with all filing requirements applicable to them.





Item 11.  Executive Compensation.





Summary Compensation Table





The following table shows the compensation of each of our named executives in 2010. Our named executives are:  our president, Mr. Wong; and our general counsel, chief financial officer and secretary, Mr. Csik.





58




Name and Principal Position
Year

Salary


Bonus


Restricted Stock Awards


Total CompensationKenneth Wong
2010

$
0


$
0


$
0


$
0President
2009


0



0



0



02008


N/A



N/A



N/A



N/AJustin D. Csik
2010


105,000



0



75,000
*


180,000General Counsel, Chief Financial Officer and Corporate Secretary
2009


15,000



0



0



15,0002008


N/A



N/A



N/A



N/A





* 50,000 shares were issued under the Long-Term Incentive Plan on November 15, 2010 (“Grant Date”); the vesting schedule for this issuance is as follows:  20% on the first anniversary of the Grant Date; 25% on the second anniversary of the Grant Date; 55% on the third anniversary of the Grant Date; the market value is based on the closing price of our common stock on December 31, 2010 of $1.50 multiplied by the number of outstanding shares.





Compensation paid to our named executives in 2010 consisted solely of cash salary and a restricted stock award of 50,000 shares to Mr. Csik under the Company’s Long-Term Incentive Plan.  In the future, our named executive officers may be eligible to receive other forms of compensation.





Long-term equity incentive awards may be granted to retain executives, build executive ownership and align compensation with the achievement of our long-term financial goals, creating shareholder value and achieving strategic objectives as measured over multi-year periods.





Executives are eligible for equity awards in the form of stock options, stock appreciation rights, restricted stock, restricted stock units, and performance grants under the Covenant Group of China Inc. 2010 Long-Term Incentive Plan. Awards are made at the discretion of the Board (or the Compensation Committee, when formed). The number of shares awarded to any individual depends on individual performance, salary level and competitive data, and the impact that such employee’s productivity may make to shareholder value over time. In addition, in determining the number of stock options, stock appreciation rights, restricted shares, restricted stock units or performance shares to grant to each executive, the Board reviews the current ownership interest of each executive to determine whether or not an additional grant will incentivize that individual to make a long term commitment to remain with Covenant. By giving executives an equity interest in Covenant, the value of which depends upon stock performance, we seek to further align management and shareholder interests.  During 2010, with the exception of a restricted stock award Mr. Csik, we determined that it was not necessary to grant equity awards to our named executives because each of them held a number of shares of our common stock sufficient to align their respective interests and commitments with those of our shareholders.





Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.





The table below sets forth information, as of March 31, 2011, concerning (a) each person that is known to us to be the beneficial owner of more than 5% of the Company’s common stock; (b) each of our named executives; (c) each director; and (d) all of the directors and executive officers as a group. Unless otherwise indicated, to our knowledge, all persons listed below have sole voting and investment power with respect to their shares, except to the extent spouses share authority under applicable law. Beneficial ownership is determined in accordance with the rules of the SEC. At the close of business on March 31, 2011, we had 9,683,909 shares of common stock outstanding.  In computing the number and percentage of shares beneficially owned by a person, shares that may be acquired by such person within 60 days of March 31, 2011 are counted as outstanding, while these shares are not counted as outstanding for computing the percentage ownership of any other person.





59




Name of Beneficial Owner

5% Shareholders:

Number of Shares

Beneficially

Owned(1)


Percentage

Beneficially

Owned(2)Ma Bing Feng

HaiNan JIEN Intelligent Engineering Co.

Floor 6, No.38 DaTong Road,

Fortune Centre,

Haikou City, Hainan Province, China 570102


810,000



8.4 %Dai Qing Hua

HaiNan JIEN Intelligent Engineering Co.

Floor 6, No.38 DaTong Road,

Fortune Centre,

Haikou City, Hainan Province, China 570102


540,000



5. 6 %Sheng Zhou/Sunrise Capital International, Inc./Good Energy Enterprise, Ltd.

Unit 2309-2310, South Tower, World Trade Centre, Huanshi Road,

Guangzhou, China 510095


1,100,909



11.4 %Directors and Executive Officers:Fredric Rittereiser


0



*Kenneth Wong


300,000



3.1 %K. Ivan F. Gothner


250,000



2. 6 %Justin D. Csik


150,000
(3)


1.5%All Directors and named Executive Officers as a group (4 persons)


700,000



7.2%





*
Represents less than 1% of the shares outstanding.(1)
Beneficial ownership has been determined in accordance with Rule 13d-3 under the Exchange Act.  Unless otherwise noted, we believe that all person named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them.(2)
Based on 9,683,909 shares of common stock issued and outstanding as of March 31, 2011.(3)
50,000 shares were issued under the Long-Term Incentive Plan on November 15, 2010 (“Grant Date”); the vesting schedule for this issuance is as follows:  20% on the first anniversary of the Grant Date; 25% on the second anniversary of the Grant Date; 55% on the third anniversary of the Grant Date.





Item 13.  Certain Relationships and Related Transactions, and Director Independence.





None.





Item 14.  Principal Accounting Fees and Services.





Our board selected the firm of Morison Cogen LLP (“Morison Cogen”) as the independent registered certified public accounting firm to audit the books and accounts of the Company and its subsidiaries for the fiscal year ended December 31, 2010.  This firm has served as the independent public accountants for the Company since 2009.





60




The following table sets forth fees billed to us by Morison Cogen for professional services rendered for 2010 and 2009:





2010


2009Audit Fees

$
179,512


$
90,000Audit-Related Fees


0



0Other


7,100



0Tax


0



0Total


185,612



90,000




Audit Fees





This category includes the aggregate fees billed for professional services rendered for the audits of our consolidated financial statements for fiscal years 2010 and 2009, respectively, and for services that are normally provided by Morison Cogen in connection with statutory and regulatory filings or engagements for the relevant fiscal year.





Audit-Related Fees





This category includes the aggregate fees billed during the period for fiscal years 2010 and 2009, respectively, for assurance and related services by Morison Cogen that are reasonably related to the performance of the audits or reviews of the financial statements and are not reported above under “Audit Fees,” and generally consist of fees for due diligence, consulting with respect to our reports under the Securities Exchange Act of 1934 and agreed-upon procedure reports.





During fiscal year 2009, Morison Cogen and Manning Elliot did not utilize any personnel in connection with the audit other than its full-time, permanent employees.





Policy for Approval of Audit and Non-audit Services





The board has adopted an approval policy regarding the approval of audit and non-audit services provided by the independent accountants, which approval policy describes the procedures and the conditions pursuant to which the board may grant general pre-approval for services proposed to be performed by our independent accountants. All services provided by our independent accountants, both audit and non-audit, must be pre-approved by the board. Our board has delegated to the chairman of the board the authority to grant pre-approvals of non-audit services provided by Morison Cogen LLP. The decisions of the chairman of the board to pre-approve such a service are required to be reported to the board at its next regularly scheduled meeting.





61





PART IV





Item 15.  Exhibits, Financial Statement Schedules.





(a)(1) Financial Statements





See Item 8, “Financial Statements and Supplementary Data.”





(a)(2) Financial Statement Schedules





All financial statement schedules for the Company and its subsidiaries have been included in the consolidated financial statements or the related notes or they are either inapplicable or not required.





(a)(3) Exhibits





The exhibits required by this item are set forth on the Exhibit Index attached hereto.





62





COVENANT GROUP OF CHINA INC.


Consolidated Financial Statements





Contents





PageAudited Financial Statements of Covenant Group of China Inc.Report of Independent Registered Public Accounting Firm
F-1Consolidated Balance Sheet as of December 31, 2010
F-2Consolidated Statement of Income and Other Comprehensive Income for the year ended December 31, 2010
F-3Consolidated Statement of Stockholders’ Equity for the year ended December 31, 2010
F-4Consolidated Statement of Cash Flow from inception for the year ended December 31, 2010
F-5Notes to Consolidated Financial Statements
F-6











REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders of
 Covenant Group of China Inc.
 
 We have audited the accompanying consolidated balance sheets of Covenant Group of China Inc. and Subsidiaries (“the Company”) as of December 31, 2010 and 2009, the related consolidated statements of income and comprehensive income, stockholders' equity and cash flows for the years then ended. The Company’s management is responsible for these financial statements.  Our responsibility is to express an opinion on these financial statements based on our audits.
 
 We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.
 
 In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2010 and 2009, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States.
 
