U.S.
SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-Q


(Mark
one)




x
            Quarterly Report Under
      Section 13 or 15(d) of the Securities Exchange Act of
      1934




For the
Quarterly Period Ended June 30, 2010


or




 ̈
            Transition Report Under
      Section 13 or 15(d) of the Securities Exchange Act of
      1934




Commission
File Number 000-50491


China
Fire & Security Group, Inc.


(Name of
small business issuer in its charter)




Florida
              
              65-1193022(State
      or other jurisdiction
              
              (I.R.S.
      Employerof
      incorporation or organization)
              
              Identification
      No.)B-2508
      TYG Center, C2Dongsanhuanbeilu,Chaoyang
      District, Beijing 100027,People’s
      Republic of China
              
              100027(Address
      of principal executive offices)
              
              (Zip
      Code)




Issuer’s
telephone number:  (86-10) 8441 7400.


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 xNo
 ̈


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 (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes  ̈No
 ̈


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




Large
      accelerated filer  ̈
              
              Accelerated
      filer xNon-accelerated
      filer   ̈(Do
      not check if smaller reporting
      company)
              
              Smaller
      reporting company  ̈


Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act)     Yes  ̈No x




As of
August 9, 2010, the registrant had 27,595,541 shares of common stock
outstanding.





China
Fire & Security Group, Inc.




Table of
Contents




PagePART
      I -
                        
                        FINANCIAL
      INFORMATIONItem
      1.
                        
                        Financial
      Statements (unaudited):Consolidated
      Balance Sheets as of June 30, 2010 (unaudited) and December 31,
      2009
                        
                        3Consolidated
      Statements of Income and Other Comprehensive IncomeFor
      the Three and Six Months Ended June 30, 2010 and 2009
      (unaudited)
                        
                        4Consolidated
      Statements of Changes in Equity
                        
                        5Consolidated
      Statements of Cash FlowsFor
      the Six Months Ended June 30, 2010 and 2009 (unaudited)
                        
                        6Notes
      to Consolidated Financial Statements (unaudited)
                        
                        7Item
      2.
                        
                        Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                        
                        33Item
      3.
                        
                        Quantitative
      and Qualitative Disclosures About Market Risk
                        
                        42Item
      4.
                        
                        Controls
      and Procedures
                        
                        43PART II -
                        
                        OTHER
      INFORMATIONItem
      1.
                        
                        Legal
      Proceedings
                        
                        43Item
      1A.
                        
                        Risk
      Factors
                        
                        43Item
      2.
                        
                        Unregistered
      Sales of Equity Securities and Use of Proceeds
                        
                        43Item
      3.
                        
                        Defaults
      Upon Senior Securities
                        
                        43Item
      4.
                        
                        (Removed
      and Reserved)
                        
                        43Item
      5.
                        
                        Other
      Information
                        
                        43Item
      6.
                        
                        Exhibits
                        
                        44


2


Item
1. Financial Statements


CHINA FIRE & SECURITY GROUP, INC. AND
SUBSIDIARIES
 
 CONSOLIDATED
BALANCE SHEETS
 AS OF
JUNE 30,2010 AND  DECEMBER 31, 2009
 
 June 30,
                              
                              
                              December 31,2010
                              
                              
                              2009(Unaudited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                              
                              $
                              27,773,889
                              
                              
                              $
                              34,976,880Restricted
      cash
                              
                              
                              4,324,670
                              
                              
                              
                              1,837,134Notes
      receivable
                              
                              
                              2,836,706
                              
                              
                              
                              4,274,268Accounts
      receivable, net of allowance for doubtful accounts of $7,274,109 and
      $6,539,787 as of June 30, 2010 and December 31, 2009,
      respectively
                              
                              
                              34,350,836
                              
                              
                              
                              30,989,569Receivables
      from related parties
                              
                              
                              156,069
                              
                              
                              
                              156,599Other
      receivables
                              
                              
                              616,311
                              
                              
                              
                              368,679Other
      receivables from related parties
                              
                              
                              1,217,736
                              
                              
                              
                              395,193Refundable
      bidding and system contracting project deposits
                              
                              
                              1,596,790
                              
                              
                              
                              1,774,330Inventories
                              
                              
                              5,528,866
                              
                              
                              
                              5,360,520Costs
      and estimated earnings in excess of billings
                              
                              
                              55,302,042
                              
                              
                              
                              36,562,573Employee
      advances
                              
                              
                              1,407,024
                              
                              
                              
                              953,625Prepayments
      and deferred expenses
                              
                              
                              3,667,230
                              
                              
                              
                              3,397,358Total
      current assets
                              
                              
                              138,778,169
                              
                              
                              
                              121,046,728PLANT
      AND EQUIPMENT, net
                              
                              
                              8,887,674
                              
                              
                              
                              8,617,521OTHER
      ASSETS:Restricted
      cash - non current
                              
                              
                              3,566,050
                              
                              
                              
                              3,602,906Accounts
      receivable – retentions
                              
                              
                              2,941,189
                              
                              
                              
                              3,463,998Deferred
      expenses - non current
                              
                              
                              116,519
                              
                              
                              
                              116,045Investment
      in joint ventures
                              
                              
                              482,502
                              
                              
                              
                              477,837Intangible
      assets, net
                              
                              
                              1,005,912
                              
                              
                              
                              1,041,156Total
      other assets
                              
                              
                              8,112,172
                              
                              
                              
                              8,701,942Total
      assets
                              
                              $
                              155,778,015
                              
                              
                              $
                              138,366,191LIABILITIES AND EQUITYCURRENT
      LIABILITIES:Accounts
      payable
                              
                              $
                              8,769,594
                              
                              
                              $
                              6,903,961Accounts
      payable to related party
                              
                              
                              -
                              
                              
                              
                              272,994Customer
      deposits
                              
                              
                              2,476,834
                              
                              
                              
                              2,182,790Billings
      in excess of costs and estimated earnings
                              
                              
                              1,488,334
                              
                              
                              
                              1,429,999Other
      payables
                              
                              
                              472,175
                              
                              
                              
                              333,121Accrued
      liabilities
                              
                              
                              15,861,264
                              
                              
                              
                              13,841,300Taxes
      payable
                              
                              
                              8,181,622
                              
                              
                              
                              9,002,470Total
      current liabilities
                              
                              
                              37,249,823
                              
                              
                              
                              33,966,635COMMITMENTS
      AND CONTINGENCIESEQUITY:Common
      stock, $0.001 par value, 65,000,000 shares authorized, 27,595,541 shares
      issued and outstanding as of June 30, 2010 and December 31, 2009,
      respectively
                              
                              
                              27,595
                              
                              
                              
                              27,595Additional
      paid-in-capital
                              
                              
                              22,672,485
                              
                              
                              
                              20,601,138Statutory
      reserves
                              
                              
                              7,147,795
                              
                              
                              
                              7,147,795Retained
      earnings
                              
                              
                              80,846,934
                              
                              
                              
                              69,266,049Accumulated
      other comprehensive income
                              
                              
                              7,791,584
                              
                              
                              
                              7,324,237Total
      shareholders' equity
                              
                              
                              118,486,393
                              
                              
                              
                              104,366,814Noncontrolling
      interest
                              
                              
                              41,799
                              
                              
                              
                              32,742Total
      equity
                              
                              
                              118,528,192
                              
                              
                              
                              104,399,556Total
      liabilities and equity
                              
                              $
                              155,778,015
                              
                              
                              $
                              138,366,191
  See
report of independent registered public accounting firm.
 The
accompanying notes are an integral part of these consolidated
statements.
  3
 
 CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
 FOR THE
THREE AND SIX MONTHS ENDED JUNE 30, 2010 AND 2009
 (Unaudited)
 
 Three Months Ended June 30,
                  
                  
                  Six Months Ended June 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009REVENUESSystem
      contracting projects
                  
                  $
                  18,267,248
                  
                  
                  $
                  18,290,930
                  
                  
                  $
                  33,788,996
                  
                  
                  $
                  31,294,114Products
                  
                  
                  3,556,422
                  
                  
                  
                  3,791,491
                  
                  
                  
                  8,087,021
                  
                  
                  
                  6,915,813Maintenance
      services
                  
                  
                  1,009,761
                  
                  
                  
                  649,447
                  
                  
                  
                  1,901,140
                  
                  
                  
                  1,234,152Total
      revenues
                  
                  
                  22,833,431
                  
                  
                  
                  22,731,868
                  
                  
                  
                  43,777,157
                  
                  
                  
                  39,444,079COST
      OF REVENUESSystem
      contracting projects
                  
                  
                  7,876,558
                  
                  
                  
                  6,970,283
                  
                  
                  
                  15,187,843
                  
                  
                  
                  11,777,541Products
                  
                  
                  1,856,133
                  
                  
                  
                  865,395
                  
                  
                  
                  3,310,200
                  
                  
                  
                  2,077,048Maintenance
      services
                  
                  
                  705,688
                  
                  
                  
                  395,619
                  
                  
                  
                  1,251,906
                  
                  
                  
                  792,160Total
      cost of revenues
                  
                  
                  10,438,379
                  
                  
                  
                  8,231,297
                  
                  
                  
                  19,749,949
                  
                  
                  
                  14,646,749GROSS
      PROFIT
                  
                  
                  12,395,052
                  
                  
                  
                  14,500,571
                  
                  
                  
                  24,027,208
                  
                  
                  
                  24,797,330OPERATING
      EXPENSESSelling
      and marketing
                  
                  
                  2,209,162
                  
                  
                  
                  2,237,873
                  
                  
                  
                  4,205,360
                  
                  
                  
                  4,140,191General
      and administrative
                  
                  
                  2,618,664
                  
                  
                  
                  1,983,443
                  
                  
                  
                  5,558,741
                  
                  
                  
                  3,664,082Depreciation
      and amortization
                  
                  
                  202,055
                  
                  
                  
                  183,456
                  
                  
                  
                  402,161
                  
                  
                  
                  376,850Research
      and development
                  
                  
                  399,701
                  
                  
                  
                  519,987
                  
                  
                  
                  796,597
                  
                  
                  
                  834,017Total
      operating expenses
                  
                  
                  5,429,582
                  
                  
                  
                  4,924,759
                  
                  
                  
                  10,962,859
                  
                  
                  
                  9,015,140INCOME
      FROM OPERATIONS
                  
                  
                  6,965,470
                  
                  
                  
                  9,575,812
                  
                  
                  
                  13,064,349
                  
                  
                  
                  15,782,190OTHER
      INCOMEOther
      income, net
                  
                  
                  302,269
                  
                  
                  
                  110,301
                  
                  
                  
                  337,532
                  
                  
                  
                  220,997Interest
      income
                  
                  
                  99,548
                  
                  
                  
                  7,206
                  
                  
                  
                  183,348
                  
                  
                  
                  129,302Total
      other income, net
                  
                  
                  401,817
                  
                  
                  
                  117,507
                  
                  
                  
                  520,880
                  
                  
                  
                  350,299INCOME
      BEFORE PROVISION FOR INCOME TAXES AND NONCONTROLING
    INTEREST
                  
                  
                  7,367,287
                  
                  
                  
                  9,693,319
                  
                  
                  
                  13,585,229
                  
                  
                  
                  16,132,489PROVISION
      FOR INCOME TAXES
                  
                  
                  1,051,259
                  
                  
                  
                  1,357,097
                  
                  
                  
                  2,054,133
                  
                  
                  
                  2,150,664NET
      INCOME BEFORE NONCONTROLLING INTEREST
                  
                  
                  6,316,028
                  
                  
                  
                  8,336,222
                  
                  
                  
                  11,531,096
                  
                  
                  
                  13,981,825Less:
      Net loss attributable to noncontrolling interest
                  
                  
                  (17,632
                  )
                  
                  
                  -
                  
                  
                  
                  (49,789
                  )
                  
                  
                  -NET
      INCOME ATTRIBUTABLE TO CONTROLLING INTEREST
                  
                  
                  6,333,660
                  
                  
                  
                  8,336,222
                  
                  
                  
                  11,580,885
                  
                  
                  
                  13,981,825OTHER
      COMPREHENSIVE INCOMEForeign
      currency translation adjustment
                  
                  
                  487,820
                  
                  
                  
                  69,294
                  
                  
                  
                  467,347
                  
                  
                  
                  (108,923
                  )COMPREHENSIVE
      INCOME
                  
                  $
                  6,821,480
                  
                  
                  $
                  8,405,516
                  
                  
                  $
                  12,048,232
                  
                  
                  $
                  13,872,902BASIC
      EARNINGS PER SHAREWeighted
      average number of shares
                  
                  
                  27,595,541
                  
                  
                  
                  27,588,598
                  
                  
                  
                  27,595,541
                  
                  
                  
                  27,587,595Earnings
      per share
                  
                  $
                  0.23
                  
                  
                  $
                  0.30
                  
                  
                  $
                  0.42
                  
                  
                  $
                  0.51DILUTED
      EARNINGS PER SHAREWeighted
      average number of shares
                  
                  
                  28,405,959
                  
                  
                  
                  28,298,850
                  
                  
                  
                  28,402,599
                  
                  
                  
                  28,258,225Earnings
      per share
                  
                  $
                  0.22
                  
                  
                  $
                  0.29
                  
                  
                  $
                  0.41
                  
                  
                  $
                  0.49
 
 The
accompanying notes are an integral part of thes consolidated financial
statements.
  4
 
 CHINA FIRE & SECURITY GROUP, INC. AND
SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF CHANGES IN EQUITY
 
 Retained
      Earnings
                            
                            
                            Accumulated otherCommon
      Stock
                            
                            
                            Additional
                            
                            
                            Statutory
                            
                            
                            
                            
                            
                            comprehensive
                            
                            
                            NoncontrollingShares
                            
                            
                            Par
      value
                            
                            
                            paid-in-capital
                            
                            
                            reserves
                            
                            
                            Unrestricted
                            
                            
                            income
                            
                            
                            interest
                            
                            
                            TotalsBALANCE,
      December 31, 2008
                            
                            
                            27,586,593
                            
                            
                            $
                            27,586
                            
                            
                            $
                            19,357,409
                            
                            
                            $
                            7,148,827
                            
                            
                            $
                            44,850,181
                            
                            
                            $
                            7,305,144
                            
                            
                            $
                            -
                            
                            
                            $
                            78,689,147Capital
      received from non-controlling interest
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            87,900
                            
                            
                            
                            87,900Net
      income (loss)
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            13,981,825
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            13,981,825Warrants
      exercised
                            
                            
                            6,682
                            
                            
                            
                            7
                            
                            
                            
                            (7
                            )Options
      issued to employees
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            490,097
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            490,097Foreign
      currency translation adjustment
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (108,923
                            )
                            
                            
                            
                            
                            
                            
                            (108,923
                            )BALANCE,
      June 30, 2009, (Unaudited)
                            
                            
                            27,593,275
                            
                            
                            
                            27,593
                            
                            
                            
                            19,847,499
                            
                            
                            
                            7,148,827
                            
                            
                            
                            58,832,006
                            
                            
                            
                            7,196,221
                            
                            
                            
                            87,900
                            
                            
                            
