U.S.
SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-Q


(Mark
one)




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




For the
Quarterly Period Ended September 30, 2009


or




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




Commission
File Number 000-50491





China
Fire & Security Group, Inc.


(Name of
small business issuer in its charter)




Florida
            
            65-1193022(State
      or other jurisdiction
              of
      incorporation or organization)
            
            (I.R.S.
      Employer
              Identification
      No.)B-2508
      TYG Center, C2
              Dongsanhuanbeilu,
              Chaoyang
      District, Beijing 100027,
              People’s
      Republic of China
            
            100027(Address
      of principal executive offices)
            
            (Zip
      Code)




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





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 oNo x




As of
November 6, 2008, the Registrant had 27,593,275 shares of common stock
outstanding.








China
Fire & Security Group, Inc.




Table of
Contents




PagePART
      I -
                  
                  FINANCIAL
      INFORMATIONItem
      1.
                  
                  Financial
      Statements (unaudited):
                  
                  1Consolidated
      Balance Sheets as of September 30, 2009 (unaudited) and December 31,
      2008
                  
                  1Consolidated
      Statements of Income and Other Comprehensive IncomeFor
      the Three and Nine Months Ended September 30, 2009 and 2008
      (unaudited)
                  
                  2Consolidated
      Statements of Changes in Equity
                  
                  3Consolidated
      Statements of Cash FlowsFor
      the Nine Months Ended September 30, 2009 and 2008
    (unaudited)
                  
                  4Notes
      to Consolidated Financial Statements (unaudited)
                  
                  5Item
      2.
                  
                  Management's
      Discussion and Analysis or Plan of Operation
                  
                  32Item
      3.
                  
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  
                  44Item
      4.
                  
                  Controls
      and Procedures
                  
                  45PART II -
                  
                  OTHER
      INFORMATIONItem
      1.
                  
                  Legal
      Proceedings
                  
                  45Item
      1A.
                  
                  Risk
      Factors
                  
                  45Item
      2.
                  
                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                  
                  45Item
      3.
                  
                  Defaults
      Upon Senior Securities
                  
                  46Item
      4.
                  
                  Submission
      of Matters to a Vote of Security Holders.
                  
                  46Item
      5.
                  
                  Other
      Information
                  
                  46Item
      6.
                  
                  Exhibits
                  
                  46





Item
1. Financial Statements


CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 CONSOLIDATED
BALANCE SHEETS
 AS OF
SEPTEMBER 30, 2009 AND DECEMBER 31, 2008
  September
      30,
                                  
                                  
                                  December
      31,2009
                                  
                                  
                                  2008(Unaudited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                                  
                                  $
                                  28,483,011
                                  
                                  
                                  $
                                  26,655,333Restricted
      cash
                                  
                                  
                                  1,515,385
                                  
                                  
                                  
                                  5,377,933Notes
      receivable
                                  
                                  
                                  6,086,333
                                  
                                  
                                  
                                  3,670,259Accounts
      receivable, net of allowance for doubtful accounts of $6,091,865 and
      $4,370,362 as of September 30, 2009 and December 31, 2008,
      respectively
                                  
                                  
                                  32,408,623
                                  
                                  
                                  
                                  25,826,343Receivables
      from related party
                                  
                                  
                                  550,517
                                  
                                  
                                  
                                  466,223Other
      receivables
                                  
                                  
                                  1,706,124
                                  
                                  
                                  
                                  1,532,259Inventories
                                  
                                  
                                  5,084,589
                                  
                                  
                                  
                                  6,538,938Costs
      and estimated earnings in excess of billings
                                  
                                  
                                  35,774,224
                                  
                                  
                                  
                                  17,821,708Employee
      advances
                                  
                                  
                                  1,386,094
                                  
                                  
                                  
                                  743,868Prepayments
      and deferred expenses
                                  
                                  
                                  3,387,997
                                  
                                  
                                  
                                  2,816,976Total
      current assets
                                  
                                  
                                  116,382,897
                                  
                                  
                                  
                                  91,449,840PLANT
      AND EQUIPMENT, net
                                  
                                  
                                  8,539,508
                                  
                                  
                                  
                                  8,445,254OTHER
      ASSETS:Restricted
      cash - non current
                                  
                                  
                                  3,481,274
                                  
                                  
                                  
                                  1,872,828Accounts
      receivable - retentions
                                  
                                  
                                  3,445,092
                                  
                                  
                                  
                                  1,107,450Advances
      on building and equipment purchases
                                  
                                  
                                  -
                                  
                                  
                                  
                                  249,859Investment
      in joint ventures
                                  
                                  
                                  477,838
                                  
                                  
                                  
                                  1,167,238Intangible
      assets, net of accumulated amortization
                                  
                                  
                                  1,059,980
                                  
                                  
                                  
                                  1,116,449Total
      other assets
                                  
                                  
                                  8,464,184
                                  
                                  
                                  
                                  5,513,824Total
      assets
                                  
                                  $
                                  133,386,589
                                  
                                  
                                  $
                                  105,408,918LIABILITIES AND EQUITYCURRENT
      LIABILITIES:Accounts
      payable
                                  
                                  $
                                  7,578,793
                                  
                                  
                                  $
                                  6,664,090Customer
      deposits
                                  
                                  
                                  2,836,162
                                  
                                  
                                  