 
 /s/Morison Cogen LLP
 
 Bala Cynwyd, Pennsylvania
 April 15, 2011




F-1






COVENANT GROUP OF CHINA INC.CONSOLIDATED BALANCE SHEETSDECEMBER 31, 2010 AND 20092010


2009ASSETSCURRENT ASSETSCash and equivalent

$
2,559,528


$
969,271Restricted cash


61,714



-Accounts receivable, net


2,426,295



2,156,112Retentions receivable


242,298



344,428Other receivables


170,069



234,066Prepayment and deposits


32,367



98,537Inventories


48,491



102,950Deferred compensation asset


15,313



-Total current assets


5,556,075



3,905,364NON-CURRENT ASSETSRetentions receivable


150,996



146,451Property, plant and equipment, net


20,019



21,794Goodwill


572,020



572,020Intangible assets


18,750



-Total non-current assets


761,785



740,265Assets of discontinued operations


-



4,162,726Total assets

$
6,317,860


$
8,808,355LIABILITIES AND STOCKHOLDERS' EQUITYCURRENT LIABILITIESShort term loans

$
-


$
37,638Note payable


-



100,000Accounts payable


1,322,651



983,656Unearned revenue


188,745



155,432Taxes payable


179,743



9,980Other payables and accrued liabilities


283,352



438,774Dividend payable


493,101



478,260Loans payable, net of unamortized discount on warrants


810,214



-Total current liabilities


3,277,806



2,203,740Liabilities of discontinued operations


-



1,616,586CONTINGENCIES AND COMMITMENTSSTOCKHOLDERS' EQUITIYCommon stock, $0.00001 par value, 20,000,000 shares

authorized, 11,083,909 shares issued and 9,683,909 shares

outstanding as of December 31, 2010, and  11,480,909

shares issued and outstanding as of December 31, 2009

respectively


97



115Additional paid-in capital


5,957,090



5,572,018Statutory surplus reserve


170,731



67,737Accumulated deficit


(375,507
)


(647,735
)Accumulated other comprehensive income (loss)


75,696



(4,106
)5,828,107



4,988,029Less: treasury stock, at cost; 1,400,000 shares of common stock


(2,788,053
)


-Total stockholders' equity


3,040,054



4,988,029TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$
6,317,860


$
8,808,355




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




F-2




COVENANT GROUP OF CHINA INC.CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOMEFOR YEAR ENDED DECEMBER 31, 2010 AND FROM INCEPTION (JUNE 10, 2009) TO DECEMBER 31, 20092010


2009NET SALES

$
7,190,215


$
3,732,408COST OF SALES


5,575,183



2,938,921GROSS PROFIT


1,615,032



793,487OPERATING EXPENSESSelling expenses


87,789



43,260General and administrative expenses


1,201,542



720,069Total Operating Expenses


1,289,331



763,329INCOME FROM OPERATIONS


325,701



30,158OTHER INCOME (EXPENSES)Other income


2,567



4,287Acquisition related cost


(150,000
)


(290,000
)Income (Loss) on settlement of debt


106,800



-Interest expense


(150,109
)


(1,197
)Total Other Expenses, net


(190,742
)


(286,910
)INCOME (LOSS) FROM CONTINUING OPERATIONS


134,959



(256,752
)INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX


-



324,053NET INCOME


134,959



67,301OTHER COMPREHENSIVE INCOMEForeign currency translation


79,802



(3,955
)COMPREHENSIVE INCOME

$
214,761


$
63,346BASIC AND DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING


9,775,791



8,940,718BASIC AND DILUTED NET INCOME PER SHARE

$
0.01


$
0.01




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




F-3




COVENANT GROUP OF CHINA INC.CONSOLIDATED STATEMENTS OF CASH FLOWFOR YEAR ENDED DECEMBER 31, 2010 AND FROM INCEPTION (JUNE 10, 2009) TO DECEMBER 31, 20092010


2009CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss) from continuing operations

$
134,959


$
(256,752
)Adjustments to reconcile net income (loss) from continuing operations to net cashprovided by (used in) operating activities of continuing operations:Depreciation and amortization


18,750



23,324Change in allowance for doubtful accounts


(54,753
)


50,378Bad debts write-off


92,331



-Forgiveness of bridge loan


(130,000
)


-Loss on disposal of fixed assets


116



-Loss on settlement of debt


23,200



-Stock compensation expense


54,583



-Deferred compensation


45,938



-Accretion of discount on loans payable


136,235



-(Increase) decrease in current assets:Accounts receivable


(236,449
)


215,593Retentions receivable


110,371



(218,872
)Other receivables


69,715



(79,713
)Restrict cash


(60,376
)


-Prepayment and deposits


67,726



139,809Inventory


56,404



31,197Increase (decrease) in current liabilities:Accounts payable


301,783



(459,927
)Unearned revenue


27,872



47,109Accrued liabilities and other payables


(165,372
)


256,200Taxes payable


165,778



(395,340
)NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES OF CONTINUNING OPERATIONS


658,811



(646,994
)NET CASH PROVIDED BY OPERATING ACTIVITIES OF DISCONTINUNED OPERATIONS


-



719,391NET CASH PROVIDED BY OPERATING ACTIVITIES


658,811



72,397CASH FLOWS FROM INVESTING ACTIVITIES:Cash acquired from acquisition


-



710,552Cash disposed with discontinued operations


-



(413,093
)Acquisition of property & equipment


(35,218
)


-NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES OF CONTINUING OPERATIONS


(35,218
)


297,459NET CASH PROVIDED BY INVESTING ACTIVITIES OF DISCONTINUED OPERATIONS


-



33,106NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES


(35,218
)


330,565CASH FLOWS FROM FINANCING ACTIVITIES:Issuance of common stock


-



799,870Proceeds from short term loans


950,000



105,563Repayment of short term loan


(37,964
)


-NET CASH  PROVIDED BY FINANCING ACTIVITIES OF CONTINUING OPERATIONS


912,036



905,433NET CASH USED IN FINANCING ACTIVITIES OF DISCONTINUED OPERATIONS


-



(339,628
)NET CASH PROVIDED BY FINANCING ACTIVITIES


912,036



565,805EFFECT OF EXCHANGE RATE CHANGE ON CASH & EQUIVALENTS


54,628



504NET INCREASE IN CASH & EQUIVALENTS


1,590,257



969,271CASH & EQUIVALENTS, BEGINNING OF PERIOD


969,271



-CASH & EQUIVALENTS, END OF PERIOD

$
2,559,528


$
969,271Supplemental disclosure of cash flow information:Cash paid for continuing operation during the period for:Interest paid

$
17,080


$
1,370Cash paid for discontinued operation during the period for:Income tax paid

$
-


$
866Supplemental disclosure of non-cash investing activities:Net assets of discontinued operations

$
2,788,053


$
-Supplemental disclosure of non-cash financing activities:Dividend declared by continuing operations

$
-


$
478,260Dividend declared (reversed) by discontinued operations

$
(240,263
)

$
242,851Cancellation of shares:Common stock


(5
)


-APIC


5



-Loan converted into shares:Loans Payable

$
(100,000
)

$
-Common Stock


1



-APIC


123,199



-Relative fair value of warrants issued with loans payable

$
146,021


$
-




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




F-4




COVENANT GROUP OF CHINA INC.CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITYFOR THE PERIOD FROM INCEPTION (JUNE 10, 2009) TO DECEMBER 31, 2010Common stockShares


Amount


Paid in capital


Statutory reserves


Other comprehensive income


Accumulated (deficit) retained earning


Treasury Stock


TotalBalance at inception (June 10, 2009)


-


$
-


$
-


$
-


$
-


$
-


$
-


$
-Issuance of funder's shares


6,230,000



62



(62
)


-



-



-



-



-Recapitalization on reverse acquisition


2,100,000



21



(21
)


-



-



-



-



-Shares issued in private placement


200,000



2



399,998



-



-



-



-



400,000Loan converted into shares


200,909



2



399,868



-



-



-



-



399,870Net income for the year


-



-



-



-



-



67,301



-



67,301Acquisition of subsidiaries at June 24, 2009


2,750,000



28



4,772,235



67,737



-



-



-



4,840,000Dividend declared






















(715,036
)


-



(715,036
)Foreign currency translation loss


-



-



-



-



(4,106
)


-



-



(4,106
)Balance at December 31, 2009


11,480,909



115



5,572,018



67,737



(4,106
)


(647,735
)


-



4,988,029Purchase of treasury stock cost


(1,400,000
)


(14
)


14



-



-



-



(2,788,053
)


(2,788,053
)Shares issued for services


33,000



0



115,833



-



-



-



-



115,833Fair value of warrants issued with loans payable


-



-



146,021



-



-



-



-



146,021Cancellation of shares


(500,000
)


(5
)


5



-



-



-



-



-Loan converted into shares amendment


70,000



1



123,199



-



-



-



-



123,200Net income for the year


-



-



-



-



-



134,959



-



134,959Transfer to statutory  reserves


-



-



-



102,994



-



(102,994
)


-



-Reverse of dividend declared by discontinued operation


-



-



-



-



-



240,263



-



240,263Foreign currency translation gain


-



-



-



-



79,802



-



-



79,802Balance at December 31, 2010


9,683,909


$
97


$
5,957,090


$
170,731


$
75,696


$
(375,507
)

$
(2,788,053
)

$
3,040,054




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




F-5
 
 
 COVENANT GROUP OF CHINA INC. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER 31, 2010 AND 2009




1. ORGANIZATION AND DESCRIPTION OF BUSINESS





Covenant Group of China Inc. (Covenant Group or the Company) (FKA: Everest Resources Corp.) was incorporated in the State of Nevada on November 8, 2006. On December 24, 2009, Covenant Group entered into and closed on a share exchange agreement with Covenant Group Holdings Inc. (Covenant Holdings), a privately held company incorporated under the laws of the State of Delaware. Pursuant to the share exchange agreement, Covenant Group acquired all of the issued and outstanding capital stock of Covenant Holdings in exchange for 9,380,909 shares of common stock.  Prior to the acquisition of Covenant Holdings, the Company was in the development stage and had minimal business operations.