                            93,140,046Net
      income (loss)
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            10,433,011
                            
                            
                            
                            
                            
                            
                            
                            (55,244
                            )
                            
                            
                            10,377,767Options
      exercised
                            
                            
                            2,266
                            
                            
                            
                            2
                            
                            
                            
                            (2
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Options
      issued to employees
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            490,099
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            490,099Stock
      based compensation for services
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            263,542
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            263,542Deconsolidation
      of statutory reserves held in TianjinTianxiao
      Fire Safety Equipment Co., Ltd.
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (1,032
                            )
                            
                            
                            1,032
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Foreign
      currency translation adjustment
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            128,016
                            
                            
                            
                            86
                            
                            
                            
                            128,102BALANCE,
      December 31, 2009
                            
                            
                            27,595,541
                            
                            
                            
                            27,595
                            
                            
                            
                            20,601,138
                            
                            
                            
                            7,147,795
                            
                            
                            
                            69,266,049
                            
                            
                            
                            7,324,237
                            
                            
                            
                            32,742
                            
                            
                            
                            104,399,556Capital
      received from non-controlling interest
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            58,920
                            
                            
                            
                            58,920Net
      income (loss)
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            11,580,885
                            
                            
                            
                            
                            
                            
                            
                            (49,789
                            )
                            
                            
                            11,531,096Options
      issued to employees
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            490,097
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            490,097Stock
      based compensation for services
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,581,250
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,581,250Foreign
      currency translation adjustment
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            467,347
                            
                            
                            
                            (74
                            )
                            
                            
                            467,273BALANCE,
      June 30, 2010, (Unaudited)
                            
                            
                            27,595,541
                            
                            
                            
                            27,595
                            
                            
                            
                            22,672,485
                            
                            
                            
                            7,147,795
                            
                            
                            
                            80,846,934
                            
                            
                            
                            7,791,584
                            
                            
                            
                            41,799
                            
                            
                            
                            118,528,192
 
 The
accompanying notes are an integral part of these consolidated
statements.
  5
 
 CHINA FIRE & SECURITY GROUP, INC. AND
SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 FOR THE
SIX MONTHS ENDED JUNE 30, 2010  AND 2009
 
 Six Months Ended June 30,2010
                                
                                
                                2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income attributable to controlling interest
                                
                                $
                                11,580,885
                                
                                
                                $
                                13,981,825Net
      loss attributable to noncontrolling interest
                                
                                
                                (49,789
                                )
                                
                                
                                -Consolidated
      net income
                                
                                
                                11,531,096
                                
                                
                                
                                13,981,825Adjustments
      to reconcile net income to cash provided by operating
      activities:Depreciation
                                
                                
                                394,351
                                
                                
                                
                                410,521Amortization
                                
                                
                                37,646
                                
                                
                                
                                37,641Provision
      for doubtful accounts
                                
                                
                                704,645
                                
                                
                                
                                662,143(Gain)
      Loss on disposal of equipment
                                
                                
                                (485
                                )
                                
                                
                                8,512Options
      issued to employees
                                
                                
                                490,097
                                
                                
                                
                                490,097Stock
      based compensation for services
                                
                                
                                1,581,250
                                
                                
                                
                                -Provision
      for estimated warranty claims
                                
                                
                                -
                                
                                
                                
                                62,973Change
      in operating assets and liabilitiesNotes
      receivable
                                
                                
                                1,449,019
                                
                                
                                
                                292,739Accounts
      receivable
                                
                                
                                (3,391,203
                                )
                                
                                
                                (4,749,389
                                )Other
      Receivable from related parties
                                
                                
                                (816,955
                                )
                                
                                
                                (37,975
                                )Other
      receivables
                                
                                
                                (296,747
                                )
                                
                                
                                (509,019
                                )Refundable
      bidding and system contracting project deposits
                                
                                
                                235,653
                                
                                
                                
                                -Inventories
                                
                                
                                (146,087
                                )
                                
                                
                                257,998Costs
      and estimated earnings in excess of billings
                                
                                
                                (18,512,944
                                )
                                
                                
                                (11,713,121
                                )Employee
      advances
                                
                                
                                (447,637
                                )
                                
                                
                                (333,729
                                )Prepayments
      and deferred expenses
                                
                                
                                (255,015
                                )
                                
                                
                                (183,819
                                )Accounts
      payable
                                
                                
                                2,050,026
                                
                                
                                
                                314,470Accounts
      payable related party
                                
                                
                                (272,994
                                )
                                
                                
                                -Customer
      deposits
                                
                                
                                283,929
                                
                                
                                
                                (3,030,801
                                )Billings
      in excess of costs and estimated earnings
                                
                                
                                52,268
                                
                                
                                
                                (2,198,063
                                )Other
      payables
                                
                                
                                137,125
                                
                                
                                
                                277,696Accrued
      liabilities
                                
                                
                                1,735,497
                                
                                
                                
                                4,505,900Taxes
      payable
                                
                                
                                (853,848
                                )
                                
                                
                                4,307,424Net
      cash (used in) provided by operating activities
                                
                                
                                (4,311,313
                                )
                                
                                
                                2,854,023CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of plant and equipment
                                
                                
                                (642,178
                                )
                                
                                
                                (962,362
                                )Proceeds
      from sale of equipment
                                
                                
                                14,376
                                
                                
                                
                                9,827Payments
      for long term investments
                                
                                
                                (4,648
                                )
                                
                                
                                -Net
      cash used in investing activities
                                
                                
                                (632,450
                                )
                                
                                
                                (952,535
                                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Change
      in restricted cash
                                
                                
                                (2,418,374
                                )
                                
                                
                                (818,891
                                )Capital
      contributed by noncontrolling interest shareholder
                                
                                
                                60,891
                                
                                
                                
                                87,942Net
      cash used in financing activities
                                
                                
                                (2,357,483
                                )
                                
                                
                                (730,949
                                )EFFECT
      OF EXCHANGE RATE CHANGES ON CASH
                                
                                
                                98,255
                                
                                
                                
                                (33,637
                                )INCREASE
      (DECREASE) IN CASH
                                
                                
                                (7,202,991
                                )
                                
                                
                                1,136,902CASH
      and CASH EQUIVALENTS, beginning of periods
                                
                                
                                34,976,880
                                
                                
                                
                                26,655,333CASH
      and CASH EQUIVALENTS, end of periods
                                
                                $
                                27,773,889
                                
                                
                                $
                                27,792,235SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATIONIncome
      taxes paid
                                
                                $
                                3,422,925
                                
                                
                                $
                                311,505Interest
      paid
                                
                                $
                                -
                                
                                
                                $
                                -NON-CASH
      TRANSACTIONS IN INVESTING ACTIVITIES:Reclassification
      of advances on building and equipment purchase to plant and equipment upon
      receipt of purchase
                                
                                $
                                -
                                
                                
                                $
                                249,536
 
 The
accompanying notes are an integral part of thes consolidated
statements.
  6




CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Note
1 - Background
 
 Principal Activities and
Reorganization
 
 China Fire & Security Group
Inc.(the
“Company” or “CFSG”), is a Florida corporation. The Company, through its
subsidiaries, is engaged in the design, development, manufacture and sale of
fire protection products and services for industrial customers in People’s
Republic of China (“China”) and India.
 
 Recent
Developments
 
 Investment of 5% interest in
Sureland Fire & Security India Private Ltd (“Sureland
India”)
 
 Sureland
India was incorporated in New Delhi, India with registered capital of
$51,398 (INR2,500,000). Sureland India engages in project design, consulting and
construction services for the fire protection industry in India. In January
2010, Sureland India received approval from the India government to
accept foreign investment of 5% equity from China Fire Protection Group, Inc.
China Fire Protection Group, Inc. has completed the payment of $2,710
(INR125,000) in January 2010. After the transaction, the Company became a
minority interest holder of Sureland Indian and the investment was recorded
under the cost accounting method. The Company made an advance payment to
Sureland Fire & Security India Private Ltd. in amount of $143,602 as of June
30, 2010 for services.
 
 Acquisition of 100% interest
in Zeetech System Private Ltd (“Zeetech”)
 
 Zeetech
was incorporated in New Delhi, India with registered capital of $2,215
(INR101,000). On February 4, 2010, China Fire Protection Group, Inc. signed an
agreement to acquire 100% ownership in Zeetech from the existing shareholders
for the consideration price of $2,215 (INR101,000) approximately equal to fair
value of the net assets as of January 12, 2010, which was approximately $1,938
(INR88,387). Thus, a loss of $277 was recognized in this transaction. After the
closing of the acquisition, Zeetech is 100% owned by China Fire Protection
Group, Inc. Zeetech does not currently have any operations.
 
 Restructuring of Sureland
Industrial
 
 During
the first quarter of 2010, our wholly-owned subsidiary, CFPG entered into an
agreement with Zeetech, our subsidiary in which we own 100%, pursuant to which
CFPG's entire interest (75%) in Sureland Industrial shall be transferred to
Zeetech. On March 12, 2010, the restructuring transaction was approved by the
Chinese Ministry of Commerce.  Subsequent to the transfer, China Fire
& Security Group, Inc. still holds 100% of the interest in Sureland
Industrial through its subsidiaries.
  7
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Restructuring
of Tianxiao Equipment
  On July
3, 2009, Sureland Industrial signed an agreement to transfer 83.3% ownership in
Tianxiao Equipment to Tianjin Fire Protection Equipment Co., Ltd. for
consideration approximately equal to the net assets of Tianxiao Equipment as of
June 30, 2009, which was approximately $1.6 million (RMB 10.6 million). Thus, a
loss of $913 was recognized in this transaction. The proceeds of $1.6 million
have been fully received by the Company as of December 31, 2009.
 
 After the
restructuring, Sureland Industrial became a minority shareholder,
with 16.7% ownership in Tianxiao Equipment.  The investment is
recorded under the cost accounting method.  Sureland Industrial is
continuing to purchase fire safety and protection products through Tiaoxiao
Equipment, which does not require the classification of the deconsolidation of
Tianxiao Equipment as a discontinued operation in accordance with FASB
Accounting Standards Codification (“ASC”) 205-20-55.
 
 Formation of Shenyang
Hongshida Electronics Co., Ltd (“Shenyang Hongshida”)
 
 Shenyang
Hongshida was incorporated in Shenyang, Liaoning Province, China with registered
capital of $1,465,000 (RMB10,000,000). Pursuant to Shengyang Hongshida’s
by-laws dated on June 1, 2009, the registered capital is required to be injected
over the subsequent two years. Shenyang Hongshida is 80% owned by Beijing Hua An
with 20% noncontrolling interest owned by an unrelated party. Shenyang Hongshida
engages in the production and sales of fire equipment, electronic products,
instrumentation, computer parts and provides technical advisory services.
Shenyang Hongshida will focus on the low- to middle-end segment of the fire
products market. The company received capital contributions of $295,200 (RMB
2,000,000) in June 2010 of those, $58,920 (RMB 400,000) was received from the
non-controlling interest investor. As of June 30, 2010, the registered capital
received was $736,500 (RMB 5,000,000) and the Company is in pre-operating
stage.
 
 Note
2 - Summary of significant accounting policies
 
 The reporting
entity
 
 The
consolidated financial statements of China Fire & Security Group Inc. and
Subsidiaries reflect the activities of the parent and the following
subsidiaries:
 
 Subsidiaries
                      
                      Incorporated in
                      
                      Ownership
                        PercentageChina
      Fire Protection Group Inc. (“CFPG”)
                      
                      British
      Virgin Islands
                      
                      
                      100
                      %Zeetech
      System Private Limited (“Zeetech”)
                      
                      India
                      
                      
                      100
                      %Sureland
      Industrial Fire Safety Limited (“Sureland Industrial”)
                      
                      People’s
      Republic of China
                      
                      
                      100
                      %Sureland
      Industrial Fire Equipment Co. Ltd. (“Sureland Equipment”)
                      
                      People’s
      Republic of China
                      
                      
                      100
                      %Beijing
      Hua An Times Fire Safety Technology Co., Ltd. (“Beijing Hua
      An”)
                      
                      People’s
      Republic of China
                      
                      
                      100
                      %Beijing
      Shian Kexin Technology Co., Ltd
                      
                      People’s
      Republic of China
                      
                      
                      100
                      %Shenyang
      Hongshida Electronics Co., Ltd
                      
                      People’s
      Republic of China
                      
                      
                      80
                      %
  8
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Basis of
presentation
 
 The
accompanying consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America.
All material intercompany transactions and balances have been eliminated in
consolidation.
  However,
these consolidated financial statements are not indicative of a full year
of operations. The information included in this Quarterly Report on Form 10-Q
should be read in conjunction with the audited consolidated financial statements
and footnotes for the year ended December 31, 2009 included in the Company’s
Annual Report on Form 10-K.
  Use of
estimates
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles of the United States of America requires management to
make estimates and assumptions that affect the amounts reported in the combined
financial statements and accompanying notes. Management believes that the
estimates utilized in preparing its financial statements are reasonable and
prudent. Actual results could differ from these estimates.
 
 Certain
of the Company’s accounting policies require higher degrees of
judgment than others in their application. These include the recognition of
revenue and earnings from system contracting projects under the
percentage-of-completion method, determining the fair value of stock based
compensation and the allowance of doubtful accounts and warranty expenses.
Management evaluates all of its estimates and judgments on an on-going
basis.
 
 Revenue
recognition
 
 Revenue
is recognized when it is probable that the economic benefits will flow to the
Company as follows:
  9
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 1.
              Revenue
      from system contracting projects are recognized using the
      percentage-of-completion method of accounting and, therefore, take into
      account the costs, estimated earnings and revenue to date on contracts not
      yet completed. Revenue recognized is that percentage of the total contract
      price that cost expended to date bears to anticipated final total cost,
      based on current estimates of costs to complete. Contract costs include
      all direct material and labor costs and those indirect costs related to
      contract performance, such as indirect labor, supplies, tools, repairs,
      and depreciation costs. Selling, general, and administrative costs are
      charged to expense as incurred. At the time a loss on a contract becomes
      known, the entire amount of the estimated ultimate loss is recognized in
      the consolidated financial statements. Claims for additional contract
      costs are recognized upon a signed change order from the
      customer.
 
 2.
              Revenue
      from product sales is recognized when the goods are delivered and title
      has passed. Product sales revenue is presented net of a value-added tax
      (“VAT”). All of the Company’s products that are sold in the People’s
      Republic of China (“PRC”) are subject to a Chinese value-added tax at a
      rate of 17% of the gross sales price. This VAT may be offset by VAT paid
      by the Company on raw materials and other materials included in the cost
      of producing the finished product.
 
 3.
              Revenue
      from the rendering of Maintenance Services is recognized over the service
      period on a straight-line basis.
 
 In
accordance with ASC 605-15, “Revenue Recognition when Right of Return Exists,”
revenue is recorded net of an estimate of markdowns, price concessions and
warranty costs. Such reserve is based on management’s evaluation of historical
experience, current industry trends and estimated costs.
 