                                  6,102,026Billings
      in excess of costs and estimated earnings
                                  
                                  
                                  1,260,403
                                  
                                  
                                  
                                  4,237,528Other
      payables
                                  
                                  
                                  405,376
                                  
                                  
                                  
                                  837,973Accrued
      liabilities
                                  
                                  
                                  11,600,618
                                  
                                  
                                  
                                  6,785,409Taxes
      payable
                                  
                                  
                                  8,667,218
                                  
                                  
                                  
                                  2,092,745Total
      current liabilities
                                  
                                  
                                  32,348,570
                                  
                                  
                                  
                                  26,719,771COMMITMENTS
      AND CONTINGENCIESEQUITY:Common
      stock, $0.001 par value, 65,000,000 shares authorized, 27,593,275 and
      27,586,593 shares issued and outstanding as of September 30, 2009 and
      December 31, 2008, respectively
                                  
                                  
                                  27,593
                                  
                                  
                                  
                                  27,586Additional
      paid-in-capital
                                  
                                  
                                  20,092,548
                                  
                                  
                                  
                                  19,357,409Statutory
      reserves
                                  
                                  
                                  7,148,827
                                  
                                  
                                  
                                  7,148,827Retained
      earnings
                                  
                                  
                                  66,385,947
                                  
                                  
                                  
                                  44,850,181Accumulated
      other comprehensive income
                                  
                                  
                                  7,317,511
                                  
                                  
                                  
                                  7,305,144Total
      shareholders' equity
                                  
                                  
                                  100,972,426
                                  
                                  
                                  
                                  78,689,147Noncontrolling
      interest
                                  
                                  
                                  65,593
                                  
                                  
                                  
                                  -Total
      equity
                                  
                                  
                                  101,038,019
                                  
                                  
                                  
                                  78,689,147Total
      liabilities and equity
                                  
                                  $
                                  133,386,589
                                  
                                  
                                  $
                                  105,408,918
 
 The
accompanying notes are an integral part of these consolidated
statements.
  - 1
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
 FOR THE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
 (Unaudited)
 
 Three Months Ended September
      30,
                    
                    
                    Nine Months Ended September
    30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008REVENUESSystem
      contracting projects
                    
                    $
                    18,710,099
                    
                    
                    $
                    15,173,858
                    
                    
                    $
                    50,004,213
                    
                    
                    $
                    41,060,246Products
                    
                    
                    5,351,659
                    
                    
                    
                    978,806
                    
                    
                    
                    12,267,472
                    
                    
                    
                    5,393,942Maintenance
      services
                    
                    
                    754,671
                    
                    
                    
                    590,603
                    
                    
                    
                    1,988,823
                    
                    
                    
                    1,639,429Total
      revenues
                    
                    
                    24,816,429
                    
                    
                    
                    16,743,267
                    
                    
                    
                    64,260,508
                    
                    
                    
                    48,093,617COST
      OF REVENUESSystem
      contracting projects
                    
                    
                    7,821,254
                    
                    
                    
                    6,459,973
                    
                    
                    
                    19,598,795
                    
                    
                    
                    18,001,928Products
                    
                    
                    2,559,838
                    
                    
                    
                    117,258
                    
                    
                    
                    4,636,886
                    
                    
                    
                    1,176,638Maintenance
      services
                    
                    
                    436,026
                    
                    
                    
                    301,605
                    
                    
                    
                    1,228,186
                    
                    
                    
                    821,932Total
      cost of revenues
                    
                    
                    10,817,118
                    
                    
                    
                    6,878,836
                    
                    
                    
                    25,463,867
                    
                    
                    
                    20,000,498GROSS
      PROFIT
                    
                    
                    13,999,311
                    
                    
                    
                    9,864,431
                    
                    
                    
                    38,796,641
                    
                    
                    
                    28,093,119OPERATING
      EXPENSESelling
      and marketing
                    
                    
                    2,470,092
                    
                    
                    
                    1,718,929
                    
                    
                    
                    6,610,283
                    
                    
                    
                    5,054,642General
      and administrative
                    
                    
                    2,416,007
                    
                    
                    
                    1,132,492
                    
                    
                    
                    6,080,089
                    
                    
                    
                    3,559,940Depreciation
      and amortization expenses
                    
                    
                    197,042
                    
                    
                    
                    123,829
                    
                    
                    
                    573,892
                    
                    
                    
                    445,779Research
      and development
                    
                    
                    390,029
                    
                    
                    
                    762,382
                    
                    
                    
                    1,224,046
                    
                    
                    
                    1,656,983Total
      operating expense
                    
                    
                    5,473,170
                    
                    
                    
                    3,737,632
                    
                    
                    
                    14,488,310
                    
                    
                    
                    10,717,344INCOME
      FROM OPERATIONS
                    
                    
                    8,526,141
                    
                    
                    
                    6,126,799
                    
                    
                    
                    24,308,331
                    
                    
                    
                    17,375,775OTHER
      INCOME (EXPENSE)Other
      income
                    
                    
                    241,521
                    
                    
                    
                    280,094
                    
                    
                    
                    463,820
                    
                    
                    
                    501,737Other
      expense
                    
                    
                    (5,604
                    )
                    