Covenant Holdings was formed in the State of Delaware on June 10, 2009 to acquire equity interests in private Chinese operating companies and provide these companies with strategic support. The total number of Covenant Holdings shares authorized for issuance is 20,000,000 with 0.00001 par value. Covenant Holdings identified for acquisition certain companies that focus on IT software in government-mandated areas in China, such as security and surveillance. There was no significant activity from June 10, 2009 through December 31, 2009 except for the two acquisitions.





On June 24, 2009, Covenant Holdings entered into a stock acquisition and reorganization agreement with Hainan Jien Intelligent Engineering Co. Ltd. (Jien or Hainan Jien) and its stockholders. Pursuant to the terms of the agreement, Covenant Holdings acquired 100% of the common stock of Jien, representing 100% of its outstanding equity interests, in exchange for 1,350,000 shares of a public shell's common stock, which would acquire all of the rights and obligations of Covenant Holdings.  The acquisition stock price was initially valued at a provisional amount of $2 per share, which was the stock price for Covenant Holdings’ prior private capital raises. The Company changed its valuation stock price to $1.76 per share, which was determined by the volume weighted average stock price for the first day of trading of the Company’s common stock plus all private sales of Covenant Holdings’ common stock prior to the completion of the share exchange with the Company.  Jien was incorporated in Hainan Province, People’s Republic of China (PRC) in 1999.  Jien specializes in the design and installation of security and surveillance infrastructure to protect financial institutions and government agencies, and it also implements intelligent construction projects for commercial customers.





On June 24, 2009, Covenant Holdings entered into a stock acquisition and reorganization agreement with Chongqing Sysway Information Technology Co. Ltd. (Chongqing Sysway) and its stockholders. Pursuant to the terms of the agreement, Covenant Holdings acquired 100% of the common stock of Chongqing Sysway, representing 100% of its outstanding equity interests, in exchange for 1,400,000 shares of a public shell's common stock, which would acquire all of the rights and obligations of Covenant Holdings.  The acquisition stock price was initially valued at a provisional amount of $2 per share, which was the stock price for Covenant Holdings’ prior private capital raises. The Company changed its valuation stock price to $1.76 per share, which was determined by the volume weighted average stock price for the first day of trading of the Company’s common stock plus all private sales of Covenant Holdings’ common stock prior to the completion of the share exchange with the Company.   Chongqing Sysway was incorporated in Chongqing City, Sichuan Province, PRC, in 1999 as a State Owned Enterprise (SOE). Since 2005, Chongqing Sysway has operated as a private enterprise mainly engaged in systems integration services, including computer system installation, website design, and system firewall setup, particularly for the tobacco industry.





For accounting purposes, the effective acquisition date of Jien and Chongqing Sysway is deemed to be July 1, 2009 as the results of any activity from June 24, 2009 through June 30, 2009 were deemed to be immaterial to the financial statements taken as a whole.





On December 24, 2009, Covenant Holdings entered into a share exchange agreement with Covenant Group.  Covenant Group agreed to exchange 9,380,909 shares of its common stock, on a one-for-one basis, for each share of Covenant Holdings shares held of record on the date of the closing. Concurrent with the share exchange agreement, one of Covenant Group’s shareholders agreed to cancel 4,500,000 shares out of 6,600,000 of the total issued and outstanding shares of Covenant Group in exchange for the immediate payment of $100,000.  He further agreed to cancel an additional 500,000 shares upon Covenant Holdings’ payment of the principal due on a note issued to the shareholder in the amount of $190,000, which, together with the $100,000 payment, represented the consideration for the acquisition of the shell company.  As of December 31, 2009, $90,000 of the $190,000 note payable was paid. During the first quarter of 2010, the 500,000 shares were cancelled and the Company issued 300,000 shares to this shareholder in lieu of the payment for the note payable of $100,000. In May of 2010, the Company and this shareholder agreed to revise and reduce the 300,000 shares to 70,000 shares (Note 14).




F-6




The share exchange was accounted for as a "reverse acquisition," since the Covenant Holdings shareholders own a majority of the outstanding shares of the Company's common stock immediately following the share exchange.  Covenant Holdings was deemed to be the accounting acquiror in the reverse acquisition.  Consequently, the assets and liabilities and the historical operations that were reflected in the financial statements prior to the share exchange were those of Covenant Holdings and were recorded at the historical cost basis of Covenant Holdings.  The consolidated financial statements after completion of the share exchange would include the assets and liabilities of the Company and Covenant Holdings and the historical operations of Covenant Holdings and operations of the Company from the closing date of the share exchange.  As a result of the issuance of the shares of the Company’s common stock pursuant to the share exchange, a change in control of the Company occurred on the date of the consummation of the share exchange.





The Company's Board of Directors decided on April 30, 2010, to terminate and rescind the Acquisition Agreement with Chongqing Sysway due to several breaches of the agreement by Chongqing Sysway, including the failure of the prior owners of Chongqing Sysway to repay a dividend paid to them by Chongqing Sysway in excess of that permitted under the agreement and under China law and the failure of Chongqing Sysway and its prior owners to cooperate with the Company in the preparation of its financial statement disclosures required under United States securities laws. As a result of the termination and rescission of the agreement, the Company transferred all of the shares of capital stock of Chongqing Sysway to the prior owners of Chongqing Sysway, and the 1,400,000 shares of common stock of the Company issued in exchange for the shares of capital stock of Chongqing Sysway were returned to the Company and treated as treasury shares. The effect of this transaction was to return the Company, Chongqing Sysway, and the prior owners of the capital stock of Chongqing Sysway to their status prior to the completion of the acquisition by the Company of the capital stock of Chongqing Sysway on December 24, 2009. The termination and rescission of the acquisition agreement resulted in the activities of Chongqing Sysway being reflected on the financial statements as discontinued operations (see Note 18).





Under the stock acquisition and reorganization agreement between the Company and Hainan Jien, the Company agreed to make a capital contribution of $2,500,000 to Hainan Jien.  On August 27, 2010, the Company entered into an agreement with Hainan Jien and its former shareholders pursuant to which Hainan Jien and such shareholders agreed to arrange for the official transfer of the shares of Hainan Jien from such shareholders to the Company in the PRC.  The Company paid $150,000 to such shareholders on October 21, 2010 and invested $350,000 in Hainan Jien upon completion of the registration of Hainan Jien's shares in the name of the Company in China on November 17, 2010.  In addition, the Company has agreed to use its best efforts to invest an additional $825,000 in Hainan Jien on or before October 31, 2010 and another $1,175,000 on or before January 31, 2011.  The parties have agreed that in the event the Company fails to make such capital contributions to Hainan Jien, the former shareholders will have no right to have the shares of stock of Hainan Jien returned to them.  As of March 31, 2011, the Company has not made any further investment in Hainan Jien.





On January 12, 2010, the Company formed a wholly owned subsidiary – Pandaz LLC, a Delaware LLC (Pandaz Delaware). On January 13, 2010, Pandaz Delaware entered into an asset purchase agreement with The Pandaz LLC, a Nevada LLC, for certain assets and intellectual property associated with an automobile dealer and customer interface, vehicle search function and automobile purchasing website that the company is tentatively looking to implement in China.  The total purchase consideration was $25,000, of which, $10,000 was paid as the forgiveness of a bridge loan that the Company provided to the seller on January 7, 2010 and $15,000 was paid as a one-time cash payment.




F-7





2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Principle of Consolidation





The consolidated financial statements include the accounts of Covenant Holdings, Covenant Group, Pandaz Delaware and Jien. All intercompany transactions and account balances are eliminated in consolidation.





Use of Estimates





In preparing the financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting year. Significant estimates, required by management, include the recoverability of long-lived assets and the valuation of inventories. Actual results could differ from those estimates.





Cash and Equivalents





For purposes of the statement of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.





Accounts and Retentions Receivable





The Company’s policy is to maintain reserves for potential credit losses on accounts receivable.  Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves.  Based on historical collection activity, the Company had allowances of $9,301 and $78,356 at December 31, 2010 and 2009, respectively.





At December 31, 2010, the Company had retentions receivable for product quality assurance of $393,294. At December 31, 2009, the Company had $490,879 of retentions receivable. The retention rate is predominantly 5% of the sales price with variable terms from 1 year to 3 years, though some contracts have a 3% or a 10% retention rate. $242,298 and $344,428 of the retentions receivable at December 31, 2010 and 2009, respectively, are current and due within one year; $150,996 and $146,451 of the retentions receivable are treated as long term assets at December 31, 2010 and 2009, respectively.





Inventories





The Company’s inventory is valued at the lower of cost or market with cost determined on a first-in, first-out basis.