 Enterprise Wide
Disclosure
 
 Almost
all of the Company’s products (fire detecting products, fire alarm control
device, and water mist/sprinkler systems) are sold via system contracting
projects or as part of the integrated product sales. The composition of these
three types of products varies significantly from project to project, both in
quantity and in dollar amounts. Although the Company could provide a breakdown
of sales contribution for the Company’s own products for each project, it is
almost impossible to provide revenues for each of the products when the revenue
from each project is recognized based on a percentage of
completion.  More importantly, the revenues from the Company’s own
products do not accurately reflect the Company’s overall financial performance.
The Company is a system contracting projects provider rather than a product
vendor that sells their own products directly or through
channels.  Therefore, it is not practical to separately disclose the
revenues from external customers for each of the products.
  10
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 The
Company’s chief operating decision-makers (i.e. chief executive officer and his
direct reports) review financial information presented on a consolidated basis,
accompanied by disaggregated information about revenues by business lines for
purposes of allocating resources and evaluating financial performance. There are
no segment managers who are held accountable for operations, operating results
and plans for levels or components below the consolidated unit level. Based on
qualitative and quantitative criteria established by ASC 280-10, “Disclosures
about Segments of an Enterprise and Related Information”, the Company considers
itself to be operating within one reportable segment.
  Shipping and
handling
 
 Costs
related to shipping and handling are included in cost of revenue pursuant to ASC
605-45 “Accounting for Shipping and Handling Fees and Costs.”
 
 Foreign currency
translation
 
 The
reporting currency of the Company is the US dollar. The Company uses their local
currency, Renminbi (RMB) and Indian Rupee (INR), as their functional currency.
Results of operations and cash flow are translated at average exchange rates
during the period, and assets and liabilities are translated at the unified
exchange rate as quoted by the People’s Bank of China at the end of the period.
Translation adjustments resulting from this process are included in accumulated
other comprehensive income in the consolidated statements of changes in equity.
  Asset and
liability accounts at June 30, 2010 were translated at 6.79 RMB to $1.00 and
46.47 INR to $1.00 as compared to 6.82 RMB to $1.00 and 46.75 INR to $1.00 at
December 31, 2009 respectively.  Equity accounts were stated at their
historical rate.  The average translation rates of RMB applied to
income statements accounts for the six months ended June 30, 2010 and 2009 were
6.82 RMB and 6.82 RMB, respectively. The average translation rates of INR
applied to income statements accounts for the six months ended June 30, 2010
were 45.72 INR. Cash flows are also translated at average translation rates for
the period, therefore, amounts reported on the statement of cash flows will not
necessarily agree with changes in the corresponding balances on the balance
sheets.
 
 Transaction
gains and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in the
results of operations as incurred.  Historically, the Company has not
entered any currency trading or hedging transactions, although there is no
assurance that the Company will not enter into such transactions in the
future.
 
 Plant and
equipment
 
 Plant and
equipment are stated at cost less accumulated depreciation. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets with a 5% residual value.  Depreciation expense amounted to
$193,222, and $ 209,754 for the three months ended June 30, 2010 and 2009,
respectively.  Depreciation expense amounted to $394,351 and $410,521 for
the six months ended June 30, 2010 and 2009, respectively.
  11
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Estimated
useful lives of the assets are as follows:
 
 Useful
                      LifeBuildings
      and improvements
                    
                    40
      yearsTransportation
      equipment
                    
                    5
      yearsMachinery
                    
                    10
      yearsOffice
      equipment
                    
                    5
      yearsFurniture
                    
                    5
      years
  Construction
in progress represents the costs incurred in connection with the construction of
buildings or additions to the Company’s plant facilities. No depreciation is
provided for construction in progress until such time as the assets are
completed and placed into service. Interest incurred during construction is
capitalized into construction in progress. All other interest is expensed as
incurred.
 
 The cost
and related accumulated depreciation of assets sold or otherwise retired are
eliminated from the accounts and any gain or loss is included in the
consolidated statements of income. Maintenance, repairs and minor renewals are
charged directly to expense as incurred. Major additions and betterments to
buildings and equipment are capitalized.
 
 Long-term
assets of the Company are reviewed at least annually, more often if
circumstances dictate, to determine whether their carrying value has become
impaired. The Company considers assets to be impaired if the carrying value
exceeds the future projected cash flows from related operations. The Company
evaluates the periods of depreciation and amortization to determine whether
subsequent events and circumstances warrant revised estimates of useful lives.
As of June 30, 2010, the Company expects these assets to be fully
recoverable.
 
 Plant and
equipment consists of the following:
 
 June 30,
                        2010
                        (Unaudited)
                      
                      
                      December 31,
                        2009Buildings
      and improvements
                      
                      $
                      6,443,427
                      
                      
                      $
                      6,439,015Transportation
      equipment
                      
                      
                      3,237,971
                      
                      
                      
                      3,307,236Machinery
                      
                      
                      906,070
                      
                      
                      
                      900,781Office
      equipment
                      
                      
                      1,490,398
                      
                      
                      
                      1,348,261Furniture
                      
                      
                      141,410
                      
                      
                      
                      165,736Total
      depreciable assets
                      
                      
                      12,219,276
                      
                      
                      
                      12,161,029Less
      accumulated depreciation
                      
                      
                      (4,024,440
                      )
                      
                      
                      (3,875,487
                      )Construction
      in progress
                      
                      
                      692,838
                      
                      
                      
                      331,979Plant
      and equipment, net
                      
                      $
                      8,887,674
                      
                      
                      $
                      8,617,521
  12
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Concentration of
risk
 
 Cash
includes cash on hand and demand deposits in accounts maintained with state
owned banks within the People’s Republic of China, Hong Kong and India. The
Company maintains balances at financial institutions which, from time to time,
may exceed Hong Kong Deposit Protection Board insured limits for the banks
located in Hong Kong. Balances at financial institutions or state owned banks
within the PRC are not covered by insurance.  The balances maintained
in India are deposited in the branch of DBS Bank (Singapore) Limited, which are
fully insured by the Government of Singapore until December 31, 2010. As of June
30, 2010 and December 31, 2009, the Company had deposits (including restricted
cash balances) totaling to $35,494,245 and $33,603,047, respectively, that are
not covered by insurance. The Company has not experienced any losses in such
accounts and believes it is not exposed to any risks on its cash in bank
accounts.
 
 The
Company's operations are mainly carried out in the PRC while the revenue
recognized from operations in India is immaterial to the Company’s financial
statement. Accordingly, the Company's business, financial condition and results
of operations may be influenced by the political, economic and legal
environments in the PRC, and by the general state of the PRC's economy. The
Company's operations in the PRC are subject to specific considerations and
significant risks not typically associated with companies in the North America
and Western Europe. These include risks associated with, among others, the
political, economic and legal environments and foreign currency exchange. The
Company's results may be adversely affected by changes in governmental policies
with respect to laws and regulations, anti-inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation, among other
things.
 
 The
Company has one major customer who represented approximately 33% and 47% of the
Company’s sales for the three and six months ended June 30, 2010, respectively.
Accounts receivable from this customer were $2,263,058 as of June 30, 2010. The
Company had one major customer who represented approximately 12% and 11% of the
Company’s sales for the three and six months ended June 30, 2009, respectively.
Accounts receivable from this customer was $0 as of June 30, 2009.
 
 Cash and cash
equivalents
 
 The
Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.  Cash and cash
equivalents also include unrestricted time deposits.
  13
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Restricted
cash
 
 Restricted
cash represents cash required to be deposited in a separate bank account subject
to withdrawal restrictions by its system contracting projects and product sales
customers to guarantee its contracts will be performed. The deposit cannot be
drawn or transferred by the Company until the restriction period has
expired.
 
 Restricted
cash consists of the following:
 
 June 30, 2010
                      (Unaudited)
                    
                    
                    December 31,
                      2009Restricted
      cashProducts
      sales
                    
                    $
                    3,747,840
                    
                    
                    $
                    3,728,599System
      contracting projects
                    
                    
                    4,142,880
                    
                    
                    
                    1,711,441Total
      restricted cash
                    
                    
                    7,890,720
                    
                    
                    
                    5,440,040Restricted
      cash - non current
                    
                    
                    (3,566,050)
                    
                    
                    
                    (3,602,906
                    )Restricted
      cash - current
                    
                    $
                    4,324,670
                    
                    
                    $
                    1,837,134
 
 Inventories
 
 Inventories
are stated at the lower of cost or market, using the weighted average
method.
 
 Inventories
consist of the following as of:
 
 June 30, 2010
                      (unaudited)
                    
                    
                    December 31,
                      2009Raw
      materials
                    
                    $
                    194,493
                    
                    
                    $
                    144,829Finished
      goods
                    
                    
                    4,354,614
                    
                    
                    
                    4,574,075Work
      in progress
                    
                    
                    979,759
                    
                    
                    
                    641,616Total
                    
                    $
                    5,528,866
                    
                    
                    $
                    5,360,520
  Raw
materials consist primarily of materials used in production. Finished goods
consist primarily of equipment used in product sales and system contracting
projects. The costs of finished goods include direct costs of raw materials as
well as direct labor used in production. Indirect production costs such as
utilities and indirect labor related to production such as assembling, shipping
and handling costs are also included in the cost of inventory.  The
Company reviews its inventories periodically to determine if any reserves are
necessary for potential obsolescence. As of June 30, 2010 and December 31, 2009,
the Company determined no reserves were necessary.
  14
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Accounts
receivable
 
 Accounts
receivable represents amounts due from customers for products sales, maintenance
services and system contracting projects. Overdue balances are reviewed
regularly by senior management. Reserves are recorded when collection of amounts
due are in doubt.  Delinquent account balances are written-off after
management has determined that collection is not probable; known bad debts are
written off against allowance for doubtful accounts when
identified.
 
 Accounts
receivable consist of the following:
 June 30, 2010
                    (Unaudited)
                  
                  
                  December 31,
                    2009Accounts
      receivable:System
      contracting projects
                  
                  $
                  24,175,892
                  
                  
                  $
                  23,814,248Maintenance
      services
                  
                  
                  3,671,927
                  
                  
                  
                  3,190,843Products
      sales
                  
                  
                  16,718,315
                  
                  
                  
                  13,988,263Total
      accounts receivable
                  
                  
                  44,566,134
                  
                  
                  
                  40,993,354Allowance
      for bad debts
                  
                  
                  (7,274,109
                  )
                  
                  
                  (6,539,787
                  )Accounts
      receivable, net
                  
                  
                  37,292,025
                  
                  
                  
                  34,453,567Accounts
      receivable - non-current retentions
                  
                  
                  (2,941,189
                  )
                  
                  
                  (3,463,998
                  )Accounts
      receivable - current
                  
                  $
                  34,350,836
                  
                  
                  $
                  30,989,569
 
 The
activity in the allowance for doubtful accounts for trade accounts receivable
for the six months ended June 30, 2010 and for the year ended December 31, 2009
is as follows:
 
 June
                    30, 2010
                    (Unaudited)
                  
                  
                  December 31,
                    2009Beginning
      allowance for doubtful accounts
                  
                  $
                  6,539,787
                  
                  
                  $
                  4,370,362Additional
      charged to bad debt expense
                  
                  
                  704,645
                  
                  
                  
                  2,172,588Write-off
      charged against the allowance
                  
                  
                  -
                  
                  
                  
                  -Foreign
      currency translation adjustment
                  
                  
                  29,677
                  
                  
                  
                  (3,163
                  )Ending
      allowance for doubtful accounts
                  
                  $
                  7,274,109
                  
                  
                  $
                  6,539,787
 
 Retentions
held by customers of system contracting projects included in the Company’s
accounts receivable are as follows:
 June 30, 2010
                    (Unaudited)
                  
                  
                  December 31,
                    2009RetentionsCurrent
                  
                  $
                  2,990,763
                  
                  
                  $
                  2,967,248Non-current
                  
                  
                  2,941,189
                  
                  
                  
                  3,463,998Total
      retentions
                  
                  $
                  5,931,952
                  
                  
                  $
                  6,431,246
  15
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 These
balances represent portions of billings made by the Company but held for payment
by the customer, pending satisfactory completion of the project. Retention
payments are generally collected within one year of the completion of the
project.
 
 Costs and estimated earnings
in excess of billings
 
 The
current asset “Costs and estimated earnings in excess of billings” on contracts,
represents revenues recognized in excess of amounts billed.
 
 Costs and
estimated earnings in excess of billings consist of the following:
 June 30, 2010
                          (Unaudited)
                        
                        
                        December 31,
                          2009Contract
      costs incurred plus recognized profits less recognizedlosses
      to date
                        
                        $
                        144,112,724
                        
                        
                        $
                        116,754,059Less:
      progress billings
                        
                        
                        (88,810,682
                        )
                        
                        
                        (80,191,486
                        )Costs
      and estimated earnings in excess of billings
                        
                        $
                        55,302,042
                        
                        
                        $
                        36,562,573
 
 Billings in excess of costs
and estimated earnings
 
 The
current liability “Billings in excess of costs and estimated earnings” on
contracts, represents billings in excess of revenues recognized.
 
 Billings
in excess of costs and estimated earnings consists of the
following:
 
 June 30, 2010
                    (Unaudited)
                  
                  
                  December 31,
                    2009Progress
      billings
                  
                  $
                  9,471,543
                  
                  
                  $
                  14,679,369Less:
      contracts costs incurred plus recognized profits less recognized losses to
      date
                  
                  
                  (7,983,209
                  )
                  
                  
                  (16,109,368
                  )Billings
      in excess of costs and estimated earnings
                  
                  $
                  1,488,334
                  
                  
                  $
                  1,429,999
 
 Research and
development
 
 Research
and development expenses include salaries, consultant fees, supplies and
materials, as well as costs related to other overhead such as depreciation,
facilities, utilities and other departmental expenses. The costs that the
Company incurs with respect to internally developed technology and engineering
services are included in research and development expenses as incurred as they
do not directly relate to any particular licensee, license agreement or licenses
fee.
  16
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Warranty
 
 Generally,
the Company’s products are not covered by specific warranty terms. However, it
is the Company’s policy to replace parts if they become defective within one
year after deployment at no additional charge to the customer.  The
Company maintains a provision for potential warranty costs on these products for
one year.  This provision represents management’s assessment of the
Company’s history of warranty costs while incorporating estimates by the quality
review staff of the potential product failure rates.  The Company
records a warranty obligation in selling expense at the time revenue is
recognized.   For the three months ended June 30, 2010 and 2009,
the Company recorded $0 and $47,777, respectively, as a provision for estimated
warranty claims. For the six months ended June 30, 2010 and 2009, the Company
recorded $0, and $62,973, respectively, as a provision for estimated warranty
claims.
 
 Fair value of financial
instruments
 
 ASC
825-10-50, "Disclosures about Fair Value of Financial Instruments," defines
financial instruments and requires fair value disclosures for those instruments.
ASC 820-10, "Fair Value Measurements," adopted January 1, 2008, defines fair
value, establishes a three-level valuation hierarchy for disclosures of fair
value measurement and enhances disclosure requirements for fair value measures.
The carrying amounts reported in the balance sheets for receivables and payables
qualify as financial instruments and are a reasonable estimate of fair value
because of the short period of time between the origination of such instruments
and their expected realization and their current market rate of interest. The
three levels are defined as follow:
  
              Level
      1 inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active
  markets.
 