                    
                    (3,675
                    )
                    
                    
                    (6,906
                    )
                    
                    
                    (89,063
                    )Interest
      income, net
                    
                    
                    99,205
                    
                    
                    
                    48,010
                    
                    
                    
                    228,507
                    
                    
                    
                    139,754Total
      other income
                    
                    
                    335,122
                    
                    
                    
                    324,429
                    
                    
                    
                    685,421
                    
                    
                    
                    552,428INCOME
      BEFORE PROVISION FOR INCOME TAXES AND NONCONTROLLING
    INTEREST
                    
                    
                    8,861,263
                    
                    
                    
                    6,451,228
                    
                    
                    
                    24,993,752
                    
                    
                    
                    17,928,203PROVISION
      FOR INCOME TAXES
                    
                    
                    1,329,732
                    
                    
                    
                    (6,736
                    )
                    
                    
                    3,480,396
                    
                    
                    
                    53,359NET
      INCOME BEFORE NONCONTROLLING INTEREST
                    
                    
                    7,531,531
                    
                    
                    
                    6,457,964
                    
                    
                    
                    21,513,356
                    
                    
                    
                    17,874,844Less:
      Net loss attributable to noncontrolling interest
                    
                    
                    (22,410
                    )
                    
                    
                    -
                    
                    
                    
                    (22,410
                    )
                    
                    
                    -NET
      INCOME ATTRIBUTABLE TO CONTROLLING INTEREST
                    
                    
                    7,553,941
                    
                    
                    
                    6,457,964
                    
                    
                    
                    21,535,766
                    
                    
                    
                    17,874,844OTHER
      COMPREHENSIVE INCOME (LOSS)Foreign
      currency translation adjustment
                    
                    
                    121,290
                    
                    
                    
                    173,873
                    
                    
                    
                    12,367
                    
                    
                    
                    3,534,472COMPREHENSIVE
      INCOME
                    
                    $
                    7,675,231
                    
                    
                    $
                    6,631,837
                    
                    
                    $
                    21,548,133
                    
                    
                    $
                    21,409,316BASIC
      EARNINGS PER SHAREWeighted
      average number of shares
                    
                    
                    27,593,275
                    
                    
                    
                    27,572,112
                    
                    
                    
                    27,589,489
                    
                    
                    
                    27,562,087Earnings
      per share
                    
                    $
                    0.27
                    
                    
                    $
                    0.23
                    
                    
                    $
                    0.78
                    
                    
                    $
                    0.65DILUTED
      EARNINGS PER SHAREWeighted
      average number of shares
                    
                    
                    28,372,332
                    
                    
                    
                    28,259,171
                    
                    
                    
                    28,299,552
                    
                    
                    
                    28,205,583Earnings
      per share
                    
                    $
                    0.27
                    
                    
                    $
                    0.23
                    
                    
                    $
                    0.76
                    
                    
                    $
                    0.63
 
 The
accompanying notes are an integral part of these consolidated
statements.
  - 2
-
 
 CHINA FIRE & SECURITY GROUP, INC. AND
SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF CHANGES IN EQUITY
 
 China Fire & Security, Inc. Shareholders' EquityRetained Earnings
                        
                        
                        Accumulated otherCommon Stock
                        
                        
                        Additional
                        
                        
                        Statutory
                        
                        
                        
                        
                        
                        comprehensive
                        
                        
                        NoncontrollingShares
                        
                        
                        Par value
                        
                        
                        paid-in-capital
                        
                        
                        reserves
                        
                        
                        Unrestricted
                        
                        
                        income
                        
                        
                        Interest
                        
                        
                        TotalsBALANCE,
      December 31, 2007
                        
                        
                        27,556,893
                        
                        
                        $
                        27,556
                        
                        
                        $
                        19,317,287
                        
                        
                        $
                        5,067,061
                        
                        
                        $
                        22,228,095
                        
                        
                        $
                        3,568,117
                        
                        
                        $
                        -
                        
                        
                        $
                        50,208,116-Net
      income
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        17,874,844
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        17,874,844Options
      issued to employees
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        36,578
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        36,578Warrants
      exercised
                        
                        
                        29,700
                        
                        
                        
                        30
                        
                        
                        
                        (30
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Foreign
      currency translation adjustment
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        3,534,472
                        
                        
                        
                        
                        
                        
                        
                        3,534,472BALANCE,
      September, 2008 (Unaudited)
                        
                        
                        27,586,593
                        
                        
                        $
                        27,586
                        
                        
                        $
                        19,353,835
                        
                        
                        $
                        5,067,061
                        
                        
                        $
                        40,102,939
                        
                        
                        $
                        7,102,589
                        
                        
                        $
                        -
                        
                        
                        $
                        71,654,010Net
      income
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        6,829,008
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        6,829,008Warrants
      exercised
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Options
      issued to employees
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        3,574
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        3,574Adjustment
      on statutory reserves
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2,081,766
                        
                        
                        
                        (2,081,766
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Foreign
      currency translation adjustment
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        202,555
                        
                        
                        
                        
                        
                        
                        
                        202,555BALANCE,
      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 noncontrolling interest
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        88,003
                        
                        
                        
                        88,003Net
      income (loss)
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        21,535,766
                        
                        
                        