Property and Equipment





Property and equipment are stated at cost, net of accumulated depreciation. Expenditures for maintenance and repairs are expensed as incurred; additions, renewals and betterments are capitalized.  When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations.  Depreciation of property and equipment is provided using the straight-line method for substantially all assets with 5% salvage value and estimated lives ranging from 3 to 25 years as follows:





Building
20 - 25 yearsLeasehold improvements
Shorter of lease term or 10 yearsVehicle
5 - 10 yearsOffice Equipment
3 - 5 years





F-8





Impairment of Long-Lived Assets





Long-lived assets, which include property, plant and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.





Recoverability of long-lived assets to be held and used is measured by comparing the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable.  Based on its review, the Company believes that, as of December 31, 2010 and 2009, there were no significant impairments of its long-lived assets.





Goodwill





Goodwill represents the excess of the fair value of the consideration transferred over the net of the acquisition date amount of identifiable assets acquired and the liability assumed. In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“Statement No. 142”), codified in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, goodwill is not amortized but is tested for impairment annually, or when circumstances indicate a possible impairment may exist. Impairment testing is performed at a reporting unit level. An impairment loss generally would be recognized when the carrying amount of the reporting unit exceeds the fair value of the reporting unit, with the fair value of the reporting unit determined using a discounted cash flow (DCF) analysis. A number of significant assumptions and estimates are involved in the application of the DCF analysis to forecast operating cash flows, including the discount rate, the internal rate of return, and projections of realizations and costs to produce. Management considers historical experience and all available information at the time the fair values of its reporting units are estimated. No impairment losses have been identified for the period ended December 31, 2010 and 2009.





Warranties





The Company offers a warranty to its customers on its products for a period from three months to three years depending on the contract terms negotiated with the customers; most warranty terms are one year. The Company accrues for warranty costs based on estimates of the costs that may be incurred under its warranty obligations. The warranty expense and related accrual is included in the Company's selling expenses and other payables, respectively, and is recorded at the time revenue is recognized. Factors that affect the Company's warranty liability include the amount of sold equipment, its estimates of anticipated rates of warranty claims, costs per claim and estimated support labor costs and the associated overhead.  The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. The Company’s warranty expense was $69,703 and $35,263 for the years ended December 31, 2010 and 2009, respectively.





Income Taxes





The Company utilizes Statement of Financial Accounting Standards (SFAS) No. 109, “Accounting for Income Taxes,” codified in FASB ASC Topic 740, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns.  Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.




F-9





The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (codified in FASB ASC Topic 740) on June 10, 2009.  As a result of the implementation of FIN 48, the Company made a comprehensive review of its portfolio of tax positions in accordance with recognition standards established by FIN 48.  As a result of the implementation of Interpretation 48, the Company recognized no material adjustments to liabilities or stockholders equity.  When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained.  The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions taken are not offset or aggregated with other positions.  Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.





Interest associated with unrecognized tax benefits is classified as interest expense and penalties are classified in selling, general and administrative expenses in the statements of income. The adoption of FIN 48 did not have a material impact on the Company’s financial statements.





Jien is qualified as a small business in the construction industry in the PRC.  The Company is subject to a 1.76% and a 3% tax rate on net sales for 2010 and 2009, respectively. Since the tax is based on sales, under US GAAP, it is not an income tax.  Accordingly, $113,908 and $108,315 were recorded as general and administrative expense for 2010 and 2009, respectively.





The following table reconciles the U.S. statutory rates to the Company’s consolidated effective tax rate for 2010 and 2009, respectively:





2010


2009Federal tax provision (credit), net of state income tax

$
51,631


$
(63,835
)State income tax provision (credit)


(16,897
)


(69,003
)Foreign tax rate less than U.S. statutory rate


(92,695
)


(39,057
)Change in valuation allowance


307,559



239,795Non tax deductible expense (non taxable income) for US company


7,888



40,593Foreign income exempt from foreign income tax


(257,486
)


(108,493
)Income tax expense

$
-


$
-





Deferred tax assets (liabilities) at December 31, 2010 and 2009 consist of the following:





Deferred tax asset arising from

2010


2009U.S. net operating loss

$
501,034


$
239,795Amortization on warrant discount


46,320



-Total


547,354



239,795Less valuation allowance


(547,354
)


(239,795
)Net deferred tax asset

$
-


$
-





The valuation allowance for deferred tax assets as of December 31, 2010 and 2009 was $547,354 and $239,795. The change in the total valuation allowance for the years ended December 31, 2010 and 2009 was an increase of $307,559 and $239,795. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the net operating losses and temporary differences become deductible. Management considered projected future taxable income and tax planning strategies in making this assessment. The value of the deferred tax assets was offset by a valuation allowance, due to the current uncertainty of the future realization of the deferred tax assets.




F-10





As of December 31, 2010 and 2009, the Company has approximately $1,327,000 and $ 591,000 of both federal tax and state tax net operating loss carryforwards, which may be available to reduce future years’ taxable income as NOLs can be carried forward up to 20 years from the year the loss is incurred.




Income tax returns filed for 2009 and thereafter are subject to examination by the relevant tax authorities.




Revenue Recognition





The Company's revenue recognition policies are in compliance with Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 104 (codified in FASB ASC Topic 605).  Revenue is recognized when services have been rendered or product delivery has occurred, a formal arrangement exists, the price is fixed or determinable, no other significant obligations of the Company exist and collectability is reasonably assured.  Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as unearned revenue.




The Company derives the majority of its revenue from the supply and installation of surveillance and security equipment and systems under fixed price contracts. The Company recognizes revenue based on the percentage of completion method as work on the contract progresses, in accordance with Statement of Position (SOP) 81-1 (codified in FASB ASC Topic 605-35).  The Company measures progress on a contract using the input method based on the ratio of costs incurred to total estimated costs. The revenue recognized is the percentage of total estimated income that incurred costs to date bear to estimated total costs.




Most of the major contracts are bundled with a post-installation service for duration of 1 to 3 years depending on customers’ requests. There is no general right of return. During this period, customers are entitled to exchange defective parts for a new part, but are not entitled to a refund.




The Company subcontracts most of its major projects to third party subcontractors who supply both the equipment and parts and provide installation service. The Company is the primary obligator in the arrangement, takes title to the equipment and has the general inventory risk; thus the Company is considered the principal and the revenue is recorded gross in accordance with FASB ASC 605-45.  The Company provides its customers with warranties for both the products and the services; however, this warranty obligation is mitigated by warranties to the Company from the product manufacturers and warranties to the Company from the third party service providers.  Thus the Company has no substantial performance obligation once the installation is completed and accepted by the customers.  Accordingly, the earnings process is considered completed upon completion of the project.  In cases where the subcontractors provide a shorter warranty period than that requested by the customers, the Company will service the customers itself, as the Company has a core team of engineers and technicians to handle this part of the service.  In such cases, the warranty service is inconsequential to the contract as a whole and the estimated potential warranty cost is accrued.




Sales revenue represents the invoiced value of goods and services, net of value-added tax (VAT).  Jien became a general tax payer on February 1, 2010, and as of this date, all of the Company’s products sold in the PRC are subject to a fixed VAT rate of 17% of the gross sales price, which can be offset by VAT incurred by the Company on its purchases. Prior to February 2010, the Company was a small business and subject to a fixed VAT rate of 3% in 2009, which cannot be offset by VAT incurred on purchases. Only sales of goods are subject to VAT.  Revenue from installation contracts is subject to a 3% business tax, which is reflected in the cost of goods sold.





Cost of Revenue





Cost of goods sold consists primarily of material costs, labor costs, and related overhead, which are directly attributable to the production of the service. Write-down of inventory to lower of cost or market is also recorded in cost of goods sold.





F-11




Basic and Diluted Earnings (Loss) per Share (EPS)





Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS is similarly computed, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Diluted net earnings per share are based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to have been exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. At December 31, 2010, the Company has outstanding warrants with an anti-dilutive feature; therefore, the basic and diluted EPS are the same.





Concentration of Credit Risk





Financial instruments that potentially subject the Company to credit risk consist primarily of accounts receivable and other receivables. The Company does not require collateral or other security to support these receivables. The Company conducts periodic reviews of its clients' financial condition and customer payment practices to minimize collection risk on accounts receivable.





The operations of the Company are located in the PRC.  Accordingly, the political, economic, and legal environments in the PRC as well as the general state of the PRC economy may influence the Company’s business, financial condition and results of operations.




Statement of Cash Flows





In accordance with SFAS No. 95, “Statement of Cash Flows,” codified in FASB ASC Topic 230, cash flows from the Company's operations are calculated based upon local currencies.  As a result, amounts related to assets and liabilities reported on the statement of cash flows may not necessarily agree with changes in the corresponding balances on the balance sheet.





Fair Value of Financial Instruments





For certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, other receivables, accounts payable, accrued liabilities and short-term debt, the carrying amounts approximate their fair values due to their short maturities.





ASC Topic 820, “Fair Value Measurements and Disclosures,” requires disclosure of the fair value of financial instruments held by the Company. ASC Topic 825, “Financial Instruments,” defines fair value, and establishes a three-level valuation hierarchy for disclosures of fair value measurement that enhances disclosure requirements for fair value measures.  The carrying amounts reported in the consolidated balance sheets for receivables and current liabilities each qualify as financial instruments and are a reasonable estimate of 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. The three levels of valuation hierarchy are defined as follows:





●
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.●
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.●
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.