 
              Level
      2 inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the assets or liability, either directly or indirectly, for
      substantially the full term of the financial
  instruments.
 
 
              Level
      3 inputs to the valuation methodology are unobservable and significant to
      the fair value.
 
 Investments
in joint ventures are also a financial instrument.  The Company
invested $167,922 (RMB 1,140,000) in Hubei Shou An Changjiang Fire Protection
Co., Ltd for 19% equity interest, invested $311,870 in Tianxiao Fire Safety
Equipment Co., Ltd. for 16.7% ownership and $2,710 in Sureland India for 5%
equity interest. Total investment as of June 30, 2010 amounted to $482,502;
there is no quoted or observable market price for the fair value of similar long
term investments in joint ventures.  The Company then used the level 3
inputs for its valuation methodology. The determination of the fair value was
based on the cost of the capital contributed to the joint
ventures.
  17
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 During
September 2009, the Company sold its 5% interest in King Galaxy Investment
Limited at cost to Mr. Wei Jing, who is the controlling shareholder of King
Galaxy Investment Limited for cash consideration of $1.0 million. The proceeds
of $1.0 million have been fully received by the Company as of December 31,
2009. King Galaxy through its wholly owned subsidiary, China Alliance
Security Holdings Company Limited, owns 100% of Wan Sent (China) Technology Co.,
Ltd.
 
 The
Company did not identify any assets and liabilities that are required to be
presented on the balance sheet at fair value in accordance with ASC
820-10.
 
 Intangible
assets
 
 Land use
rights - All land in the People’s Republic of China is owned by the government.
However, the government grants the user “land use rights”. The Company acquired
land use rights in 2001 and the land use rights expire in 2051. The costs of
these rights are being amortized over fifty years using the straight-line
method.
 
 Technology
rights - In May 2007, the Company acquired the rights to manufacture
two fire protection products and the costs of these rights are being
amortized over ten years using the straight-line method.
 
 Intangible
assets consist of the following:
  June 30, 2010
                      (Unaudited)
                    
                    
                    December 31,
                      2009Land
      use rights
                    
                    $
                    770,789
                    
                    
                    $
                    770,789Technology
      rights
                    
                    
                    608,745
                    
                    
                    
                    608,745Accumulated
      amortization
                    
                    
                    ( 373,622
                    )
                    
                    
                    (338,378
                    )Balance
                    
                    $
                    1,005,912
                    
                    
                    $
                    1,041,156
 
 Amortization
expense amounted to $18,825 and $ 18,822 for the three months ended June 30,
2010 and 2009, respectively. Amortization expense amounted to $37,646 and
$37,641 for the six months ended June 30, 2010 and 2009,
respectively.
 
 Intangible
assets of the Company are reviewed annually, or more often when circumstances
require, to determine whether their carrying value has become impaired. The
Company considers assets to be impaired if the carrying value exceeds the future
projected cash flows from related operations. The Company also evaluates the
periods of amortization to determine whether subsequent events and circumstances
warrant revised estimates of useful lives. As of June 30, 2010, the Company
expects these assets to be fully recoverable.
  18
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Income
taxes
 
 The
Company reports income taxes pursuant to ASC 740, “Accounting for Income Taxes”
ASC 740-10, “Accounting for Uncertainty in Income Taxes” (formerly “FIN 48”).
ASC 740 requires the recognition of deferred income tax liabilities and assets
for the expected future tax consequences of temporary differences between income
tax basis and financial reporting basis of assets and liabilities. Provision for
income taxes consist of taxes currently due plus deferred taxes. Deferred tax
assets amounted to $114,236 and $84,126 as of June 30, 2010 and December 31,
2009, respectively, and are classified as prepayment and deferred expenses in
the accompanying consolidated balance sheets.
 
 Under ASC
740-10, a tax position is recognized as a benefit only if it is “more likely
than not” that the tax position would be sustained in a tax examination, with a
tax examination being presumed to occur. The amount recognized is the largest
amount of tax benefit that is greater than 50% likely of being realized on
examination. For tax positions not meeting the “more likely than not” test, no
tax benefit is recorded. ASC 740-10 also provides guidance on de-recognition,
classification, interest and penalties, accounting in interim periods,
disclosures, and transition. Penalties and interest incurred related to
underpayment of income tax are classified as income tax expense in the year
incurred.  No significant penalties or interest relating to income taxes
have been incurred during the three and six months ended June 30, 2010 and
2009.
 
 The
Company’s operations are subject to income and transaction taxes in the United
States, the PRC and the India jurisdictions. Significant estimates and judgments
are required in determining the Company’s worldwide provision for income taxes.
Some of these estimates are based on interpretations of existing tax laws or
regulations. The ultimate amount of tax liability may be uncertain as a
result.
 
 The
Company does not anticipate any events which could cause change to these
uncertainties.
 
 The
charge for taxation is based on the results for the year as adjusted for items,
which are non-assessable or disallowed. It is calculated using tax rates that
have been enacted or substantively enacted by the balance sheet
date.
 
 Deferred
tax is accounted for using the balance sheet liability method in respect of
temporary differences arising from differences between the carrying amount of
assets and liabilities in the financial statements and the corresponding tax
basis used in the computation of assessable tax profit.
  19
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 In
principal, deferred tax liabilities are recognized for all taxable temporary
differences, and deferred tax assets are recognized to the extent that it is
probable that taxable profit will be available against which deductible
temporary differences can be utilized. Deferred tax is calculated using tax
rates that are expected to apply to the period when the asset is realized or the
liability is settled. Deferred tax is charged or credited in the income
statement, except when it is related to items credited or charged directly to
equity, in which case the deferred tax is also dealt with in equity. Deferred
tax assets and liabilities are offset when they relate to income taxes levied by
the same taxation authority and the Company intends to settle its current tax
assets and liabilities on a net basis.
 
 Value Added
Tax
 
 Enterprises
or individuals who sell products, engage in repair and maintenance or import and
export goods in the PRC are subject to a value added tax in accordance with
Chinese laws. The value added tax standard rate is 17% of the gross sales price.
A credit is available whereby VAT paid on the purchases of semi-finished
products or raw materials used in the contract and production of the Company’s
finished products can be used to offset the VAT due on sales of the finished
product.  All of our PRC subsidiaries’ VAT is subject to 17% rate
except Beijing Hua An.  To support the development of the software
industry, the Chinese government has instituted policies to rebate VAT charged
for software certified by the government up to 14%. As a result, Beijing Hua An,
is paying its VAT at an effective rate of 3% for their intercompany software
sales.
 
 VAT on
sales and VAT on purchases amounted to $1,689,478 and $1,277,422 for the three
months ended June 30, 2010, respectively. VAT on sales and VAT on purchases
amounted to $2,046,371 and $1,401,272 for the three months ended June 30, 2009.
VAT on sales and VAT on purchases amounted to $3,157,369 and $2,121,581 for the
six months ended June 30, 2010, respectively. VAT on sales and VAT on purchases
amounted to $3,026,838 and $2,195,044 for the six months ended June 30, 2009.
Sales and purchases are recorded net of VAT collected and paid as the Company
acts as an agent for the government. VAT taxes are not impacted by the income
tax holiday.
 
 Stock-based
compensation
 
 The
Company adopted ASC 718, “Accounting for Stock-Based Compensation,” at the
beginning of 2006, which defines a fair-value-based method of accounting for
stock-based employee compensation and transactions in which an entity issues its
equity instruments to acquire goods and services from non-employees. Stock
compensation granted to non-employees has been determined in accordance with ASC
718 and the ASC 505-50, "Accounting for Equity Instruments that are issued to
Other than Employees for Acquiring, or in Conjunction with Selling Goods or
Services," as the fair value of the consideration received or the fair value of
equity instruments issued, whichever is more reliably measured.
  20
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Recently issued accounting
pronouncements
 
 In
January 2010, FASB issued ASU No. 2010-01- "Accounting for Distributions to
Shareholders with Components of Stock and Cash." The amendments in this Update
clarify 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 in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update are effective for interim and
annual periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. Adoption of this ASU did not have material impact on the
Company’s consolidated financial statements.
 
 In
January 2010, FASB issued ASU No. 2010-02 – "Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification." The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity.  The amendments in this update are
effective beginning in the period that an entity adopts SFAS No. 160,
“Non-controlling Interests in Consolidated Financial Statements – An Amendment
of ARB No. 51.” If an entity has previously adopted SFAS No. 160 as of the date
the amendments in this update are included in the Accounting Standards
Codification, the amendments in this update are effective beginning in the first
interim or annual reporting period ending on or after December 15, 2009. The
amendments in this update should be applied retrospectively to the first period
that an entity adopted SFAS No. 160. Adoption of this ASU did not have material
impact on the Company’s consolidated financial statements.
 
 In
January 2010, FASB issued ASU No. 2010-06 – "Improving Disclosures about Fair
Value Measurements." This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and
2.  A reporting entity should disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 fair value measurements
and describe the reasons for the transfers.  2)  Activity in
Level 3 fair value measurements.  In the reconciliation for fair value
measurements using significant unobservable inputs (Level 3), a reporting entity
should present separately information about purchases, sales, issuances, and
settlements (that is, on a gross basis rather than as one net number). This
update provides amendments to Subtopic 820-10 that clarifies existing
disclosures as follows: 1) Level of disaggregation. A reporting entity
should provide fair value measurement disclosures for each class of assets and
liabilities. A class is often a subset of assets or liabilities within a line
item in the statement of financial position. A reporting entity needs to use
judgment in determining the appropriate classes of assets and liabilities.
2) Disclosures about inputs and valuation techniques. A reporting entity
should provide disclosures about the valuation techniques and inputs used to
measure fair value for both recurring and nonrecurring fair value measurements.
Those disclosures are required for fair value measurements that fall in either
Level 2 or Level 3. The new disclosures and clarifications of existing
disclosures are 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. These disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. The
Company is currently evaluating the impact of this ASU; however, the Company
does not expect the adoption of this ASU to have a material impact on its
consolidated financial statements.
  21
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 In
February 2010, the FASB issued Accounting Standards Update 2010-09, “Subsequent
Events (Topic 855): Amendments to Certain Recognition and Disclosure
Requirements,” or ASU 2010-09. ASU 2010-09 primarily rescinds the requirement
that, for listed companies, financial statements clearly disclose the date
through which subsequent events have been evaluated. Subsequent events must
still be evaluated through the date of financial statement issuance; however,
the disclosure requirement has been removed to avoid conflicts with other SEC
guidelines. ASU 2010-09 was effective immediately upon issuance and was adopted
in February 2010.
 
 In April
2010, the FASB issued Accounting Standards Update 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,” or ASU 2010-13. This Update provides amendments to
Topic 718 to clarify that an employee share-based payment award with an exercise
price denominated in currency of a market in which a substantial porting 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 Company does not expect the adoption of ASU 2010-13 to have a
significant impact on its consolidated financial statements.
 
 In April
2010, the FASB issued Accounting Standard Update 2010-17, “Revenue
Recognition—Milestone Method (Topic 605): Milestone Method of Revenue
Recognition” or ASU 2010-17. This Update provides guidance on the recognition of
revenue under the milestone method, which allows a vendor to adopt an accounting
policy to recognize all of the arrangement consideration that is contingent on
the achievement of a substantive milestone (milestone consideration) in the
period the milestone is achieved. The pronouncement is effective on a
prospective basis for milestones achieved in fiscal years and interim periods
within those years, beginning on or after June 15, 2010. The Company does
not expect the adoption of ASU 2010-17 have a significant impact on its
consolidated financial statements.
  22
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Reclassifications
 
 Certain
prior period amounts have been reclassified to conform to the current period
presentation. These reclassifications have no effect on net income or cash
flows.
 
 Note
3 - Earnings per share
 
 The
Company reports earnings per share in accordance with the provisions of ASC
260-10, “Earnings per Share.” ASC260-10 requires presentation of basic and
diluted earnings per share in conjunction with the disclosure of the methodology
used in computing such earnings per share.  Basic earnings per share
are computed by dividing income available to common stockholders by the weighted
average common shares outstanding during the period. Diluted earnings per share
takes into account the potential dilution that could occur if securities or
other contracts to issue common stock were exercised and converted into common
stock.
 
 The
following is a reconciliation of the basic and diluted earnings per share
computation for the three months ended June 30:
  2010
                        (Unaudited)
                      
                      
                      2009
                        (Unaudited)Net
      income for earnings per share
                      
                      $
                      6,333,660
                      
                      
                      $
                      8,336,222Weighted
      average shares used in basic computation
                      
                      
                      27,595,541
                      
                      
                      
                      27,588,598Diluted
      effect of stock options and warrants
                      
                      
                      810,418
                      
                      
                      
                      710,252Weighted
      average shares used in diluted computation
                      
                      
                      28,405,959
                      
                      
                      
                      28,298,850Earnings
      per share:Basic
                      
                      $
                      0.23
                      
                      
                      $
                      0.30Diluted
                      
                      $
                      0.22
                      
                      
                      $
                      0.29
 
 The
following is a reconciliation of the basic and diluted earnings per share
computation for the six months ended June 30:
 
 2010
                      (Unaudited)
                    
                    
                    2009
                      (Unaudited)Net
      income for earnings per share
                    
                    $
                    11,580,885
                    
                    
                    $
                    13,981,825Weighted
      average shares used in basic computation
                    
                    
                    27,595,541
                    
                    
                    
                    27,587,595Diluted
      effect of stock options and warrants
                    
                    
                    807,058
                    
                    
                    
                    670,630Weighted
      average shares used in diluted computation
                    
                    
                    28,402,599
                    
                    
                    
                    28,258,225Earnings
      per share:Basic
                    
                    $
                    0.42
                    
                    
                    $
                    0.51Diluted
                    
                    $
                    0.41
                    
                    
                    $
                    0.49
  23
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 As of June 30, 2010 and 2009, all outstanding
stock options and warrants were included in the calculation of diluted earnings
per share.
 
 Note
4 - Related party transactions
 
 The
Company has other receivable from Hubei Shou An Changjiang Fire Protection
Co., Ltd. (“Hubei Shou An”), in which the Company has a 19% ownership interest.
The accounts receivable due from Hubei Shou An was $156,069 as of June 30, 2010,
which resulted from product sales prior to December 31, 2009. This amount
is expected to be repaid by December 31, 2010 in cash.
 
 In
addition, the Company has other receivable from Hubei Shou An in the amounts
of $401,921 and $396,359 as of June 30, 2010 and December 31, 2009,
respectively.  This balance was for operating capital in Hubei Shou An
and is expected to be repaid by December 31, 2010 in cash.
 
 The
Company has prepayments to Tianjin Tianxiao Fire Safety Equipment Co., Ltd., in
which the Company has 16.7% ownership interest. The prepayment to Tianjin
Tianxiao Fire Safety Equipment Co., Ltd. was $672,213 as of June 30, 2010 and
accounts payable were $272,994 as of December 31, 2009, resulting from product
purchases of $2,330,174 for the six months ended June 30, 2010, after the
restructuring of 83.3% ownership interest in Tianxiao Equipment.
 