                        
                        
                        
                        
                        (22,410
                        )
                        
                        
                        21,513,356Warrants
      exercised
                        
                        
                        6,682
                        
                        
                        
                        7
                        
                        
                        
                        (7
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Options
      issued to employees
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        735,146
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        735,146Foreign
      currency translation adjustment
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        12,367
                        
                        
                        
                        
                        
                        
                        
                        12,367BALANCE,
      September 30, 2009 (Unaudited)
                        
                        
                        27,593,275
                        
                        
                        $
                        27,593
                        
                        
                        $
                        20,092,548
                        
                        
                        $
                        7,148,827
                        
                        
                        $
                        66,385,947
                        
                        
                        $
                        7,317,511
                        
                        
                        $
                        65,593
                        
                        
                        $
                        101,038,019
 
 The
accompanying notes are an integral part of these consolidated
statements.
  - 3
-
 
 CHINA FIRE & SECURITY GROUP, INC. AND
SUBSIDIARIES
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
 (Unaudited)
 
 Nine Months Ended September 30,2009
                        
                        
                        2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income attributable to controlling interest
                        
                        $
                        21,535,766
                        
                        
                        $
                        17,874,844Net loss
      attributable to noncontrolling interest
                        
                        
                        (22,410
                        )
                        
                        
                        -Consolidated
      net income
                        
                        
                        21,513,356
                        
                        
                        
                        17,874,844Adjustments
      to reconcile net income to net cash (used in) provided by operating
      activities:Depreciation
                        
                        
                        611,661
                        
                        
                        
                        652,290Amortization
                        
                        
                        56,461
                        
                        
                        
                        56,224Provision
      for doubtful accounts
                        
                        
                        1,724,705
                        
                        
                        
                        527,870Gain
      (loss) on disposal of equipments
                        
                        
                        9,427
                        
                        
                        
                        (32,828
                        )Stock
      compensation to employees
                        
                        
                        735,146
                        
                        
                        
                        36,578Provision
      for estimated warranty claims
                        
                        
                        74,866
                        
                        
                        
                        -Change
      in operating assets and liabilitiesNotes
      receivable
                        
                        
                        (2,414,263
                        )
                        
                        
                        (1,569,203
                        )Accounts
      receivable
                        
                        
                        (10,825,671
                        )
                        
                        
                        (2,635,095
                        )Receivables
      from related party
                        
                        
                        (84,231
                        )
                        
                        
                        (323,278
                        )Other
      receivables
                        
                        
                        (277,941
                        )
                        
                        
                        (483,680
                        )Inventories
                        
                        
                        212,023
                        
                        
                        
                        (3,364,122
                        )Costs
      and estimated earnings in excess of billings
                        
                        
                        (17,939,056
                        )
                        
                        
                        (14,544,590
                        )Employee
      advances
                        
                        
                        (660,086
                        )
                        
                        
                        225,922Prepayments
      and deferred expenses
                        
                        
                        (592,077
                        )
                        
                        
                        (1,149,078
                        )Accounts
      payable
                        
                        
                        1,340,372
                        
                        
                        
                        754,465Customer
      deposits
                        
                        
                        (3,254,294
                        )
                        
                        
                        10,869,806Billings
      in excess of costs and estimated earnings
                        
                        
                        (2,974,893
                        )
                        
                        
                        (1,809,272
                        )Other
      payables
                        
                        
                        (412,977
                        )
                        
                        
                        1,134,642Accrued
      liabilities
                        
                        
                        4,771,623
                        
                        
                        
                        838,157Taxes
      payable
                        
                        
                        6,596,492
                        
                        
                        
                        287,605Net
      cash (used in) provided by operating activities
                        
                        
                        (1,789,357
                        )
                        
                        
                        7,347,257CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of equipment
                        
                        
                        (1,039,560
                        )
                        
                        
                        (1,637,531
                        )Advances
      on building and equipment purchase
                        
                        
                        -
                        
                        
                        
                        (156,709
                        )Proceeds
      from sale of equipments
                        
                        
                        9,828
                        
                        
                        
                        67,839Deconsolidation
      of cash held at Tianxiao Fire Safety Equipment Co. Ltd.
                        
                        
                        (241,311
                        )
                        
                        
                        -Proceeds
      from restructuring on Tianxiao Fire Safety Equipment Co.
    Ltd.
                        
                        
                        1,550,922
                        
                        
                        
                        -Proceeds
      from sales of investment in King Galaxy Investments
Limited
                        
                        
                        1,000,000
                        
                        
                        
                        -Net
      cash provided by (used in) investing activities
                        
                        
                        1,279,879
                        
                        
                        
                        (1,726,401
                        )CASH
      FLOWS FROM FINANCING ACTIVITIES:Change
      in restricted cash
                        
                        
                        2,252,851
                        
                        
                        
                        (2,039,634
                        )Capital
      contributed by noncontrolling interest shareholder
                        
                        
                        87,954
                        
                        
                        
                        -Net
      cash provided by (used in) financing activities
                        
                        
                        2,340,805
                        
                        
                        
                        (2,039,634
                        )EFFECT
      OF EXCHANGE RATE CHANGES ON CASH
                        
                        
                        (3,649
                        )
                        