F-12




The Company analyzes all financial instruments with features of both liabilities and equity under ASC 480, “Distinguishing Liabilities from Equity,” and ASC 815.





As of December 31, 2010 and 2009, the Company did not have any financial instruments that are required to be presented on the balance sheet at fair value.





Foreign Currency Translation and Transactions





The accompanying consolidated financial statements are presented in United States Dollars (“USD”). The Company’s functional currency is the USD, while the Company’s wholly-owned Chinese subsidiaries’ functional currency is the Renminbi (“RMB”). The functional currencies of the Company’s foreign operations are translated into USD for balance sheet accounts using the current exchange rates in effect as of the balance sheet date and for revenue and expense accounts using the weighted-average exchange rate during the fiscal year. The translation adjustments are recorded as a separate component of stockholders’ equity, captioned accumulated other comprehensive income (loss). Gains and losses resulting from transactions denominated in foreign currencies are included in other income (expense) in the consolidated statements of operations. There have been no significant fluctuations in the exchange rate for the conversion of RMB to USD after the balance sheet date.





Comprehensive Income (Loss)





The Company uses SFAS 130 “Reporting Comprehensive Income” (codified in FASB ASC Topic 220). Comprehensive income is comprised of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. Comprehensive income for 2010 and 2009 included net income and foreign currency translation adjustments.





Stock-Based Compensation





The Company accounts for its stock-based compensation in accordance with SFAS No. 123R, “Share-Based Payment, an Amendment of FASB Statement No. 123,” codified in FASB ASC Topic 718 and 505. The Company recognizes in the statement of operations the grant-date fair value of stock options and other equity-based compensation issued to employees and non-employees.





Segment Reporting





SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," codified in FASB ASC Topic 280, requires use of the “management approach” model for segment reporting.  The management approach model is based on the way a company's management organizes segments within the company for making operating decisions and assessing performance.  Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.





SFAS 131 has no effect on the Company's financial statements as substantially all of the Company's operations are conducted in one industry segment.  The Company consists of one reportable business segment.  Most of the Company's assets are located in the PRC and its principal market is in the PRC, except US banks accounts for Covenant Holdings, Covenant Group of China, and Pandaz Delaware, and $25,000 of intangible assets that belong to Pandaz Delaware.





New Accounting Pronouncements





F-13




Recently Issued Accounting Pronouncements Not Yet Adopted





In April 2010 the FASB issued Accounting Standards Update (ASU) No. 2010-13, Compensation – Stock Compensation (Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades. This Update provides amendments to Accounting Standards Codification (ASC) Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency  of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The amendments in this Update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. The cumulative-effect adjustment should be calculated for all awards outstanding as of the beginning of the fiscal year in which the amendments are initially applied, as if the amendments had been applied consistently since the inception of the award. The cumulative-effect adjustment should be presented separately. Earlier application is permitted. This standard will be adopted effective January 1, 2011.




In December 2010, FASB issued ASU No. 2010-28, Intangibles – Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.The amendments in this Update affect all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing Step 1 of the goodwill impairment test is zero or negative. The amendments in this Update modify Step 1 so that for those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. Upon adoption of the amendments, any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of an adoption. Any goodwill impairments occurring after the initial adoption of the amendments should be included in earnings. This standard will be adopted effective January 1, 2011.




In December 2010, FASB issued ASU No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this Update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company intends to adopt the disclosure requirements for any business combinations in 2011.




As of December 31, 2010, there are no other recently issued accounting standards not yet adopted which would have a material effect on the Company’s financial statements.




Recently Adopted Accounting Pronouncements




In January 2010, FASB issued ASU No. 2010-05, Compensation – Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. This update codifies Emerging Issues Task Force D-110. This standard is not currently applicable to the Company.




In January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This update provides amendments to ASC Topic 820 that will provide more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. This standard is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.




F-14




In January 2010, FASB issued ASU N0. 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash. The update clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected prospectively in earnings per share and is not considered a stock dividend for purposes of ASC Topic 505 and Topic 260, Earnings Per Share. This standard is effective for interim and annual periods ending on or after December 15, 2009, and should be applied on a retrospective basis. The adoption of this standard did not have a material impact to the Company’s financial position or results of operations.





3. INVENTORY





Inventory consisted of the following at December 31, 2010 and 2009:





2010


2009Raw Material

$
16,176


$
20,056Work in Process


32,315



82,894Total

$
48,491


$
102,950





4. ACQUISITION AND GOODWILL





On June 24, 2009, Covenant Holdings entered into stock acquisition and reorganization agreements with Jien and Chongqing Sysway (note 1).  For convenience of reporting the acquisition for accounting purposes, July 1, 2009 has been designated as the acquisition date.





The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition.


Jien


Chongqing Sysway


TotalCash

$
710,552


$
44,098


$
754,650Accounts receivable


2,420,881



1,380,413



3,801,294Retention receivable


271,770



1,084,047



1,355,817Prepaid expenses


238,275



-



238,275Advance to suppliers


-



1,661



1,661Other receivables


154,237



132,186



286,423Inventory


134,087



83,858



217,945Property and equipment


45,102



37,265



82,367Intangible assets-core software


-



152,256



152,256Goodwill


572,020



902,303



1,474,323Accounts payable


(1,442,990
)


(991,463
)


(2,434,453
)Other current liabilities


(182,370
)


(25,499
)


(207,869
)Unearned revenue


(108,245
)


-



(108,245
)Tax payable


(405,263
)


(337,125
)


(742,388
)Short term loan


(32,056
)


-



(32,056
)Purchase price

$
2,376,000


$
2,464,000


$
4,840,000








The fair value of the consideration transferred was initially valued at a provisional amount of $2 per share, which was the stock price for Covenant Holdings’ prior private capital raises. The Company subsequently changed its valuation stock price to $1.76 per share, which was determined by the volume weighted average stock price for the first day of trading of the Company’s common stock plus all private sales of Covenant Holdings’ common stock prior to the completion of the reverse merger with the Company. The excess of the fair value of the consideration transferred over the net of the acquisition date amounts of identifiable assets acquired and liabilities assumed was allocated to goodwill.





F-15




The Company's Board of Directors decided on April 30, 2010 to terminate and rescind the Acquisition Agreement with Chongqing Sysway due to several breaches of the agreement by Chongqing Sysway, including the failure of the prior owners of Chongqing Sysway to repay a dividend paid to them by Chongqing Sysway in excess of that permitted under the agreement and under China law and the failure of Chongqing Sysway and its prior owners to cooperate with the Company in the preparation of its financial statement disclosures required under United States securities laws.





The following pro forma consolidated results of operations of the Company for the year ended December 31, 2009 presents the consolidated operations of the Company as if the acquisition of Jien occurred on January 1, 2009.





2009Net revenue

$
6,758,243Cost of revenue


(5,239,587
)Gross profit


1,518,656Total operating expenses


(992,829
)Income from operations


525,827Non-operating expenses


(291,422
)Income tax


-Net income

$
234,405





As a result of subsequent negotiations with the original shareholders of Hainan Jien following the initial stock acquisition and reorganization agreement, Covenant Holdings and the original shareholders entered into an agreement on share transfer and increase of registered capital.  The share transfer agreement reflects a $150,000 cash payment to the original shareholders as additional consideration for their ownership interest in Hainan Jien, which, combined with their 1,350,000 shares of the Company’s common stock received under the acquisition agreement, represents the full consideration paid to the original shareholders for the equity of Hainan Jien, permitting the registration of Hainan Jien’s equity in Covenant Holdings’ name in China.





The 150,000 cash payment to the former Hainan Jien shareholders was made on October 21, 2010, and was recorded as acquisition related cost, and the registration of the transfer of the shares of Hainan Jien in the Company’s name was approved by the Chinese government and completed on November 4, 2010. Following Hainan Jien’s approval to obtain a foreign exchange account as a Wholly-Owned Foreign Entity with the State Administration of Foreign Exchange of the Chinese Central Government on November 17, 2010, the Company invested $350,000 as a capital contribution to Hainan Jien pursuant to the share transfer agreement.





5. PROPERTY AND EQUIPMENT, NET





Property and equipment consisted of the following at December 31, 2010 and 2009:





2010


2009Vehicle

$
7,947


$
-Office equipment


33,529



32,876Leasehold Improvement


12,631



12,251Subtotal


54,107



45,127Less: Accumulated depreciation


(34,088
)


(23,333
)$
20,019


$
21,794





Depreciation expense for 2010 and 2009 was $12,500 and $23,333, respectively.




F-16




6. OTHER RECEIVABLES





Other receivables consisted of the following at December 31, 2010 and 2009:





2010


2009Short term advance to third parties

$
88,981


$
180,043Advance to staff


7,695



42,307Advance to subcontractors


71,883



-Deposit


1,510



11,716$
170,069


$
234,066





7. INTANGIBLE ASSETS





Intangible assets of $25,000 at December 31, 2010 mainly consisted of website operating software with vehicle search function, manufacture’s code and dealer interface capabilities for the amount of $15,000 and intellectual property for technical information for the amount of $10,000, which were purchased by Pandaz Delaware during the first quarter of 2010. The amortization for the intangible assets for 2010 was $6,250.