 Advance
payments to Sureland India were $143,602 and $103,174 as of June 30, 2010 and
December 31, 2009, respectively.  This balance was for the advance
payment to Sureland India for the delivery of future services.
 
 Note
5 - Notes receivable
 
 Notes
receivable represents trade accounts receivable due from various customers where
the customers’ bank has guaranteed the payment of the receivable. This amount is
non-interest bearing and is normally paid within three to nine months. The
Company has the ability to submit their request for payment to the customer’s
bank earlier than the scheduled payment date. However, the Company will incur an
interest charge and a processing fee when they submit the payment request early.
The Company‘s notes receivable totaled $2,836,706 and $4,274,268 as of June
30, 2010 and December 31, 2009, respectively.
  24
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Note
6 - Prepayments and deferred expenses
 
 Prepayments
and deferred expenses are monies deposited with or advanced to subcontractors to
perform services on system contracting projects. Some subcontractors require a
certain amount of money to be deposited as a guarantee payment in order for them
to start performing the services.  Prepayments and deferred expenses
also include monies deposited or advanced to vendors on future inventory
purchases to ensure timely delivery. The total outstanding amount was $3,667,230
and $3,397,358 as of June 30, 2010 and December 31, 2009,
respectively.
 
 Note
7 - Investment in joint ventures
 
 During
the second quarter of 2007, the Company invested $167,922 (RMB1, 140,000) for a
19% interest in Hubei Shou An Changjiang Fire Protection Co., Ltd., located in
China Hubei, PRC.  The investment is recorded under the cost
accounting method.
 
 As of
December 31, 2009, the Company held an investment of $311,870 (RMB2, 117,246)
for a 16.7% interest in Tianjin Tianxiao Fire Safety Equipment Co., Ltd. as a
non-controlling interest holder. The investment is recorded under the cost
accounting method at fair value at the deconsolidation date.
 
 In
January, 2010, the company invested $2,710 (INR125,000) for a 5% interest in
Sureland India as a non-controlling interest holder. The investment is recorded
under the cost accounting method.
 
 Note
8 - Customer deposits
 
 Customer
deposits represent amounts advanced by customers on products orders and
maintenance services deposits and system contracting projects deposits. The
product or service normally is shipped or performed within nine months after
receipt of the advance payment and the related sale is recognized in accordance
with the Company’s revenue recognition policy.  Customer deposits also
represent amounts advanced by customers on system contracting projects deposits.
The advance payment will apply to the invoices when the Company bills the
customer based on the progression of the projects. As of June 30, 2010 and
December 31, 2009, customer deposits amounted to $2,476,834, and $2,182,790,
respectively.
 
 Note
9 - Accrued liabilities
 
 Accrued
liabilities represent subcontractors’ expenses incurred as of the balance sheet
date for system contracting projects. Accrued liabilities also represent an
accrued estimation of warranty expenses.  As of June 30, 2010 and
December 31, 2009, accrued liabilities amounted to $15,861,264 and $13,841,300
respectively.
  25
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Note
10 - Income taxes
 
 Local PRC Income
Tax
 
 Starting
from January 1, 2008, all of the Company’s Chinese subsidiaries are subject to a
25% income tax rate according to the newly issued Income Tax Laws of the PRC.
According to the PRC’s central government policy, certain new technologies
and/or high technology companies will enjoy preferential tax rate of 15%,
instead of 25%. Beijing Hua An qualifies for the preferential tax
treatment. Sureland Industrial, Sureland Equipment and Beijing Hua An will
receive a 50% income tax reduction for three years beginning in January 2009 due
to the fact that they are located in a specially designated region.
 
 India Project Office Income
Tax
 
 The
Company’s operation in India is managed on a project basis and projects are
conducted under the name of CFPG or Sureland Industrial as a foreign enterprise.
Under the India Income Tax Act, the Company’s projects are generally subject to
an income tax at an effective rate of 40% on income reported in the statutory
financial statements after appropriate tax adjustments in accordance with Indian
tax regulations.
 
 The
Company’s subsidiaries are paying the following tax rate for three and six
months ended June 30, 2009:
 
 Subsidiaries
                  
                  Income tax
                    exemption
                  
                  
                  Effective
                    income tax
                    rateSureland
      Industrial
                  
                  
                  12.5
                  %
                  
                  
                  12.5
                  %Sureland
      Equipment
                  
                  
                  12.5
                  %
                  
                  
                  12.5
                  %Beijing
      Hua An
                  
                  
                  17.5
                  %
                  
                  
                  7.5
                  %Tianxiao
      Equipment
                  
                  
                  -
                  %
                  
                  
                  25.0
                  %Shian
      Kexin
                  
                  
                  -
                  %
                  
                  
                  25.0
                  %Shanyang
      Hongshida
                  
                  
                  -
                  %
                  
                  
                  25.0
                  %
  26
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 The
Company’s subsidiaries are paying the following tax rate for three and six
months ended June 30, 2010
 
 Subsidiaries
                  
                  Income tax
                    exemption
                  
                  
                  Effective
                    income tax
                    rateSureland
      Industrial
                  
                  
                  12.5
                  %
                  
                  
                  12.5
                  %Sureland
      Equipment
                  
                  
                  12.5
                  %
                  
                  
                  12.5
                  %Beijing
      Hua An
                  
                  
                  17.5
                  %
                  
                  
                  7.5
                  %Shian
      Kexin
                  
                  
                  -
                  %
                  
                  
                  25.0
                  %Zeetech
                  
                  
                  -
                  %
                  
                  
                  40.0
                  %India
      Project Office
                  
                  
                  -
                  %
                  
                  
                  40.0
                  %Shanyang
      Hongshida
                  
                  
                  -
                  %
                  
                  
                  25.0
                  %
 
 The
provision for income taxes amounted to $1,051,259 and $ 1,357,097 for the three
months ended June 30, 2010 and 2009, respectively. The provision for income
taxes amounted to $2,054,133 and $2,150,664 for the six months ended June 30,
2010 and 2009, respectively.
 
 The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the three and six months ended June 30:
 
 Three months ended June
                                  30,
                                
                                
                                Six months ended June
                                  30,2010
                                  (Unaudited)
                                
                                
                                2009
                                  (Unaudited)
                                
                                
                                2010
                                  (Unaudited)
                                
                                
                                2009
                                  (Unaudited)U.S.
      Statutory rates
                                
                                
                                34.0
                                %
                                
                                
                                34.0
                                %
                                
                                
                                34.0
                                %
                                
                                
                                34.0
                                %Foreign
      income not recognized in USA
                                
                                
                                (34.0
                                )
                                
                                
                                (34.0
                                )
                                
                                
                                (34.0
                                )
                                
                                
                                (34.0
                                )China
      income taxes
                                
                                
                                25.0
                                
                                
                                
                                25.0
                                
                                
                                
                                25
                                
                                
                                
                                25China
      income tax exemption
                                
                                
                                (13.7
                                )
                                
                                
                                (11.8
                                )
                                
                                
                                (15.8
                                )
                                
                                
                                (12.6
                                )Other
      item (1)
                                
                                
                                3.0
                                
                                
                                
                                0.8
                                
                                
                                
                                5.9
                                
                                
                                
                                0.9Total
      provision for income taxes
                                
                                
                                14.3
                                %
                                
                                
                                14.0
                                %
                                
                                
                                15.1
                                %
                                
                                
                                13.3
                                %
 
 (1)  The
3.0% and 0.8% represents $1,208,706 and $583,352 in expenses incurred by CFSG
and CFPG that are not deductible in PRC for the three months ended June 30, 2010
and 2009 , respectively. The 5.9% and 0.9% represents $2,595,865 and $1,164,075
in expenses incurred by CFSG and CFPG that are not deductible in PRC for the six
months ended June 30, 2010, and 2009, respectively.
 
 The estimated tax savings for
the three months ended June 30, 2010 and 2009 amounted to $1,006,394 and $
1,375,546, respectively. The net effect on basic and diluted earnings per share
if the income tax had been applied would reduce basic and diluted earnings per
share for the three months ended June 30, 2010, and 2009 by $0.04 and 0.05,
respectively. The
estimated tax savings for the six months ended June 30, 2010 and 2009 amounted
to $2,146,172 and $ 2,161,025, respectively. The net effect on basic and diluted
earnings per share if the income tax had been applied would reduce basic and
diluted earnings per share for the six months ended June 30, 2010, and 2009 by
$0.08 and $0.08 respectively.
  27
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 China
Fire & Security Group, Inc. was incorporated in the United States and has
incurred net operating losses of $0 for income tax purposes for the six months
ended June 30, 2010.  The estimated net operating loss carry forwards
for United States income taxes amounted to $1,079,324 which may be available to
reduce future years’ taxable income.  These carry forwards will
expire, if not utilize, from 2027 through 2029.  Management believes
that the realization of the benefits from these losses appears uncertain due to
the Company’s limited operating history and continuing losses for United States
income tax purposes.  Accordingly, the Company has provided a 100%
valuation allowance on the deferred tax asset benefit to reduce the asset to
zero.  The net change in the valuation allowance for the three
months ended June 30, 2010 and 2009 was $0 and the accumulated valuation
allowance as of June 30, 2010 amounted to $366,970 Management reviews this
valuation allowance periodically and makes adjustments as
warranted.
 
 The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $85.5 million as of June 30, 2010, which is included in
the consolidated retained earnings and will continue to be indefinitely
reinvested in international operations.  Accordingly, no provision has been
made for U.S. deferred taxes related to future repatriation of these earnings,
nor is it practicable to estimate the amount of income taxes that would have to
be provided if the Company concluded that such earnings will be remitted in the
future.
 
 Taxes
payable
 
 Taxes
payable consisted of the following:
  June 30, 2010
                      (Unaudited)
                    
                    
                    December 31,
                      2009VAT
      taxes payable
                    
                    $
                    4,894,259
                    
                    
                    $
                    4,636,786Income
      taxes payable
                    
                    
                    1,532,807
                    
                    
                    
                    2,936,047Sales
      taxes
                    
                    
                    1,662,941
                    
                    
                    
                    1,358,372Other
      taxes payable
                    
                    
                    91,615
                    
                    
                    
                    71,265Total
                    
                    $
                    8,181,622
                    
                    
                    $
                    9,002,470
 
 Note
11 - Retirement plan
 
 The
Company and its subsidiaries are required to participate in a central pension
scheme operated by the local municipal government. The Company is required to
contribute 20% of its payroll costs to the central pension scheme in 2010 and
2009. The contributions are charged to the consolidated income statement of the
Company as they become payable in accordance with the rules of the scheme. The
aggregate contributions of the Company to retirement benefit schemes amounted to
$108,536, and $101,489 for the three months ended June 30, 2010 and 2009,
respectively. The aggregate contributions of the Company to retirement benefit
schemes amounted to $208,965 and $176,477 for the six months ended June 30,
2010 and 2009, respectively.
  28
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited) Note
12 - Statutory reserves
 
 The laws
and regulations of the People’s Republic of China require that before an
enterprise distributes profits to its partners, it must first satisfy all tax
liabilities, provide for losses in previous years, and make allocations, in
proportions determined at the discretion of the board of directors, after the
statutory reserve. The statutory reserves include a surplus reserve fund and the
enterprise fund. These statutory reserves represent restricted retained
earnings.
 
 Surplus reserve
fund
 
 The
Company is required to transfer 10% of its net income, as determined in
accordance with the PRC accounting rules and regulations, to a statutory surplus
reserve fund until such reserve balance reaches 50% of the Company’s registered
capital.
 
 The
transfer to this reserve must be made before distribution of any dividend to
shareholders. 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.
 
 Because
the surplus reserve fund already totals 50% of Sureland Industrial, Sureland
Equipment, and Beijing Hua An’s registered capital, the Company did not reserve
any surplus reserve fund at the end of June 30, 2010 for these
subsidiaries.  As of June 30, 2010, the remaining
reserve required for Shian Kexin and Shenyang Hongshida to fulfill the
50% registered capital requirement totaled $736,500.
 
 Enterprise
fund
 
 The
enterprise fund may be used to acquire plant and equipment or to increase the
working capital to expend on production and operation of the business. No
minimum contribution is required and the Company did not make any contribution
to this fund for the three and six months ended June 30, 2010 and
2009.
  29
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Note
13 - Warrants
 
 On
February 1, 2007, CFPG issued 50,000 warrants to Hayden Communication, the
Company’s investor relations consultant, as part of its compensation. These
warrants meet the conditions for equity classification pursuant to SFAS 133 and
EITF 00-19. Therefore, the warrants were classified as equity and accounted for
as compensation expenses. The warrants vested on February 1, 2008. The Company
used the Black-Scholes model to value the options at the time they were issued,
based on an exercise price of $4.25 and expiration dates of the
instruments, a risk-free rate of 4.84% and volatility of 50%. These 50,000
warrants had a fair value of $94,274 on the date of the grant and were
recognized over the one year service period.
 
 In 2008,
a total of 40,000 warrants were converted into 26,066 shares of common
stock by Hayden Communications using a cashless exercise
option.
 
 In June
2009, the remaining 10,000 warrants were converted into 6,682 shares of common
stock using a cashless exercise. There were no outstanding warrants as
of June 30, 2010.
 
 Note
14 - Options issued to employees
 
 On
December 31, 2008, pursuant to the Company's 2008 Omnibus Long-term Incentive
Plan, the Company's Board of Directors authorized the issuance of 1,000,000
shares of options for its employees with a total of 800,000 options issued to
executive officers. The options will vest evenly each quarter over the following
four years, starting from the first quarter of 2009. The Company used the Black
Scholes Model to value the options at the time they were issued, based on the
exercise price of $6.81, which was the closing price of the Company’s stock on
December 31, 2008 and using the risk-free rate of 0.875%, 1.125%, 1.313% and
1.5% and the volatility of 86% that was estimated by analyzing the trading
history of the Company’s stock. Because the Company did not have historical
history exercise period from its previous issued option, the Company used the
simplified method to calculate the term, which is the midpoint between the start
vesting date and expiration date of the options, as a variable of the model. The
1,000,000 employee options had a fair value of $3,863,606. The related
compensation expense is recognized on a straight-line basis over the four year
vesting period.
 