                        
                        1,113,669INCREASE
      IN CASH
                        
                        
                        1,827,678
                        
                        
                        
                        4,694,891CASH
      and CASH EQUIVALENTS, beginning of period
                        
                        
                        26,655,333
                        
                        
                        
                        17,110,449CASH
      and CASH EQUIVALENTS, end of period
                        
                        $
                        28,483,011
                        
                        
                        $
                        21,805,340SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATIONIncome
      taxes paid
                        
                        $
                        759,948
                        
                        
                        $
                        36,473Interest
      paid
                        
                        $
                        -
                        
                        
                        $
                        -NON-CASH
      TRANSACTIONS INVESTING AND FINANCING ACTIVITIES:Reclassification
      of advances on building and equipment purchase to plant and equipment upon
      receipt of purchase
                        
                        $
                        249,672
                        
                        
                        $
                        390,898
 
 The
accompanying notes are an integral part of these consolidated
statements.
  - 4
-




CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (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.
 
 Current
Development
 
 Formation
ofBeijing
Shian Kexin Technology Co., Ltd (“Shian Kexin”)
 
 Shian
Kexin was incorporated in May 2009 in Beijing, China with registered capital
amounted to $732,500 (RMB5,000,000).  Shian Kexin is 100% owned by
Sureland Industrial and engages in technology developing, transferring and
consulting, computer software development and selling of fire safe product and
equipment.
 
 Formation ofShenyang
Hongshida Electronics Co., Ltd (“Shenyang Hongshida”)
 
 Shenyang
Hongshida was incorporated in Shenyang, Liaoning Province, China with registered
capital amounted to $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. ShenyangHongshida is 80% owned by Beijing Hua An
with 20% noncontrolling interest owned by an unrelated party. Shenyang Hongshida
engages in production and selling of fire equipment, electronic products,
instrumentation, computer parts and providing technical advisory services.
Shenyang Hongshida will focus on the low-end and middle-end market of fire
product. As of September 30, 2009, the registered capital received was $439,500
(RMB3,000,000) and the Company is in pre-operating stage.
 
 Sales of 5% interest in King
Galaxy Investments Limited (“King Galaxy”)
 
 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 proceed of
$1.0 million have been fully received by the Company as of September 30,
2009. King Galaxy through its wholly owned subsidiary, China Alliance
Security Holdings Company Limited, owns 100% of Wan Sent (China) Technology Co.,
Ltd.
 
 Restructuring of 83.3%
ownership in Tianjin Tianxiao Fire Safety Equipment Co., Ltd. (“Tianxiao
Equipment”)
  - 5
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 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 the
consideration price 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 proceed of $1.6
million have been fully received by the Company as of September 30,
2009.
 
 After the
restructuring of Tianxiao Equipment, Sureland Industrial held 16.7% ownership in
Tianxiao Equipment as a minority interest holder.  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 to FASB Accounting
Standards Codification  (“ASC”)  205-20-55.
 
 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
                                              %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
                                              %
  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.
  - 6
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 In June
2009, the FASB issued Statement of Financial Accounting Standards No. 168, The
FASB Accounting Standards CodificationTM and the Hierarchy of Generally
Accepted Accounting Principles a Replacement of FASB Statement No. 162 (“FAS
168”). This Standard establishes the FASB Accounting Standards Codification
(the “Codification” or “ASC”) as the source of authoritative accounting
principles recognized by the FASB to be applied by nongovernmental entities
in the preparation of financial statements in conformity with U.S. GAAP. The
Codification does not change current U.S. GAAP, but is intended to simplify
user access to all authoritative U.S. GAAP by providing all the authoritative
literature related to a particular topic in one place. The Codification is
effective for interim and annual periods ending after September 15, 2009, and as
of the effective date, all existing accounting standard documents will be
superseded. The Codification is effective for the Company in the third quarter
of 2009, and accordingly, the Company’s Quarterly Report on Form 10-Q for
the quarter ending September 30, 2009 and all subsequent public filings will
reference the Codification as the sole source of authoritative
literature.
 
 Management
has included all normal recurring adjustments considered necessary to give a
fair presentation of operating results for the periods presented. Interim
results are not necessarily indicative of results for a full year. The
information included in this Form 10-Q should be read in conjunction with
information included in the 2008 annual report filed 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.
 
 The
Company’s certain 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.
  - 7
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Revenue
recognition
 
 Revenue
is recognized when it is probable that the economic benefits will flow to the
Company as follows:
 
 1.
              Revenue
      from system contracting projects are recognized using the
      percentage-of-completion method of accounting and, therefore, take into
      account the costs, estimated earnings and revenue to date on contracts not
      yet completed. Revenue recognized is that percentage of the total contract
      price that cost expended to date bears to anticipated final total cost,
      based on current estimates of costs to complete. Contract costs include
      all direct material and labor costs and those indirect costs related to
      contract performance, such as indirect labor, supplies, tools, repairs,
      and depreciation costs. Selling, general, and administrative costs are
      charged to expense as incurred. At the time a loss on a contract becomes
      known, the entire amount of the estimated ultimate loss is recognized in
      the consolidated financial statements. Claims for additional contract
      costs are recognized upon a signed change order from the customer or in
      accordance with paragraphs 62 and 65 of the AICPA’S Statement of Position
      ("SOP") 81-1, "Accounting for Performance of Construction - Type and
      Certain Production - Type Contracts" ("SOP 81-1") [ASC
      605-35-25].
 