8. TAX PAYABLE





Tax payable consisted of the following at December 31, 2010 and 2009:





2010


2009Business tax payable

$
119,499


$
12,244Other taxes payable


60,244



(2,264
)$
179,743


$
9,980





9. ACCRUED LIABILITIES AND OTHER PAYABLES





Accrued liabilities and other payables consisted of the following at December 31, 2010 and 2009:





2010


2009Warranty provision

$
58,644


$
48,475Short term advance from third parties


224,708



390,299$
283,352


$
438,774





10. COMMON STOCK





Effective November 10, 2009, the Company and the lender of three bridge loans agreed to cancel the promissory note of $399,870. In lieu of principal and interest payments due to the lender, the Company issued 200,909 shares of the Company’s common stock to the lender.





Pursuant to the confidential private placement memorandum dated November 24, 2009, the Company offered to sell up to 750,000 shares at $2.00 per share, with a minimum purchase of 10,000 Shares ($20,000) per investor and a minimum total quantity of 150,000 Shares ($300,000) that must be subscribed for by all investors to affect a closing and avoid termination of the offering. At December 16, 2009, the Company sold 200,000 shares through the private placement, which were converted into publicly-traded securities upon the Company’s merger with a public shell company on December 24, 2009.




F-17





During the first quarter of 2010, one shareholder cancelled 500,000 shares of the Company’s stock that was originally held as collateral for a note arising from the share exchange transaction on December 24, 2009 with an outstanding balance of $100,000. The Company issued 300,000 shares to this shareholder in lieu of the payment for the note payable of $100,000.  On May 13, 2010, the Company and this shareholder entered into a Second Amendment to the Share Cancellation and Loan Agreement, whereby the shareholder agreed to reduce the 300,000 shares to 70,000 shares as settlement of the debt (Note 14).





On April 8, 2010, the Company’s board of directors approved the issuance of 8,000 shares of the Company’s common stock to two individuals as partial consideration for web design services rendered. The Company recorded $21,200, fair value of stock-based compensation for the shares issued.





On June 15, 2010, the Company’s board of directors approved the issuance of 25,000 shares of the Company’s common stock to a company as consideration for providing services in connection with the Company’s offering of convertible preferred shares. This company commenced its work on the offering on April 1, 2010 and the offering is to remain open for one year from that date.  The Company recorded $61,250, fair value of the stock issued, as deferred compensation. During the year ended December 31, 2010, the Company amortized $45,938 as stock-based compensation.





On November 15, 2010, the Company granted one officer and three advisory board members 50,000 shares of restricted common stock each. 20% of the shares shall vest as of the first anniversary of the date of grant; 25% of the shares shall vest as of the second anniversary of the date of grant; and 55% of the shares shall vest as of the third anniversary of the date of grant. The stock price was $2.55 at the grant date. The fair value of the stock was $510,000, which will be expensed over the vesting term using the graded vesting attribution method. As of December 31, 2010, $33,383 was recorded as stock compensation expense.





11. DIVIDEND PAYABLE





The Company declared a 30% dividend of Jien’s 2008 net income to Jien’s original shareholders and management as part of the acquisition agreement dated June 24, 2009. The dividend declared for Jien was $200,608, and has been recorded as a dividend payable at December 31, 2009. As part of the acquisition agreement, the Company also agreed to pay the original shareholders and management of Jien a 30% dividend on 2009 year end profits. The dividend was declared and was recorded as a dividend payable for Jien in the amount of $277,653, which was the retained earnings that were available for declaring a dividend at December 31, 2009.





At December 31, 2010, the dividend payable was approximately $493,101.





12. MAJOR CUSTOMERS AND SUPPLIERS





Five customers accounted for 63% of the total sales for 2010, with each accounting for 16%, 14%, 13%, 10% and 10% of total sales, respectively. The names of these customers, in order of percentage of 2010 sales, are as follows:  Hainan Modern Trade Co., Ltd.; Haikou Central Government Service Hall; Haikou Central Government Governor’s Office; Hainan Jingrui Real Estate Co., Ltd.; and Hainan South Sea Information Technology Company.  At December 31, 2010, the total receivable balance due from these customers was $2,178,706.





One supplier accounted for 63% of the total purchases for 2010. At December 31, 2010, the total payable due to this vendor was $1,271,385. The name of this supplier is Hainan Shengyi Systems Engineering Co., Ltd.  This concentration makes the Company vulnerable to a near term adverse impact should the relationship be terminated.





Three customers accounted for 35% of the total sales for the period since business inception through December 31, 2009, each customer accounted for 13%, 11%, and 11%, respectively. The names of these customers, in order of percentage of 2009 sales, are as follows:  Hainan Medical College; Hainan South Sea Technology Co., Ltd.; and Hainan Land and Resources Bureau.  At December 31, 2009, the total receivable balance due from these customers was $ 374,079.




F-18




One supplier accounted for 23% of the total purchases for the period since business inception through December 31, 2009.  The name of this supplier is Hainan Shenyi System Project Ltd., Co.  At December 31, 2009, the total payable due to this vendor was $ 371,416.




13. SHORT TERM LOANS




During the year ended December 31, 2009, the Company borrowed $37,600 (RMB 257,000) from Shenzhen Development Bank. The loan bore interest at 5.832% per year and was due in February 2010. The loan was paid in full upon maturity.




During the three months ended March 31, 2010, the Company borrowed $263,294 (RMB 1,788,000) from Shenzhen Development Bank. The loan bore interest at 5.59% per year and was due on July 26, 2010. This loan is collateralized by $396,024 (RMB 2,689,360) of accounts receivable. This loan was paid in full upon maturity.





During the three months ended September 30, 2010, the Company borrowed $135,799 (RMB 910,000), $241,602 (RMB 1,619,000) and $273,985 (RMB 1,836,000) from Shenzhen Development Bank. The loans bore interest at 5.589% per year and were due on November 27, December 26 and December 6, 2010, respectively. These loans were collateralized by $838,998 (RMB 5,622,211) of accounts receivable. This loan was paid in full upon maturity.





14. NOTE PAYABLE





At December 31, 2009, note payable represented the $100,000 remaining balance from a $190,000 promissory note issued to a former majority shareholder of Covenant Group plus cash consideration for the acquisition of the shell company. This note was settled on March 25, 2010 by issuing the shareholder 300,000 common shares of the Company with a fair value of $528,000, resulting in a loss on settlement of $428,000.  On May 13, 2010, the Company and this shareholder entered into a Second Amendment to the Share Cancellation and Loan Agreement, whereby the shareholder agreed to reduce the 300,000 shares to 70,000 shares as settlement of the debt.  As a result, the loss on settlement became $23,200.





15. LOANS PAYABLE WITH WARRANTS ISSUED





On April 22, 2010, the Company entered into a bridge loan agreement to obtain $120,000 in short-term financing from a private investor. In addition, 200,000 restricted common stock shares were issued to this investor in connection with this financing.  On June 30, 2010, the Company entered into an amendment to this loan agreement, whereby both parties agreed to cancel the 200,000 restricted common stock shares and the Company issued a warrant to purchase up to 14,400 shares of restricted common stock at a $3 strike price, exercisable within 2 years from April 22, 2010. The warrants are immediately exercisable; the fair value of the warrants was determined by using the Black-Scholes pricing model with the following assumptions:  discount rate– 2.76%; dividend yield– 0%; expected volatility– 88% and term of 2 years.  The fair value of the warrants was $20,773. The entire principal balance was payable in full three months from April 22, 2010. On August 13, 2010, the parties entered into a second amendment to this agreement to extend the term of the loan, whereby the entire principal balance will be payable in full three months from August 13, 2010. The loan was extended to February 28, 2011. On March 11, 2011, the Company entered into an amendment to extend the maturity to June 11, 2011.





On June 10, 2010, the Company entered into a bridge loan agreement to obtain $130,000 in short-term financing from a private investor. In addition, the Company issued a warrant to purchase up to 15,600 shares of restricted common stock at a $3 strike price, exercisable within 2 years from June 10, 2010. The entire principal balance will be payable in full three months from June 10, 2010. The loan was extended to February 28, 2011. On December 23, 2010, the Company entered an amended note with the lender. The lender forgave the $130,000 loan but still retained full right and title in and to the warrants as consideration to the loan.





The warrants are immediately exercisable and expire on the second anniversary of their issuance. The value of warrants was determined by using the Black-Scholes pricing model with the following assumptions: discount rate– 2.76%; dividend yield– 0%; expected volatility– 88% and term of 2 years.  The fair value of the warrants was $40,972.




F-19




On July 1, 2010, the Company entered into a bridge loan agreement with an investor for an amount up to $1,000,000.  Under the agreement, the Company can withdraw from this loan with mutual agreement of Covenant and the investor.  On July 2 and September 8, 2010, the Company withdrew $500,000 and $150,000 from this loan, respectively. Upon draw down of $650,000, the investor was granted 97,500 warrants. As consideration for the loan, the investor is entitled to warrants to purchase up to 150,000 shares of the Company’s common stock at a $3.00 strike price, with a two-year term from date of grant. The investor is granted the warrants pro-rata with the amount drawn down from the loan. The principal balance will be payable in full five months from each borrowing date. To date, the Company has not repaid any amounts due under this bridge loan agreement and is in default as to its obligation to repay $500,000 and $150,000 to the investor by December 2, 2010 and February 8, 2011, respectively.  As a result, the Company is in active negotiations with the investor to extend the repayment terms of the $650,000 due and owing under the bridge loan agreement and the related promissory note.