 The total
stock option compensation expense recognized for the three months ended June 30,
2010 and June 30, 2009 was $245,048 respectively. The total stock option
compensation expense recognized for the six months ended June 30, 2010 and June
30, 2009 was $490,097 respectively. As of June 30, 2010, approximately $2.44
million of estimated expense related to un-vested stock-based awards has yet to
be recognized and will be recognized over the employee’s remaining service
period of approximately 2.48 years.
  30
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 The
Company has stock options as follows:
 
 WeightedAverage
                      
                      
                      AggregateOptions
                      
                      
                      Exercise
                      
                      
                      IntrinsicOutstanding
                      
                      
                      Price
                      
                      
                      ValueOutstanding,
      December 31, 2008
                      
                      
                      779,500
                      
                      
                      $
                      1.43
                      
                      
                      $
                      8,925,615Granted
                      
                      
                      1,000,000
                      
                      
                      
                      6.81
                      
                      
                      
                      -ForfeitedExercised
                      
                      
                      (3,500
                      )
                      
                      
                      4.51
                      
                      
                      
                      -Outstanding,
      December 31, 2009
                      
                      
                      1,776,000
                      
                      
                      $
                      4.45
                      
                      
                      $
                      16,120,860GrantedForfeitedExercisedOutstanding,
      June 30, 2010 (Unaudited)
                      
                      
                      1,776,000
                      
                      
                      $
                      4.45
                      
                      
                      $
                      8,395,260
 
 Following
is a summary of the status of options outstanding at June 31, 2010:
 Outstanding Options
                                                
                                                
                                                Exercisable OptionsAverage
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                AverageRemaining
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                RemainingNumber of
                                                
                                                Exercise
                                                
                                                
                                                Contractual
                                                
                                                
                                                Number of
                                                
                                                
                                                Exercise
                                                
                                                
                                                ContractualOptions
                                                
                                                Price
                                                
                                                
                                                Life
                                                
                                                
                                                Options
                                                
                                                
                                                Price
                                                
                                                
                                                Life750,000
                                                
                                                $
                                                1.25
                                                
                                                
                                                
                                                6.00
                                                
                                                
                                                
                                                750,000
                                                
                                                
                                                $
                                                1.25
                                                
                                                
                                                
                                                6.006,000
                                                
                                                $
                                                4.51
                                                
                                                
                                                
                                                1.83.
                                                
                                                
                                                
                                                6,000
                                                
                                                
                                                $
                                                4.51
                                                
                                                
                                                
                                                1.8320,000
                                                
                                                $
                                                6.70
                                                
                                                
                                                
                                                2.00
                                                
                                                
                                                
                                                15,000
                                                
                                                
                                                $
                                                6.70
                                                
                                                
                                                
                                                2.001,000,000
                                                
                                                $
                                                6.81
                                                
                                                
                                                
                                                3.50
                                                
                                                
                                                
                                                375,000
                                                
                                                
                                                $
                                                6.81
                                                
                                                
                                                
                                                3.50
 
 Note
15 - Restricted stocks issued to employees
 
 On
December 1, 2009, pursuant to the Company's 2008 Omnibus Long-term Incentive
Plan, the Company's Board of Directors authorized the issuance of 1,000,000
shares of restricted stocks for its employee with total 285,000 shares of
restricted stocks issued to executive officers. The restricted stocks will vest
evenly each year over the following four years, starting from the December 1,
2009. The Company used the closing price of the Company’s stock at the time they
were issued, based on the closing price of $12.65, which was the closing price
of the Company’s stock on November 30, 2009. The 1,000,000 employee restricted
stocks had a fair value of $12,650,000. The related compensation expense is
recognized on a straight-line basis over the vesting periods.
 
 The total
restricted stock compensation expense recognized for the three and six months
ended June 30, 2010 was $790,625 and $1,581,250
respectively.
  31
 CHINA
      FIRE & SECURITY GROUP, INC. AND SUBSIDIARIESNOTES
      TO CONSOLIDATED FINANCIAL STATEMENTSJune
      30, 2010(Unaudited)
 Note
16 - Commitments and Contingencies
 
 Commitments:
 
 As
described in Note 1, Shenyang Hongshida has a registered capital of $1,465,000,
of which, $736,500 has been invested as of June 30, 2010. The remaining of
$728,500 is scheduled to be injected within two years of June 01, 2009, the date
of the Company’s by-laws.
 
 Contingencies
 
 In 2009,
the Company filed four lawsuits against four different companies for the
infringement of the Company’s intellectual properties in linear heat detectors.
These four cases are still pending. The Company expects these four pending cases
will be settled in the Company’s favor. In 2009, as a defensive move by the
Company’s lawsuit against one company, the Company was counter-sued by the
company in two cases for the invalidation of the Company’s intellectual
properties in linear heat detectors and these two cases are still pending. The
Company expects these two pending cases will be settled in the Company’s favor
in the future as well.
 
 The
Company cannot predict with certainty the result of the litigation matters and
believes that the outcome of the above described matters will not have a
material effect on its business or results of operations.
 
 Note 17 – Subsequent Events
 
 The
Company has performed an evaluation of subsequent events through the date the
financial statements were issued.
  32




Item
2. Management's Discussion and Analysis of Financial Condition and Results of
Operations




General





The
following discussion and analysis provides information which the management of
China Fire & Security Group, Inc., (the "Company" or "CFSG") believes to be
relevant to an assessment and understanding of the Company's results of
operations and financial condition. This discussion should be read together with
the Company's financial statements and the notes to financial statements, which
are included in this report.




Overview


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


Reorganization


We were
organized as a Florida corporation on June 17, 2003.




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


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


On
February 9, 2007, Unipro changed its name to China Fire & Security Group,
Inc. (CFSG) and started trading on the OTC Bulletin Board under its new ticker
symbol CFSG. On July 16, 2007, China Fire & Security Group, Inc. began
trading on the Nasdaq Capital Market and retained the ticker symbol
CFSG.




CFSG
owns, through its wholly owned subsidiary China Fire Protection Group, Inc.,
Sureland Industrial and Sureland Equipment (jointly “Sureland”). Sureland is
engaged primarily in the design, development, manufacture and sale in China of a
variety of fire safety products for the industrial fire safety market as well as
the design and installation of industrial fire safety systems in which it uses a
combination of fire safety products including its own fire safety products. To a
minor extent, it provides maintenance services for customers of its industrial
fire safety systems. Its business is primarily in China, but it has recently
begun contract manufacturing products for the export market and it has begun to
provide a fire safety system for a Chinese company operating
abroad.


33


Sureland
markets its industrial fire safety products and systems primarily to major
companies in the iron and steel, power and petrochemical industries in China. It
has also completed projects for highway and railway tunnels, wine distilleries
and a nuclear reactor. It is expanding its business in the transportation, wine,
vessels, nuclear energy, and public space markets. Its products can be readily
adapted for use on vessels and in exhibition halls and theatres. It plans to
expand its marketing efforts to secure business in these
industries.


Sureland
has internal research and development facilities engaged primarily in furthering
fire safety technologies. It believes that its technologies allow it to offer
cost-effective and high-quality fire safety products and systems. It has
developed products for industrial fire detecting and extinguishing. It believes
that it is the largest manufacturer in China that has successfully
developed a comprehensive line of linear heat detectors.




In May
2009, Beijing Shian Kexin Technology Co., Ltd. (“Shian Kexin”) was incorporated
in Beijing, China under the laws of the PRC with registered capital of
RMB5,000,000 or approximately $732,500. Shian Kexin is 100% owned by Sureland
Industrial.





In May
2009, Shenyang Hongshida Electronics Co., Ltd. (“Hongshida”) was incorporated in
Shenyang, Liaoning Province, China under the laws of the PRC with registered
capital of RMB10,000,000 or approximately  $1,465,000. Hongshida is
80% owned by Beijing Hua An Times Fire Safety Technology Co., Ltd. ("Beijing Hua
An") with a 20% non-controlling interest owned by an unrelated party. Beijing
Hua An is 100% owned by Sureland Industrial.






During
the first quarter of 2010, our wholly-owned subsidiary, China Fire Protection
Group, Inc. entered into an agreement with Zeetech System Private Limited
(“Zeetech”), our subsidiary in which we own 100%, pursuant to which China Fire
Protection Group Inc.’s entire interest (75%) in Sureland Industrial shall be
transferred to Zeetech. On March 12, 2010, the restructuring transaction was
approved by the Chinese Ministry of Commence. Subsequent to the transfer, China
Fire & Security Group, Inc. still holds 100% of the interest in Sureland
Industrial through its subsidiaries.






As of
June 30, 2010, Sureland operates more than 20 sales and liaison offices in
China. Sureland has been ranked as the leading Chinese industrial fire safety
company and the largest contractor by the China Association for Fire Prevention
based on six major factors including total revenue, growth rate, net profit,
return on assets, investment in research and development and intellectual
property. Its key products include linear heat detectors and water mist
extinguishers, whose sales volumes are the largest in China. Its products have
been used by its customers in more than 20 provinces throughout
China.


Critical
Accounting Policies and Estimates


While our
significant accounting policies are more fully described in Note 2 to our
consolidated financial statements appearing at the end of this quarterly report,
we believe that the following accounting policies are the most critical to aid
you in fully understanding and evaluating our reported financial
results.




Revenue
recognition




Revenue
is recognized when it is probable that the economic benefits will flow to the
Company as follows:




1.
            Revenue from system contracting
      projects are recognized using the percentage-of-completion method of
      accounting and, therefore, take into account the costs, estimated earnings
      and revenue to date on contracts not yet completed. Revenue recognized is
      that percentage of the total contract price that cost expended to date
      bears to anticipated final total cost, based on current estimates of costs
      to complete the contract. Contract costs include all direct material and
      labor costs and those indirect costs related to contract performance,
      such as indirect labor, supplies, tools, repairs, and depreciation costs.
      Selling, general, and administrative costs are charged to expense as
      incurred. At the time a loss on a contract becomes known, the entire
      amount of the estimated ultimate loss is recognized in the consolidated
      financial statements. Claims for additional contract costs are recognized
      upon a signed change order from the customer or in accordance with
      paragraphs 62 and 65 of AICPA Statement of Position 81-1, "Accounting for
      Performance of Construction - Type and Certain Production - Type
      Contracts" ("SOP
81-1")


34




2.
            Revenue from product sales is
      recognized when the goods are delivered and title has passed. Product
      sales revenue represents the invoiced value of goods, net of a value-added
      tax (VAT). All of the Company’s products that are sold in the PRC are
      subject to a Chinese value-added tax at a rate of 17 percent of the gross
      sales price. This VAT may be offset by VAT paid by the Company on raw
      materials and other materials included in the cost of producing the
      finished product.




3.
            Revenue from the rendering of
      Maintenance Services is recognized when such services are
      provided.




4.
            Provision is made for foreseeable
      losses as soon as they are anticipated by
    management.




5.
            Where contract costs incurred to
      date plus recognized profits less recognized losses exceed progress
      billings, the surplus is treated as an amount due from contract consumers.
      Where progress billings exceed contract costs incurred to date plus
      recognized profits less recognized losses, the surplus is treated as an
      amount due to contract
customers.


Foreign currency
translation


The
reporting currency of the Company is the US dollar. The Company uses their local
currency, Renminbi (RMB), as their functional currency. Results of operations
and cash flow are translated at the average exchange rates during the period,
and assets and liabilities are translated at the unified exchange rate as quoted
by the People’s Bank of China at the end of the period. Translation adjustments
resulting from this process are included in accumulated other comprehensive
income in the statement of changes in equity. Transaction gains and losses that
arise from exchange rate fluctuations on transactions denominated in a currency
other than the functional currency are included in the results of operations as
incurred. Historically, the Company has not entered into any currency trading or
hedging, although there is no assurance that the Company will not enter
into such activities in the future.




Plant and
equipment




Plant and
equipment are stated at cost less accumulated depreciation. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets with a 5 percent residual value.




Use of
estimates




The
preparation of financial statements in conformity with generally accepted
accounting principles of the United States of America requires management to
make estimates and assumptions that affect the amounts reported in the combined
financial statements and accompanying notes. Management believes that the
estimates utilized in preparing its financial statements are reasonable and
prudent. Actual results could differ from these estimates.





Certain
of the Company’s accounting policies require higher degrees of judgment than
others in their application. These include the recognition of revenue and
earnings from system contracting projects under the percentage of completion
method and the allowance for doubtful accounts. Management evaluates all of its
estimates and judgments on an on-going basis.


35


Inventories




Inventories
are stated at the lower of cost or market, using the weighted average method.
Inventories consist of raw materials, work in progress, finished goods and
consumables. Raw materials consist primarily of materials used in production.
Finished goods consist primarily of equipment used in project contracts. The
cost of finished goods included direct costs of raw materials as well as
direct labor used in production. Indirect production costs such as
utilities and indirect labor related to production such as assembling, shipping
and handling costs are also included in the cost of inventory. The Company
reviews its inventory annually for possible obsolete goods and to determine if
any reserves are necessary for potential obsolescence.


Accounts
receivable




Accounts
receivable represents the products sales, maintenance services and system
contracting projects with its customers that were on credit. The credit term is
generally for a period of three months for major customers. Each customer has a
maximum credit limit. The Company seeks to maintain strict control over its
outstanding receivables. Overdue balances are reviewed regularly by senior
management.


Results of Operations


Comparison
of the Three Months Ended June 30, 2010 and 2009:


For the Three Months Ended June 30,2010
                      
                      
                      2009
                      
                      
                      Y/Y ChangeAmount ($)
                      
                      
                      % of
                        Total
                        Revenue
                      
                      
                      Amount ($)
                      
                      
                      % of
                        Total
                        Revenue
                      
                      
                      Amount ($)
                      
                      
                      %RevenueSystem
      contracting projects
                      
                      
                      18,267,248
                      
                      
                      
                      80.0
                      %
                      
                      
                      18,290,930
                      
                      
                      
                      80.4
                      %
                      
                      
                      -23,682
                      
                      
                      
                      -0.1
                      %Products
                      
                      
                      3,556,422
                      
                      
                      
                      15.6
                      %
                      
                      
                      3,791,491
                      
                      
                      
                      16.7
                      %
                      
                      
                      -235,069
                      
                      
                      
                      -6.2
                      %Maintenance
      services
                      
                      
                      1,009,761
                      
                      
                      
                      4.4
                      %
                      
                      
                      649,447
                      
                      
                      
                      2.9
                      %
                      
                      
                      360,314
                      
                      
                      
                      55.5
                      %Total
      Revenue
                      
                      
                      22,833,431
                      
                      
                      
                      100.0
                      %
                      
                      
                      22,731,868
                      
                      
                      
                      100.0
                      %
                      
                      
                      101,563
                      
                      
                      
                      0.4
                      %





Total
revenues were approximately $22.8 million for the three months ended June 30,
2010 as compared to approximately $22.7 million for the three months ended June
30, 2009, a slight increase of approximately $0.1 million or 0.4 percent. This
increase was primarily attributable to the increase in our revenues from
maintenance services, offset by the decrease in our revenues from system
contracting projects and product sales. We recognized revenues from 213 total
solution, product sales and maintenance contracts for the three months ended
June 30, 2010 as compared to 205 contracts for the three months ended June 30,
2009.


Revenues
from system contracting projects decreased by 0.1 percent to $18.3 million
derived from 111 contracts for the three months ended June 30, 2010, compared to
$18.3 million derived from 113 contracts for the three months ended June 30,
2009. This slight decrease in the revenues from system contracting projects
was mainly attributable to the slowdown in the execution of system contracting
projects from the iron and steel industry, which experienced industry weakness
with lower steel selling prices and the rise in the cost of iron ore during the
period. Revenues from product sales were $3.6 million with 48 contracts executed
for the three months ended June 30, 2010, compared to $3.8 million with 40
contracts executed for the three months ended June 30, 2009. The decrease in the
revenues from product sales was mainly attributable to delays in the product
sales contract signing and execution from the iron and steel industry, which
experienced industry weakness with lower steel selling prices and the rise in
the cost of iron ore during the period. The revenues from maintenance services
increased by 55.5 percent to $1.0 million derived from 54 contracts for the
three months ended June 30, 2010, compared to $0.6 million derived from 52
contracts for the three months ended June 30, 2009. The increase in revenues
from maintenance service was mainly attributable to the rise in the unit
contract value as well as the increase in the number of maintenance service
contracts that we executed as the result of the expansion in our customer
base in the iron and steel industry during the period.