 2.
              Revenue
      from product sales is recognized when the goods are delivered and title
      has passed. Product sales revenue is presented net of a value-added tax
      (VAT). All of the Company’s products that are sold in the People’s
      Republic of China (“PRC”) are subject to a Chinese value-added tax at a
      rate of 17% of the gross sales price. This VAT may be offset by VAT paid
      by the Company on raw materials and other materials included in the cost
      of producing their finished
product.
 
 3.
              Revenue
      from the rendering of Maintenance Services is recognized over the service
      period on a straight-line basis.
 
 In
accordance with SFAS 48 [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 the Company’s products (fire detecting products, fire alarm control device,
and water mist/sprinkler systems) are sold via system contracting projects or as
part of the integrated products sales. The composition of these three types of
products varies significantly from project to project, both in quantity and in
dollar amounts. Although the Company could provide a breakdown of sales
contribution for 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 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 product vendors who sell their own
products directly or through channels.  Therefore, it is not practical
to separately disclose the revenues from external customers for each of the
products.
  - 8
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (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 SFAS 131 [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
EITF 00-10 [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 September 30, 2009 were translated at 6.82 RMB to $1.00
and 48.2 INR to $1.00 as compared to 6.82 RMB to $1.00 at December 31,
2008.  Equity accounts were stated at their historical
rate.  The average translation rates of RMB applied to income
statements accounts for the nine months ended September 30, 2009 and 2008 were
6.82 RMB and 6.97 RMB, respectively. The average translation rates of INR
applied to income statements accounts for the nine months ended September 30,
2009 were 49.0 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
sheet.
 
 Transaction
gains and losses that arise from exchange rate fluctuations on transactions
denominated in a currency other than the functional currency are included in the
results of operations as incurred.  Historically, the Company has not
entered any currency trading or hedging transactions, although there is no
assurance that the Company will not enter into such transactions in the
future.
  - 9
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 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
$201,140 and $325,742 for the three months ended September 30, 2009 and 2008,
respectively. Depreciation expense amounted to $611,661 and $652,290 for the
nine months ended September 30, 2009 and 2008, respectively.
 
 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 September 30, 2009, the Company expects these assets to be fully
recoverable.
  - 10
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Plant and
equipment consists of the following:
 
 September 30,
                                      2009
                                      (Unaudited)
                                    
                                    
                                    December 31,
                                      2008Buildings
      and improvements
                                    
                                    $
                                    6,439,015
                                    
                                    
                                    $
                                    6,417,304Transportation
      equipment
                                    
                                    
                                    3,195,052
                                    
                                    
                                    
                                    2,747,038Machinery
                                    
                                    
                                    873,497
                                    
                                    
                                    
                                    1,249,470Office
      equipment
                                    
                                    
                                    1,322,255
                                    
                                    
                                    
                                    1,262,426Furniture
                                    
                                    
                                    150,026
                                    
                                    
                                    
                                    90,882Total
      depreciable assets
                                    
                                    
                                    11,979,845
                                    
                                    
                                    
                                    11,767,120Less
      accumulated depreciation
                                    
                                    
                                    (3,709,440
                                    )
                                    
                                    
                                    (3,321,866
                                    )Construction
      in progress
                                    
                                    
                                    269,103
                                    
                                    
                                    
                                    -Plant
      and equipment, net
                                    
                                    $
                                    8,539,508
                                    
                                    
                                    $
                                    8,445,254
  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. 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 till December 31, 2010. As of September
30, 2009 and December 31, 2008, the Company had deposits (including restricted
cash balances) totaling to $29,954,270 and $30,765,488, 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 two major customers who represent approximately 23% of the Company’s
sales for the three months ended September 30, 2009 and the Company has one
major customer who represents approximately 11% of the Company’s sales for the
nine months ended September 30, 2009. Accounts receivable from these customers
were $0 as of September 30, 2009. The Company had one major customer who
represented approximately 34% and 21% of the Company’s sales for the three
months and nine months ended September 30, 2008,
respectively.  Accounts receivable from this customer were $0 as of
September 30, 2008.
  - 11
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 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.
  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:
 
 September 30, 2009
                              (Unaudited)
                            
                            
                            December 31,
                              2008Restricted
      cashProducts
      sales
                            
                            $
                            4,148,565
                            
                            
                            $
                            1,608,056System
      contracting projects
                            
                            
                            848,094
                            
                            
                            
                            5,642,705Total
      restricted cash
                            
                            
                            4,996,659
                            
                            
                            
                            7,250,761Restricted
      cash - non current
                            
                            
                            (3,481,274
                            )
                            
                            
                            (1,872,828
                            )Restricted
      cash - current
                            
                            $
                            1,515,385
                            
                            
                            $
                            5,377,
      933
 
 Inventories
 
 Inventories
are stated at the lower of cost or market, using the weighted average
method.
 