The 97,500 warrants are immediately exercisable and expire on the second anniversary of their issuance. The value of warrants was determined by using the Black-Scholes pricing model with the following assumptions:  discount rate– 2.76%; dividend yield– 0%; expected volatility– 88% and term of 2 years.  The fair value of the warrants was $194,226.





On November 24, 2010, the Company entered into a bridge loan agreement to obtain $50,000 in short-term financing from a private investor.   In addition, the Company issued a warrant to purchase up to 6,000 shares of restricted common stock at a $2.50 strike price, exercisable within 2 years from November 24, 2010.  The entire principal balance will be payable in full four months from November 24, 2010. On March 11, 2011, a second amendment was entered into to extend the maturity date to June 11, 2011.





The 6,000 warrants are immediately exercisable and expire on the second anniversary of their issuance. The value of warrants was determined by using the Black-Scholes pricing model with the following assumptions:  discount rate– 2.76%; dividend yield– 0%; expected volatility– 64% and term of 2 years.  The fair value of the warrants was $5,700.





Volatility in all instances presented is the Company’s estimate of volatility that is based on the volatility of other public companies that are in closely related industries to the Company.





The fair value of the warrants was allocated to the total proceeds from the loans, based on the relative fair value of the warrants and debts, as an unamortized discount totaling $146,021, to be amortized over the term of the loans.  The warrants were classified as equity. The amortized discount expense for 2010 was $136,235. At December 31, 2010, loans payable net of unamortized discount on warrants was $810,214.





The following table summarizes the loan payable transactions for the period January 1, 2010 through December 31, 2010:




Proceeds from loans:

$
950,000Forgiveness of bridge loan:


(130,000)Discount due to warrants issued with loans:


(146,021)Amortization of discount:


136,235Balance at December 31, 2010:

$
810,214




F-20




Following is a summary of the warrant activity:




Option/Warrant

Shares


Exercise

Price


Weighted

Average Exercise PriceO Outstanding, June 10, 2009 (Date of Inception)


—


$
—


$
—Granted


—



—



—Exercised


—



—



—Forfeited


—



—



—Outstanding at December 31, 2009


—



—



—Exercisable at December 31, 2009


—



—



—Granted


133,500


$
2.50 - $3.00


$
2.98Exercised


—



—



—Forfeited


—



—



—Outstanding at December 31, 2010


133,500


$
2.50 - $3.00


$
2.98Exercisable at December 31, 2010


133,500


$
2.50 - $3.00


$
2.98Weighted Average Remaining Life,

Exercisable, December 31, 2010 (year)


1.49





16. STATUTORY RESERVES





Pursuant to the corporate law of the PRC effective January 1, 2006, PRC subsidiaries of the Company are required to maintain a statutory reserve by appropriating from its after-tax profit before declaration or payment of dividends. The statutory reserve represents restricted retained earnings, in which dividends cannot be distributed.





Surplus reserve fund





The PRC subsidiaries of the Company are required to transfer 10% of their net income, as determined under PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital.  The Company had $170,731 in this reserve at December 31, 2010.





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.





Common welfare fund





Common welfare fund is a voluntary fund to which the Company can elect to transfer 5% to 10% of its net income.  The Company did not make any contribution to this fund for 2010 and 2009.





This fund can only be utilized on capital items for the collective benefit of the Company’s employees, such as construction of dormitories, cafeteria facilities, and other staff welfare facilities. This fund is non-distributable other than upon liquidation.





Pursuant to the "Circular of the Ministry of Finance (MOF) on the Issue of Corporate Financial Management after the Corporate Law Enforced" (No.67 [2006]), effective on April 1, 2006, issued by the MOF, companies transferred the balance of SCWF (Statutory Common Welfare Fund) as of December 31, 2005 to Statutory Surplus Reserve. Any deficit in the SCWF was charged in turn to Statutory Surplus Reserve, additional paid-in capital and undistributed profit of previous years. If a deficit still remains, it should be transferred to retained earnings and be reduced to zero by a transfer from after tax profit of following years. At December 31, 2005, the Company did not have a deficit in the SCWF.





F-21




17. COMMITMENTS





Jien leased its office under a long term, non-cancelable, and renewable operating lease agreement on November 8, 2007, with an expiration date of November 7, 2009.  Upon expiration, the Company renewed the lease for a period from November 8, 2009 to November 7, 2012, with monthly rent of approximately $3,600 (RMB 24,509). Annual rental expense is approximately $43,200 for the year ending December 31, 2011, and approximately $36,000 for the year ending December 31, 2012. For 2010, the rental expense was $43,400. For the period since business inception through December 31, 2009, the rental expense was $21,527.





18. DISPOSAL OF SUBSIDIARY





The Company records discontinued operations if both of the following conditions are met: (a) the operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the Company as a result of the disposal transaction and (b) the Company will not have any significant continuing involvement in the operations of the component after the disposal transaction. During a period in which a component of the Company either has been disposed of or is classified as held for sale, the income statement of the Company for current and prior periods shall report the results of operations of the component, including any gain or loss recognized in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” (codified in FASB ASC Topic 360) in discontinued operations. The results of operations of a component classified as held for sale shall be reported in discontinued operations in the period(s) in which they occur. The results of discontinued operations, less applicable income taxes (benefit), shall be reported as a separate component of income before extraordinary items and the cumulative effect of accounting changes (if applicable).





The Company's Board of Directors decided on April 30, 2010 to terminate and rescind the Acquisition Agreement with Chongqing Sysway due to several breaches of the agreement by Chongqing Sysway, including the failure of the prior owners of Chongqing Sysway to repay a dividend paid to them by Chongqing Sysway in excess of that permitted under the agreement and under China law and the failure of Chongqing Sysway and its prior owners to cooperate with the Company in the preparation of the financial statement disclosures required under United States securities laws.




As a result of the termination and rescission of the agreement, the Company transferred all of the shares of capital stock of Chongqing Sysway to the prior owners of Chongqing Sysway, and the 1,400,000 shares of common stock of the Company issued in exchange for the shares of capital stock of Chongqing Sysway were returned to the Company and treated as treasury shares. This transaction returned the Company, Chongqing Sysway, and the prior owners of the capital stock of Chongqing Sysway to their status prior to the completion of the acquisition by the Company of the capital stock of Chongqing Sysway on December 24, 2009. For convenience of reporting for accounting purposes, January 1, 2010 has been designated as the date of rescission.




The assets and liabilities of Chongqing Sysway have been reclassified at December 31, 2009 as assets of discontinued operations and liabilities of discontinued operations.





Identifiable net assets of Chongqing Sysway as of December 31, 2009 were as follows:





Cash & cash equivalents

$
413,093Accounts receivable, net


1,456,008Other current assets


1,159,231Goodwill


902,303Other noncurrent assets


232,091Total assets

$
4,162,726Accounts payable

$
829,444Tax payable


536,633Dividend payable


242,851Other current liabilities


7,658Total liabilities

$
1,616,586





F-22




19. CONTINGENCIES





The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal 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’s sales, purchases and expenses transactions are denominated in RMB, and all of the Company’s assets and liabilities are also denominated in RMB. The RMB is not freely convertible into foreign currencies under the current law. In China, foreign exchange transactions are required by law to be transacted only by authorized financial institutions. Remittances in currencies other than RMB may require certain supporting documentation in order to effect the remittance.





20. EQUITY CREDIT AGREEMENT





On January 31, 2010, the Company entered into an equity credit agreement with an institutional investor providing the Company with the right, but not the obligation, to issue shares of its common stock at any time and from time to time during the next two years for gross proceeds of up to $20,000,000. The Company may require the investor to purchase shares of its common stock from time to time under the equity credit agreement by delivering a put notice specifying the total purchase price for the shares to be purchased. The investment amount may not be greater than the lesser of (a) $1,000,000 or (b) 300% of the average dollar volume (closing bid price times the volume on the OTC Bulletin Board for a trading day) for the 20 trading days preceding the put notice. The purchase price per share for the shares to be purchased for the investment amount will be 94% of the lowest closing bid price on the OTC Bulletin Board during the five trading days following the put notice.





The Company also agreed to issue to the investor warrants to purchase an additional 300,000 shares of its common stock during a five year period at an exercise price of $2.00 per share. The warrant will be issued to the investor upon the effectiveness of a registration statement on Form S-1 to be filed with the Securities and Exchange Commission (SEC).  The warrant will be exercisable in whole or in part upon issuance and will remain exercisable for a five-year period.





The Company also entered into a registration rights agreement as part of the transaction. The registration rights agreement requires the Company to prepare promptly, and file with the SEC within 60 days, the registration statement for the resale of the shares of common stock issuable upon exercise of the warrant.