36


In
particular, the three largest total solution projects were from Wuhan Iron and
Steel Group, Capital Iron and Steel Group, and Anshan Iron and Steel Group,
which collectively contributed approximately $11.8 million of revenues,
representing 51.9 percent of total revenues for the three months ended June 30,
2010.





For the Three Months Ended June 30,2010
                          
                          
                          2009
                          
                          
                          Y/Y ChangeAmount ($)
                          
                          
                          % of
                            Revenue
                          
                          
                          Amount ($)
                          
                          
                          % of
                            Revenue
                          
                          
                          Amount ($)
                          
                          
                          %Cost
      of RevenuesSystem
      contracting projects
                          
                          
                          7,876,558
                          
                          
                          
                          43.1
                          %
                          
                          
                          6,970,283
                          
                          
                          
                          38.1
                          %
                          
                          
                          906,275
                          
                          
                          
                          13.0
                          %Products
                          
                          
                          1,856,133
                          
                          
                          
                          52.2
                          %
                          
                          
                          865,395
                          
                          
                          
                          22.8
                          %
                          
                          
                          990,738
                          
                          
                          
                          114.5
                          %Maintenance
      services
                          
                          
                          705,688
                          
                          
                          
                          69.9
                          %
                          
                          
                          395,619
                          
                          
                          
                          60.9
                          %
                          
                          
                          310,069
                          
                          
                          
                          78.4
                          %Total
      Cost of Revenues
                          
                          
                          10,438,379
                          
                          
                          
                          45.7
                          %
                          
                          
                          8,231,297
                          
                          
                          
                          36.2
                          %
                          
                          
                          2,207,082
                          
                          
                          
                          26.8
                          %Gross
      ProfitSystem
      contracting projects
                          
                          
                          10,390,690
                          
                          
                          
                          56.9
                          %
                          
                          
                          11,320,647
                          
                          
                          
                          61.9
                          %
                          
                          
                          -929,957
                          
                          
                          
                          -8.2
                          %Products
                          
                          
                          1,700,289
                          
                          
                          
                          47.8
                          %
                          
                          
                          2,926,096
                          
                          
                          
                          77.2
                          %
                          
                          
                          -1,225,807
                          
                          
                          
                          -41.9
                          %Maintenance
      services
                          
                          
                          304,073
                          
                          
                          
                          30.1
                          %
                          
                          
                          253,828
                          
                          
                          
                          39.1
                          %
                          
                          
                          50,245
                          
                          
                          
                          19.8
                          %Total
      Gross Profit
                          
                          
                          12,395,052
                          
                          
                          
                          54.3
                          %
                          
                          
                          14,500,571
                          
                          
                          
                          63.8
                          %
                          
                          
                          -2,105,519
                          
                          
                          
                          -14.5
                          %





Cost of
revenues for the three months ended June 30, 2010 was approximately $10.4
million, as compared to $8.2 million for the three months ended June 30, 2009,
an increase of approximately $2.2 million or 26.8%. The increase in our cost of
revenues was mainly driven by the increase in our unit labor cost and material
costs during the period. Gross profit for the three months ended June 30, 2010
was approximately $12.4 million, as compared to $14.5 million for the three
months ended June 30, 2009, a decrease of approximately $2.1 million or 14.5
percent. Gross margin for the three months ended June 30, 2010 was 54.3 percent,
which is lower than the gross margin of 63.8 percent for the three months ended
June 30, 2009. The decrease in our gross margin was mainly due to the decrease
in the gross margins of our system contracting projects, product sales and
maintenance services during the period.





Gross
margin of system contracting projects was 56.9 percent for the three months
ended June 30, 2010, compared to 61.9 percent for the three months ended June
30, 2009. This decrease in the gross margin of system contracting projects was
mainly attributable to the lower revenue contribution from the iron and steel
industry during the period. Total solution projects from the iron and steel
industry contributed higher gross margins than the projects from other
industries, due to a higher percentage of our self-manufactured proprietary
products being utilized in the iron and steel projects. The gross margin of
product sales was 47.8 percent for the three months ended June 30, 2010,
compared to 77.2 percent for the three months ended June 30, 2009. This decrease
in the gross margin of product sales was mainly attributable to the product mix
during the period, as a lower percentage of self-manufactured proprietary
products sold through product sales contracts during the period contributed
to lower gross margins. The gross margin of maintenance services was 30.1
percent for the three months ended June 30, 2010, compared to 39.1 percent for
the three months ended June 30, 2009. The decrease in the gross margin of
maintenance service was mainly attributable to an increase in unit labor
costs during the period.





For the Three Months Ended June 30,2010
                                          
                                          
                                          2009
                                          
                                          
                                          Y/Y ChangeAmount ($)
                                          
                                          
                                          % of
                                            Total
                                            Revenue
                                          
                                          
                                          Amount ($)
                                          
                                          
                                          % of
                                            Total
                                            Revenue
                                          
                                          
                                          Amount ($)
                                          
                                          
                                          %Operating
      ExpensesSelling
      Expense
                                          
                                          
                                          2,209,162
                                          
                                          
                                          
                                          9.7
                                          %
                                          
                                          
                                          2,237,873
                                          
                                          
                                          
                                          9.8
                                          %
                                          
                                          
                                          -28,711
                                          
                                          
                                          
                                          -1.3
                                          %General
      Administrative
                                          
                                          
                                          2,618,664
                                          
                                          
                                          
                                          11.5
                                          %
                                          
                                          
                                          1,983,443
                                          
                                          
                                          
                                          8.7
                                          %
                                          
                                          
                                          635,221
                                          
                                          
                                          
                                          32.0
                                          %Depreciation
      and Amortization
                                          
                                          
                                          202,055
                                          
                                          
                                          
                                          0.9
                                          %
                                          
                                          
                                          183,456
                                          
                                          
                                          
                                          0.8
                                          %
                                          
                                          
                                          18,599
                                          
                                          
                                          
                                          10.1
                                          %R&D
                                          
                                          
                                          399,701
                                          
                                          
                                          
                                          1.7
                                          %
                                          
                                          
                                          519,987
                                          
                                          
                                          
                                          2.4
                                          %
                                          
                                          
                                          -120,286
                                          
                                          
                                          
                                          -23.1
                                          %Total
      Operating Expenses
                                          
                                          
                                          5,429,582
                                          
                                          
                                          
                                          23.8
                                          %
                                          
                                          
                                          4,924,759
                                          
                                          
                                          
                                          21.7
                                          %
                                          
                                          
                                          504,823
                                          
                                          
                                          
                                          10.3
                                          %Income
      From Operations
                                          
                                          
                                          6,965,470
                                          
                                          
                                          
                                          30.5
                                          %
                                          
                                          
                                          9,575,812
                                          
                                          
                                          
                                          42.1
                                          %
                                          
                                          
                                          -2,610,342
                                          
                                          
                                          
                                          -27.3
                                          %


37


Operating
expenses were approximately $5.4 million for the three months ended June 30,
2010 as compared to approximately $4.9 million for the three months ended June
30, 2009, an increase of approximately $0.5 million or 10.3 percent. This
increase in operating expenses was mainly attributable to the increase in our
general administrative expenses, offset by the decrease in our selling
expenses during the period.


Selling
expenses were approximately $2.2 million for the three months ended June 30,
2010 as compared to approximately $2.2 million for the three months ended June
30, 2009, a decrease of approximately $28,711 or 1.3 percent. This decrease
in selling expenses was mainly attributable to improved cost control over
sales-related expenditure including business traveling and customer
entertainment during the period. General administrative expenses were
approximately $2.6 million for the three months ended June 30, 2010, as compared
to approximately $2.0 million for the three months ended June 30,
2009, an increase of approximately $0.6 million or 32.0 percent. The
increase in general administrative expenses were mainly attributable to the
increase in employee salaries and the compensation related to issued options and
restricted stocks during the period.  Depreciation and amortization
expenses were approximately $0.2 million for the three months ended June 30,
2010 as compared to approximately $0.2 million for the three months ended
June 30, 2009, an increase of $18,599 or 10.1 percent. This increase in
depreciation and amortization expenses was mainly due to the increase in the
number of equipment used for business operations. R&D expenses were
approximately $0.4 million for the three months ended June 30, 2010 as compared
to approximately $0.5 million for the three months ended June 30, 2009,
a decrease of $120,286 or 23.1 percent. The decrease in our R&D
expenses was mainly attributable to the variance in expenditure required in
different product development cycles.


Income
from operations was approximately $7.0 million for the three months ended June
30, 2010 as compared to approximately $9.6 million for the three months ended
June 30, 2009, a decrease of $2.6 million or 27.3 percent. The decrease in our
operating income was mainly attributable to the decrease in our gross profit and
increase in our operating expenses during the period.


Total
other income was $0.4 million for the three months ended June 30, 2010 as
compared to $0.1 for the three months ended June 30, 2009, an increase of
$0.3 million or 242.0 percent.


Income
before income tax was approximately $7.4 million for the three months ended June
30, 2010 as compared to approximately $9.7 million of income before income tax
for the three months ended June 30, 2009, a decrease of $2.3 million or 24.0
percent. This decrease in income before income tax was mainly due to the
decrease in our gross profit and increase in our operating expenses during the
period.  Provision for income tax was approximately $1.1 million for
the three months ended June 30, 2010 with an effective tax rate of
approximately 14.3 percent, as compared to approximately $1.4 million in
provision for income tax for the three months ended June 30, 2009, a decrease of
$0.3 million. This decrease in our provision for income tax was mainly due to
the decrease in our income before income tax during the period.


Our net
income was approximately $6.3 million for the three months ended June 30, 2010
as compared to approximately $8.3 million for the three months ended June 30,
2009, a decrease of approximately $2.0 million or 24.0 percent. This
decrease in the net income was mainly due to the decrease in our gross profit
and increase in our operating expenses during the period.


Currency
translation adjustments resulting from RMB appreciation amounted to $487,820 and
$69,294 for the three months ended June 30, 2010 and 2009, respectively. The
positive amount of currency translation adjustments during the period is due to
the appreciation of the RMB against the US dollar during the
period.




The income,
which adds the currency adjustment to the net income, was approximately $6.8
million for the three months ended June 30, 2010 as compared to approximately
$8.4 million in comprehensive income for the three months ended June 30, 2009, a
decrease of $1.6 million or 18.8 percent.


38


Comparison
of the Six Months Ended June 30, 2010 and 2009:





For the Six Months Ended June 30,2010
                      
                      
                      2009
                      
                      
                      Y/Y ChangeAmount ($)
                      
                      
                      % of
                        Total
                        Revenue
                      
                      
                      Amount ($)
                      
                      
                      % of
                        Total
                        Revenue
                      
                      
                      Amount ($)
                      
                      
                      %RevenueSystem
      contracting projects
                      
                      
                      33,788,996
                      
                      
                      
                      77.2
                      %
                      
                      
                      31,294,114
                      
                      
                      
                      79.3
                      %
                      
                      
                      2,494,882
                      
                      
                      
                      8.0
                      %Products
                      
                      
                      8,087,021
                      
                      
                      
                      18.5
                      %
                      
                      
                      6,915,813
                      
                      
                      
                      17.5
                      %
                      
                      
                      1,171,208
                      
                      
                      
                      16.9
                      %Maintenance
      services
                      
                      
                      1,901,140
                      
                      
                      
                      4.3
                      %
                      
                      
                      1,234,152
                      
                      
                      
                      3.2
                      %
                      
                      
                      666,988
                      
                      
                      
                      54.0
                      %Total
      Revenue
                      
                      
                      43,777,157
                      
                      
                      
                      100.0
                      %
                      
                      
                      39,444,079
                      
                      
                      
                      100.0
                      %
                      
                      
                      4,333,078
                      
                      
                      
                      11.0
                      %





Total
revenues were approximately $43.8 million for the six months ended June 30,
2010 as compared to approximately $39.4 million for the six months
ended June 30, 2009, an increase of approximately $4.3 million or 11.0
percent. This increase was primarily due to the increase in our revenues from
system contracting projects and product sales, which totally contributed 95.7
percent of revenues during the period. We recognized revenues from 260 total
solution, product sales and maintenance contracts for the six months ended June
30, 2010 as compared to 256 contracts for the six months ended June 30,
2009.





Revenues
from system contracting projects increased by 8.0 percent to $33.8 million
derived from 127 contracts for the six months ended June 30, 2010, compared
to $31.3 million derived from 140 contracts for the six months ended June 30,
2009. This increase in the revenues from system contracting projects was mainly
attributable to the increase in the number of system contracting projects we
executed and the successful execution of large-size projects from Wuhan Iron and
Steel Group during the period. Revenues from our product sales were
$8.1 million with 78 contracts executed for the six months ended June 30, 2010,
compared to $6.9 million with 62 contracts executed for the six months ended
June 30, 2009. The increase in the revenues from product sales was mainly due to
the increased demand in our linear heat detectors and other products during the
period. The revenues from maintenance services increased by 54.0 percent to
$1.9 million derived from 55 contracts for the six months ended June 30, 2010,
compared to $1.2 million derived from 54 contracts for the six months ended June
30, 2009. The increase in revenues from maintenance services was mainly
attributable to the rise in the unit contract value as well as the increase in
the number of maintenance service contracts that we executed as the result of
the expansion in our customer base during the period.


In
particular, the three largest customers were Wuhan Iron and Steel
Group, Capital Iron and Steel Group, and Shenhua Baotou Charcoal
Chemical Industry Co. Ltd., which collectively contributed approximately $25.26
million of revenues, representing 57.7 percent of total revenues for the six
months ended June 30, 2010.