 Inventories
consist of the following as of:
 
 September 30, 2009
                            (Unaudited)
                          
                          
                          December 31,
                            2008Raw
      materials
                          
                          $
                          186,771
                          
                          
                          $
                          896,797Finished
      goods
                          
                          
                          4,030,935
                          
                          
                          
                          4,597,407Work
      in progress
                          
                          
                          866,883
                          
                          
                          
                          1,044,734Total
                          
                          $
                          5,084,589
                          
                          
                          $
                          6,538,938
  - 12
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Raw
materials consist primarily of materials used in production. Finished goods
consist primarily of equipment used in product sales and system contracting
projects. The costs of finished goods include direct costs of raw materials as
well as direct labor used in production. Indirect production costs such as
utilities and indirect labor related to production such as assembling, shipping
and handling costs are also included in the cost of inventory.  The
Company reviews its inventories periodically to determine if any reserves are
necessary for potential obsolescence. As of September 30, 2009 and December 31,
2008, the Company determined no reserves are necessary.
 
 Accounts
receivable
 
 Accounts
receivable represents amounts due from customers for products sales, maintenance
services and system contracting projects. Overdue balances are reviewed
regularly by senior management. Reserves are recorded when collection of amounts
due are in doubt.  Delinquent account balances are written-off after
management has determined that the likelihood of collection is not probable,
known bad debts are written off against allowance for doubtful accounts when
identified.
 
 Accounts
receivable consists of the following:
  September 30, 2009
                                (Unaudited)
                              
                              
                              December 31,
                                2008Accounts
      receivable:System
      contracting projects
                              
                              $
                              24,185,709
                              
                              
                              $
                              19,167,096Maintenance
      services
                              
                              
                              3,047,949
                              
                              
                              
                              3,193,166Products
      sales
                              
                              
                              14,711,922
                              
                              
                              
                              8,943,893Total
      accounts receivable
                              
                              
                              41,945,580
                              
                              
                              
                              31,304,155Allowance
      for bad debts
                              
                              
                              (6,091,865
                              )
                              
                              
                              (4,370,362
                              )Accounts
      receivable, net
                              
                              
                              35,853,715
                              
                              
                              
                              26,933,793Accounts
      receivable - non-current retentions
                              
                              
                              (3,445,092
                              )
                              
                              
                              (1,107,450
                              )Accounts
      receivable - current
                              
                              $
                              32,408,623
                              
                              
                              $
                              25,826,343
 
 The
activity in the allowance for doubtful accounts for trade accounts receivable
for the nine months ended September 30, 2009 and for the year ended December 31,
2008 is as follows:
 
 September 30, 2009
                            (Unaudited)
                          
                          
                          December 31,
                            2008Beginning
      allowance for doubtful accounts
                          
                          $
                          4,370,362
                          
                          
                          $
                          2,483,359Additional
      charged to bad debt expense
                          
                          
                          1,724,705
                          
                          
                          
                          1,683,336Write-off
      charged against the allowance
                          
                          
                          -
                          
                          
                          
                          -Foreign
      currency translation adjustment
                          
                          
                          (3,202
                          )
                          
                          
                          203,667Ending
      allowance for doubtful accounts
                          
                          $
                          6,091,865
                          
                          
                          $
                          4,370,362
  - 13
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Retentions
held by customers of system contracting projects included in the Company’s
accounts receivable are as follows:
  September 30, 2009
                            (Unaudited)
                          
                          
                          December 31,
                            2008RetentionsCurrent
                          
                          $
                          3,031,110
                          
                          
                          $
                          3,685,136Non-current
                          
                          
                          3,445,092
                          
                          
                          
                          1,107,450Total
      retentions
                          
                          $
                          6,476,202
                          
                          
                          $
                          4,792,586
 
 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:
 
 September 30, 2009
                            (Unaudited)
                          
                          
                          December 31,
                            2008Contract
      costs incurred plus recognized profits less recognized losses to
      date
                          
                          $
                          128,983,178
                          
                          
                          $
                          68,149,817Less:
      progress billings
                          
                          
                          (93,208,954
                          )
                          
                          
                          (50,328,109
                          )Costs
      and estimated earnings in excess of billings
                          
                          $
                          35,774,224
                          
                          
                          $
                          17,821,708
 
 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.
  - 14
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Billings
in excess of costs and estimated earnings consists of the
following:
 
 September 30, 2009
                            (Unaudited)
                          
                          
                          December 31,
                            2008Progress
      billings
                          
                          $
                          9,806,624
                          
                          
                          $
                          31,456,807Less:
      contracts costs incurred plus recognized profits less recognized losses to
      date
                          
                          
                          (8,546,221
                          )
                          
                          
                          (27,219,279
                          )Billings
      in excess of costs and estimated earnings
                          
                          $
                          1,260,403
                          
                          
                          $
                          4,237,528
 
 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 the Company
incur with respect to internally developed technology and engineering services
are included in research and development expenses as incurred as they do not
directly relate to any particular licensee, license agreement or licenses
fee.
 
 Warranty
 
 Generally,
the Company’s products are not covered by specific warranty terms. However, it
is the Company’s policy to replace parts if they become defective within one
year after deployment at no additional charge.  The Company maintains
a provision for potential warranty costs on these products for one
year.  This provision represents management’s assessment of 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.  As of September 30, 2009 and December 31, 2008, the
Company recorded $603,042 and $518,940, respectively, as reserve for estimated
warranty claims.
 