As of December 31, 2010, the Company has not delivered any put notices to the investor.





21. SUBSEQUENT EVENT





On February 23, 2011, the Company entered into a bridge loan agreement with an investor for an amount up to $150,000.  Under the agreement, the Company can draw down from this loan upon the mutual agreement of Covenant and the investor.  On February 23, 2011, March 1, 2011, April 13, 2011 and April 15, 2011, the Company drew down $30,000, $20,000, $10,000 and $45,429 from this loan, respectively. As consideration for the loan, the investor is entitled to warrants to purchase up to 18,000 shares of the Company’s common stock at a $2.00 strike price, with a two-year term from date of grant. The principal balance will be payable in full eight months from the first borrowing date.





F-23





SIGNATURES





Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 15th day of April, 2011.





Covenant Group of China Inc.By:
/s/ Kenneth WongName: Kenneth WongTitle: PresidentBy:
/s/ Justin D. CsikName: Justin D. CsikTitle: Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)





Power of Attorney





Pursuant to the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.





Each of the undersigned hereby appoints Kenneth Wong and Justin D. Csik his true and lawful attorney-in-fact and agent, for him and in his name and place, to sign the name of the undersigned in the capacity or capacities indicated below to the Annual Report of Covenant Group of China Inc. on Form 10-K for the year ended December 31, 2010 and any and all amendments to such Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith, with all necessary or appropriate governmental or other entities, including, but not limited to, the Securities and Exchange Commission, granting to such attorney-in-fact and agent full power and authority to perform each act necessary to be done as fully to all intents and purposes as he might do in person, hereby ratifying and confirming all that such attorney-in-fact and agent may lawfully do or cause to be done by virtue hereof.





Signature

Title

Date/s/ Fredric Rittereiser

Chairman of the Board of Directors

April 15, 2011Fredric Rittereiser/s/ Kenneth Wong

President and Director

April 15, 2011Kenneth Wong/s/ K. Ivan F. Gothner

Director

April 15, 2011K. Ivan F. Gothner





63





INDEX TO EXHIBITS





The following is a complete list of Exhibits filed as part of this Annual Report:





Exhibit Number

Description2.1

Share Exchange Agreement by and among Covenant Group Holdings Inc., Covenant Group of China Inc. (formerly Everest Resources Corp.), and the Shareholders of Covenant Group Holdings Inc., dated as of December 24, 2009. (Incorporated herein by reference to Exhibit 2.1 to the Current Report on Form 8-K of the Registrant filed on December 31, 2009)3.1

Articles of Incorporation of Covenant Group of China Inc. (formerly Everest Resources Corp.) (Incorporated herein by reference to Exhibit 3.1 to the Registration Statement on Form SB-2 of the Registrant filed on August 30, 2007)3.2

Certificate of Amendment to the Articles of Incorporation of Covenant Group of China Inc. (formerly Everest Resources Corp.) (Incorporated herein by reference to Exhibit 3(i).1 to the Current Report on Form 8-K of the Registrant filed on December 31, 2009)3.3

Bylaws of Covenant Group of China Inc. (formerly Everest Resources Corp.) (Incorporated herein by reference to Exhibit 3.1 to the Registration Statement on Form SB-2 of the Registrant filed on August 30, 2007)3.4

Amendment to Bylaws of Covenant Group of China Inc. (formerly Everest Resources Corp.) (Incorporated herein by reference to Exhibit 3(ii).2 to the Current Report on Form 8-K of the Registrant filed on December 31, 2009)4.1

Specimen Stock Certificate of Covenant Group of China Inc. (formerly Everest Resources Corp.) (Incorporated herein by reference to Exhibit 4.1 to the Current Report on Form 8-K of the Registrant filed on December 31, 2009)4.2

Form of Common Stock Purchase Warrant (Incorporated herein by reference to Exhibit 10.9 to the Current Report on Form 8-K of the Registrant filed on February 4, 2010)4.3

Warrant to Sui Generis Capital Partners LLC, dated June 30, 2010 (Incorporated herein by reference to Exhibit 4.1 to the Quarterly Report on Form 10-Q of the Registrant filed on August 16, 2010)4.4

Warrant to Walston Dupont Global Advisors LLC, dated June 10, 2010 (Incorporated herein by reference to Exhibit 4.2 to the Quarterly Report on Form 10-Q of the Registrant filed on August 16, 2010)4.5

Warrant to JD Holdings 1, Inc., dated July 2, 2010 (Incorporated herein by reference to Exhibit 4.3 to the Quarterly Report on Form 10-Q of the Registrant filed on August 16, 2010)4.6

Warrant to JD Holdings 1, Inc. dated September 8, 2010 (Incorporated herein by reference to Exhibit 4.6 to the Registration Statement on Form S-1 of the Registrant filed on September 23, 2010)4.7

Warrant to Sui Generis Capital Partners LLC, dated November 24, 20104.8

Warrant to Walston Dupont Global Advisors LLC, dated February 23, 201110.1

Registration Rights Agreement dated January 31, 2010 between Covenant Group of China Inc. and Southridge Partners II, LP (Incorporated herein by reference to Exhibit 10.8 to the Current Report on Form 8-K of the Registrant filed on February 4, 2010)10.2

Equity Credit Agreement dated January 31, 2010 between Covenant Group of China Inc. and Southridge Partners II, LP (Incorporated herein by reference to Exhibit 10.7 to the Current Report on Form 8-K of the Registrant filed on February 4, 2010)10.4

Second Amendment to Share Cancellation and Loan Agreement among Covenant Group of China Inc., Covenant Group Holdings Inc, and Gary Sidhu (Incorporated herein by reference to Exhibit 10.3 to the Quarterly Report on Form 10-Q of the Registrant filed on May 17, 2010)10.5

Amendment to Equity Credit Agreement between Covenant Group of China Inc. and Southridge Partners II, LP (Incorporated herein by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q of the Registrant filed on May 17, 2010)10.6

Bridge Loan Agreement dated as of April 22, 2010, by and between Covenant Group of China Inc. and Sui Generis Capital Partners LLC (Incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of the Registrant filed on May 17, 2010)10.7

Bridge Loan Agreement dated as of June 10, 2010, between Covenant Group of China, Inc. and Walston DuPont Global Advisors LLC (Incorporated herein by reference to Exhibit 10.15 to the Registration Statement on Form S-1 of the Registrant filed on July 2, 2010)10.8

Agreement on Share Transfer and Increase of Registered Capital dated August 27, 2010 by and among Covenant Group of China, Inc., Hainan JIEN Intelligent Engineering Co., Ltd, Bingfeng Ma and Qinghua Dai (Incorporated herein by reference to Exhibit 10.16 to the Registration Statement on Form S-1 of the Registrant filed on September 23, 2010)  64
  10.9

First Amendment to Promissory Note by and between Covenant Group of China Inc. and Sui Generis Capital Partners LLC, dated June 30, 2010 (Incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of the Registrant filed on August 16, 2010)10.10

Second Amendment to Promissory Note by and between Covenant Group of China Inc. and Sui Generis Capital Partners LLC, dated June 30, 2010 (Incorporated herein by reference to Exhibit 10.4 to the Quarterly Report on Form 10-Q of the Registrant filed on August 16, 2010)10.11

Bridge Loan Agreement by and between Covenant Group of China Inc. and JD Holdings 1, Inc., dated July 1, 2010 (Incorporated herein by reference to Exhibit 10.3 to the Quarterly Report on Form 10-Q of the Registrant filed on August 16, 2010)10.12

First Amendment to Promissory Note by and between Covenant Group of China Inc. and Walston Dupont Global Advisors LLC, dated October 28, 2010 (Incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of the Registrant filed on November 15, 2010)10.13

Third Amendment to Promissory Note by and between Covenant Group of China Inc. and Sui Generis Capital Partners LLC, dated October 28, 2010 (Incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of the Registrant filed on November 15, 2010)10.14

Bridge Loan Agreement and Promissory Note by and between Covenant Group of China Inc. and Sui Generis Capital Partners LLC, dated November 24, 201010.15

Fourth Amendment to Promissory Note by and between Covenant Group of China Inc. and Sui Generis Capital Partners LLC, dated March 11, 201110.16

First Amendment to Promissory Note by and between Covenant Group of China Inc. and Sui Generis Capital Partners LLC, dated March 11, 201110.17

Cancellation of June 10, 2010 Bridge Loan Agreement and Promissory Note by and between Covenant Group of China Inc. and Walston Dupont Global Advisors LLC, dated December 23, 201010.18
*
Restricted Stock Award Agreement to Justin D. Csik, dated March 18, 201110.19

Restricted Stock Award Agreement to Gerard Daignault, dated March 18, 201110.20

Restricted Stock Award Agreement to Thomas Zhi Yang, dated March 24, 201110.21

Restricted Stock Award Agreement to James Shaugnhessy, dated April 8, 201110.22

Bridge Loan Agreement and Promissory Note by and between Covenant Group of China Inc. and Walston Dupont Global Advisors LLC, dated February 23, 201121

List of subsidiaries of the Company31.1

Certification of Chief Principal Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1

Certification of Chief Principal Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2

Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
concerns management compensation








65