For the Six Months Ended June 30,2010
                          
                          
                          2009
                          
                          
                          Y/Y ChangeAmount ($)
                          
                          
                          % of
                            Revenue
                          
                          
                          Amount ($)
                          
                          
                          % of
                            Revenue
                          
                          
                          Amount ($)
                          
                          
                          %Cost
      of RevenuesSystem
      contracting projects
                          
                          
                          15,187,843
                          
                          
                          
                          44.9
                          %
                          
                          
                          11,777,541
                          
                          
                          
                          37.6
                          %
                          
                          
                          3,410,302
                          
                          
                          
                          29.0
                          %Products
                          
                          
                          3,310,200
                          
                          
                          
                          40.9
                          %
                          
                          
                          2,077,048
                          
                          
                          
                          30.0
                          %
                          
                          
                          1,233,152
                          
                          
                          
                          59.4
                          %Maintenance
      services
                          
                          
                          1,251,906
                          
                          
                          
                          65.9
                          %
                          
                          
                          792,160
                          
                          
                          
                          64.2
                          %
                          
                          
                          459,746
                          
                          
                          
                          58.0
                          %Total
      Cost of Revenues
                          
                          
                          19,749,949
                          
                          
                          
                          45.1
                          %
                          
                          
                          14,646,749
                          
                          
                          
                          37.1
                          %
                          
                          
                          5,103,200
                          
                          
                          
                          34.8
                          %Gross
      ProfitSystem
      contracting projects
                          
                          
                          18,601,153
                          
                          
                          
                          55.1
                          %
                          
                          
                          19,516,573
                          
                          
                          
                          62.4
                          %
                          
                          
                          -915,420
                          
                          
                          
                          -4.7
                          %Products
                          
                          
                          4,776,821
                          
                          
                          
                          59.1
                          %
                          
                          
                          4,838,765
                          
                          
                          
                          70.0
                          %
                          
                          
                          -61,944
                          
                          
                          
                          -1.3
                          %Maintenance
      services
                          
                          
                          649,234
                          
                          
                          
                          34.1
                          %
                          
                          
                          441,992
                          
                          
                          
                          35.8
                          %
                          
                          
                          207,242
                          
                          
                          
                          46.9
                          %Total
      Gross Profit
                          
                          
                          24,027,208
                          
                          
                          
                          54.9
                          %
                          
                          
                          24,797,330
                          
                          
                          
                          62.9
                          %
                          
                          
                          -770,122
                          
                          
                          
                          -3.1
                          %


39


Cost of
revenues for the six months ended June 30, 2010 was approximately $19.7 million,
as compared to $14.6 million for the six months ended June 30, 2009, an increase
of approximately $5.1 million or 34.8%. Gross profit for the six months ended
June 30, 2010 was approximately $24.0 million, as compared to $24.8 million for
the six months ended June 30, 2009, a decrease of approximately $0.8 million or
3.1 percent. Gross margin for the six months ended June 30, 2010 was 54.9
percent, which is lower than the gross margin of 62.9 percent for the six months
ended June 30, 2009. The decrease in our gross margin was mainly due to the
decrease in the gross margins of our system contracting projects, product sales
and maintenance services during the period.


Gross
margin of system contracting projects was 55.1 percent for the six months ended
June 30, 2010, compared to 62.4 percent for the six months ended June 30, 2009.
This decrease in the gross margin of system contracting projects was mainly
attributable to the lower revenue contribution from iron and steel industry
during the period. Total solution projects from the iron and steel industry
contributed higher gross margins than the projects from other industries due to
a higher percentage of our self-manufactured proprietary products being utilized
in the iron and steel projects, contributing higher gross margins. The
gross margin of our product sales was 59.1 percent for the six months ended June
30, 2010, compared to 70.0 percent for the six months ended June 30, 2009.
This decrease in the gross margin of product sales was mainly attributable
to a lower percentage of our self-manufactured proprietary products being sold
in product sales contracts, which contributed higher gross margins than our
outsourced products manufactured by third parties.





For the Six Months Ended June 30,2010
                                            
                                            
                                            2009
                                            
                                            
                                            Y/Y ChangeAmount ($)
                                            
                                            
                                            % of
                                              Total
                                              Revenue
                                            
                                            
                                            Amount ($)
                                            
                                            
                                            % of
                                              Total
                                              Revenue
                                            
                                            
                                            Amount ($)
                                            
                                            
                                            %Operating
      ExpensesSelling
      Expense
                                            
                                            
                                            4,205,360
                                            
                                            
                                            
                                            9.6
                                            %
                                            
                                            
                                            4,140,191
                                            
                                            
                                            
                                            10.5
                                            %
                                            
                                            
                                            65,169
                                            
                                            
                                            
                                            1.6
                                            %General
      Administrative
                                            
                                            
                                            5,558,741
                                            
                                            
                                            
                                            12.7
                                            %
                                            
                                            
                                            3,664,082
                                            
                                            
                                            
                                            9.3
                                            %
                                            
                                            
                                            1,894,659
                                            
                                            
                                            
                                            51.7
                                            %Depreciation
      and Amortization
                                            
                                            
                                            402,161
                                            
                                            
                                            
                                            0.9
                                            %
                                            
                                            
                                            376,850
                                            
                                            
                                            
                                            1.0
                                            %
                                            
                                            
                                            25,311
                                            
                                            
                                            
                                            6.7
                                            %R&D
                                            
                                            
                                            796,597
                                            
                                            
                                            
                                            1.8
                                            %
                                            
                                            
                                            834,017
                                            
                                            
                                            
                                            2.1
                                            %
                                            
                                            
                                            -37,420
                                            
                                            
                                            
                                            -4.5
                                            %Total
      Operating Expenses
                                            
                                            
                                            10,962,859
                                            
                                            
                                            
                                            25.0
                                            %
                                            
                                            
                                            9,015,140
                                            
                                            
                                            
                                            22.9
                                            %
                                            
                                            
                                            1,947,719
                                            
                                            
                                            
                                            21.6
                                            %Income
      From Operations
                                            
                                            
                                            13,064,349
                                            
                                            
                                            
                                            29.8
                                            %
                                            
                                            
                                            15,782,190
                                            
                                            
                                            
                                            40.0
                                            %
                                            
                                            
                                            -2,717,841
                                            
                                            
                                            
                                            -17.2
                                            %


Operating
expenses were approximately $11.0 million for the six months ended June 30, 2010
as compared to approximately $9.0 million for the six months ended June 30,
2009, an increase of approximately $1.9 million or 21.6 percent. The increase in
operating expenses was mainly due to the increase in our
general administrative expenses, selling expenses and depreciation and
amortization expenses, which was offset by a decrease in R&D expenses during
the period.


Selling
expenses were approximately $4.2 million for the six months ended June 30, 2010
as compared to approximately $4.1 million for the six months ended June 30,
2009, an increase of approximately $65,169 or 1.6
percent. This increase in our selling expenses was mainly attributable
to improved cost control over sales-related expenditures including business
travel and customer entertainment during the period. General administrative
expenses were approximately $5.6 million for the six months ended June 30, 2010,
as compared to approximately $3.7 million for the six months ended June 30,
2009, an increase of approximately $1.9 million or 51.7 percent. The significant
increase in general administrative expenses was mainly attributable to the
increase in employee salaries, the compensation related to issued options
and restricted stocks and the increase in bad debt expenses during the period.
Depreciation and amortization expenses were approximately $0.4 million for the
six months ended June 30, 2010 as compared to approximately $0.4 million for the
six months ended June 30, 2009, an increase of $25,311 or 6.7 percent. The
increase in depreciation and amortization expenses was mainly due to an increase
in the number of equipment used for business operations. R&D expenses were
approximately $0.8 million for the six months ended June 30, 2010 as compared to
approximately $0.8 million for the six months ended June 30, 2009, a decrease of
$37,420 or 4.5 percent. The decrease in our R&D expenses was mainly
attributable to the variance in expenditure required in different product
development cycles.


40


Income
from operations was approximately $13.1 million for the six months ended June
30, 2010 as compared to approximately $15.8 million for the six months ended
June 30, 2009, a decrease of $2.7 million or 17.2 percent. The decrease in our
operating income was mainly attributable to the decrease in our gross profit and
increase in our operating expenses during this period.


Total
other income was approximately $0.5 million for the six months ended June 30,
2010 as compared to approximately $0.4 million for the six months ended June 30,
2009, an increase of $170,581 or 48.7 percent. This increase was mainly
attributable to the increase in our interest income during the
period.


Income
before income tax was approximately $13.6 million for the six months ended June
30, 2010 as compared to approximately $16.1 million of income before income tax
for the six months ended June 30, 2009, a decrease of $2.5 million or 15.8
percent. The reason for this decrease in income before income tax was
mainly due to the decrease in our gross profit and increase in our operating
expenses during the period. Provision for income tax was approximately $2.1
million for the six months ended June 30, 2010 as compared to approximately $2.2
million in provision for income tax for the six months ended June 30, 2009,
a decrease of $96,531. This decrease in our provision for income tax was
mainly due to the decrease in our income before income tax during the
period.


Our net
income was approximately $11.6 million for the six months ended June 30, 2010 as
compared to approximately $14.0 million net income for the six months ended June
30, 2009, a decrease of approximately $2.4 million or 17.2 percent. This
decrease in the net income was mainly due to the decrease in our gross profit
and the increase in our operating expenses during the period.


Currency
translation adjustments resulting from RMB appreciation amounted to
$467,347 and negative $108,923 as of the six months ended June 30, 2010 and
2009, respectively. The positive amount of currency translation adjustments
during the period is due to the appreciation of the RMB against the US dollar
during the period.


The
comprehensive income, which adds the currency adjustment to the net income, was
approximately $12.0 million for the six months ended June 30, 2010 as compared
to approximately $13.9 million in comprehensive income for the six months ended
June 30, 2009, a decrease of $1.8 million or 13.2 percent.


Liquidity
and Capital Resources


As of
June 30, 2010, we had working capital of $101.5 million, including cash and
cash equivalents of $27.8 million.


Statement
of Cash Flow


For
      the six months ended June 30,2010
                      
                      
                      2009Net
      cash provided by (used in) operating activities
                      
                      $
                      (4,311,313
                      )
                      
                      $
                      2,854,023Net
      cash used in investing activities
                      
                      
                      (632,450
                      )
                      
                      
                      (952,535
                      )Net
      cash used in financing activities
                      
                      
                      (2,357,483
                      )
                      
                      
                      (730,949
                      )Effect
      of foreign currency translation on cash and cash
    equivalents
                      
                      
                      98,255
                      
                      
                      
                      (33,637
                      )Net
      cash flow
                      
                      $
                      (7,202,991
                      )
                      
                      $
                      1,136,902


41


Operating
Activities


Net cash
used in operating activities was approximately $4.3 million for the six months
ended June 30, 2010 as compared to approximately $2.9 million net cash provided
by operating activities for the same period in 2009. Net cash used in
operating activities in the six months ended June 30, 2010 was mainly due to a
$3.4 million increase in accounts receivable and a $18.5 million increase in
costs and estimated earnings in excess of billings, offset by the net income of
$11.5 million, the decrease of $1.4 million in notes receivable, the increase of
$2.1 million in account payable and the increase of $1.7 million of accrued
liabilities.


The
increase of $3.4 million in accounts receivable was mainly attributable to the
delays in payment by our clients in the iron and steel industry, which
experienced industry weakness during the period. The increase of $18.5 million
in costs and estimated earnings in excess of billings was mainly due to the
increase in the aggregate value of projects in which we have recognized revenues
more than we have billed customers.


Investing
Activities


Net cash
used in investing activities in the six months ended June 30, 2010 was $0.6
million as compared to net cash used in investing activities of $0.9 million in
the same period of 2009. The cash used in investing activities in the six months
ended June 30, 2010 was mainly attributable to the capital expenditure in the
purchase of new equipment.


Financing
Activities


Net cash
used in financing activities in the six months ended June 30, 2010 totaled
$2.4 million as compared to $0.7 million used in financing activities in the
same period of 2009. The cash used in financing activities in the six
months ended June 30, 2010 was mainly attributable to the increase in restricted
cash during the period.


As a
result of the total cash activities, net cash decreased $7.2 million from
December 31, 2009 to June 30, 2010. We believe that our currently available
working capital of $101.5 million, including cash and cash equivalents of $27.8
million, is adequate to sustain our operations at our current
level.


Item
3. Quantitative and Qualitative Disclosures about Market Risk


Market
risk is the risk of loss to future earnings, to fair values or to future cash
flows that may result from changes in the price of a financial instrument. The
value of a financial instrument may change as a result of changes in interest
rates, exchange rates, commodity prices, equity prices and other market changes.
Our cash and cash equivalents are held for working capital purposes and consist
primarily of bank deposits. We do not enter into investments for trading or
speculative purposes.


Interest
Rate Risk


We
currently do not have any long-term debt. Our exposure to interest rate risk
primarily relates to the interest income generated by excess cash invested in
demand deposits. We have not used derivative financial instruments in our
investment portfolio in order to reduce interest rate risk. Interest earning
instruments carry a degree of interest rate risk and our future interest income
may change, depending on market interest rate movement.


Foreign
Currency Risk


Our
business is operated in the PRC and India, and its value is effectively
denominated in Renminbi and India’s Rupee. The fluctuation of foreign exchange
rate between U.S. dollars and Renminbi and U.S. dollar and India’s Rupee could
affect the value of our common stock. Our revenues and expenses are primarily
denominated in Renminbi and India’s Rupee, and so our exposure to foreign
exchange risks should generally be limited. We do not have material monetary
assets and liabilities denominated in U.S. dollars, although to the extent that
we do in the future, the fluctuation of foreign exchange rate would affect the
value of these monetary assets and liabilities denominated in U.S. dollars.
Generally, appreciation of Renminbi and India’s Rupee against U.S. dollars will
devaluate the assets and liabilities denominated in U.S. dollar, while
devaluation of Renminbi and India’s Rupee again U.S. dollars will appreciate the
assets and liabilities denominated in U.S. dollar. In China and India, very
limited hedging transactions are available to reduce our exposure to exchange
rate fluctuations. To date, we have not entered into any hedging transactions in
an effort to reduce our exposure to foreign currency exchange risk. While we may
decide to enter into hedging transactions in the future, the availability and
effectiveness of these hedges may be limited and we may not be able to
successfully hedge our exposure at all.


42


Item
4. Controls and Procedures.


(a)
  Evaluation of
Disclosure Controls. As required by Exchange Act Rule 13a-15(b), our
management has carried out an evaluation, under the supervision of our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures as of June 30,
2010.


Disclosure
controls and procedures refer to controls and other procedures designed to
ensure that information required to be disclosed in the reports we file or
submit under the Securities Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the SEC and
that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required
disclosure.


Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that the Company’s disclosure controls and procedures were effective
as of June 30, 2010.


(b)
  Changes in internal
control over financial
reporting. There was no change in our internal control over
financial reporting that occurred in the second quarter of 2010 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.


PART
II - OTHER INFORMATION




Item
1. Legal Proceedings


None.


Item
1A. Risk Factors


We have
no material changes to the risk factors previously disclosed in our Form 10-K
for the year ended December 31, 2009.




Item
2. Unregistered Sales of Equity Securities and Use of Proceeds


None.




Item
3. Defaults Upon Senior Securities


None.




Item
4. (Removed
and Reserved)


Item
5. Other Information


None.


43


Item
6.  Exhibits




The
following exhibits are hereby filed as part of this Quarterly Report on Form
10-Q.




Exhibit
                    Number:
                  
                  Description31.1
                  
                  Certification
      of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of
      2002.31.2
                  
                  Certification
      of Principal Accounting Officer under Section 302 of the Sarbanes-Oxley
      Act of 2002.32.1
                  
                  Certifications
      Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
      Section 1350





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant certifies that it has duly caused this Quarterly Report on
Form 10-Q to be signed on its behalf by the undersigned, thereunto duly
authorized.




CHINA
      FIRE & SECURITY GROUP, INC.Dated:
      August 9, 2010
                    By:
                    /s/ Brian
      LinBrian
      LinChief
      Executive OfficerDated:
      August 9, 2010
                    By:
                    /s/ Tongzhou
      QinTongzhou
      QinChief
      Financial
Officer


44