 Fair value of financial
instruments
 
 SFAS 107
[ASC 825-10-50], Disclosures About Fair Value of Financial Instruments, defines
financial instruments and requires fair value disclosures for those
instruments.  SFAS 157 [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 disclosures
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.
  - 15
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 ·
              Level
      2 inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the assets or liability, either directly or indirectly, for
      substantially the full term of the financial
  instruments.
 ·
              Level
      3 inputs to the valuation methodology are unobservable and significant to
      the fair value.
 
 The
investment in joint ventures is also a financial instrument.  The
Company invested $167,238 (RMB 1,140,000) in Hubei Shou An Changjiang Fire
Protection Co., Ltd for 19% ownership, and invested $310,600 in Tianxiao Fire
Safety Equipment Co., Ltd. for 16.7% ownership. Total investment as of September
30, 2009 amounted to $477,838 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 contribution to the joint ventures.
 
 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 SFAS 157 [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 two technology rights to manufacture
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:
 
 September 30, 2009
                            (Unaudited)
                          
                          
                          December 31,
                            2008Land
      use rights
                          
                          $
                          770,789
                          
                          
                          $
                          770,789Technology
      rights
                          
                          
                          608,745
                          
                          
                          
                          608,745Accumulated
      amortization
                          
                          
                          (319,554
                          )
                          
                          
                          (263,085
                          )Balance
                          
                          $
                          1,059,980
                          
                          
                          $
                          1,116,449
 
 Amortization
expense amounted to $18,820 and $ 18,816 for the three months ended September
30, 2009 and 2008, respectively. Amortization expense amounted to $56,461 and
$56,224 for the nine months ended September 30, 2009 and 2008,
respectively.
  - 16
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Intangible
assets of the Company are reviewed annually, more often when circumstances
require, to determine whether their carrying value has become impaired. The
Company considers assets to be impaired if the carrying value exceeds the future
projected cash flows from related operations. The Company also evaluates the
periods of amortization to determine whether subsequent events and circumstances
warrant revised estimates of useful lives. As of September 30, 2009, the Company
expects these assets to be fully recoverable.
 
 Income
taxes
 
 The
Company reports income taxes pursuant to SFAS 109, “Accounting for Income Taxes”
and FASB Interpretation 48 [primarily be incorporated into ASC 740-10]
“Accounting for Uncertainty in Income Taxes” (“FIN 48”).  SFAS 109
[primarily be incorporated into 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 $75,380and
$0 as ofSeptember
30, 2009 and December 31, 2008, respectively.
 
 Under FIN
48 [primarily be incorporated into 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. FIN 48 [primarily be
incorporated into ASC 740-10] also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosures, and transition.
 
 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.
  - 17
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (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.
 
 VAT on
sales and VAT on purchases amounted to $1,658,245and $1,241,110, respectively,
for the three months ended September 30, 2009 and$4,685,083
and $3,436,154, respectively, for the nine months ended September 30, 2009. VAT
on sales and VAT on purchases amounted to $1,573,500 and $1,195,867,
respectively, for the three months ended September 30, 2008 and $4,291,620 and
$3,266,583, respectively, for the nine months ended September 30, 2008. Sales
and purchases are recorded net of VAT collected and paid as the Company acts as
an agent for the government. VAT taxes are not impacted by the income tax
holiday.
 
 Stock-based
compensation
 
 The
Company adopted SFAS 123R [primarily be incorporated into 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 SFAS 123R [primarily be incorporated into ASC
718] and the EITF 96-18 [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.
  - 18
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Recently issued accounting
pronouncements
 
 In
January 2009, the FASB issued FSP EITF 99-20-1 [ASC 325-40], “Amendments to the
Impairment Guidance of EITF Issue No. 99-20 [ASC 325-40], “Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets”. FSP EITF 99-20-1 [ASC 325-40] changes the
impairment model included within EITF 99-20 to be more consistent with the
impairment model of SFAS 115 [ASC-320]. FSP EITF 99-20-1 [ASC 325-40]
achieves this by amending the impairment model in EITF 99-20 [ASC 325-40] to
remove its exclusive reliance on “market participant” estimates of future cash
flows used in determining fair value. Changing the cash flows used to analyze
other-than-temporary impairment from the “market participant” view to a holder’s
estimate of whether there has been a “probable” adverse change in estimated cash
flows allows companies to apply reasonable judgment in assessing whether an
other-than-temporary impairment has occurred. The adoption of FSP EITF 99-20-1
[ASC 325-40] did not have a material impact on the Company’s consolidated
financial statements because all of the investments in debt securities are
classified as trading securities.
 
 In April
2009, the FASB issued FSP FAS 157-4 [ASC 820-10], “Determining Fair Value When
the Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly” (FSP FAS 157-4).
FSP FAS 157-4 [ASC 820-10] amends SFAS 157 and provides additional guidance for
estimating fair value in accordance with SFAS 157 when the volume and level of
activity for the asset or liability have significantly decreased and also
includes guidance on identifying circumstances that indicate a transaction is
not orderly for fair value measurements. This FSP shall be applied prospectively
with retrospective application not permitted. The adoption of FSP FAS 157-4 [ASC
820-10] did not have a material impact on the Company’s consolidated financial
statements.
 
 In April
2009, the FASB issued FSP FAS 115-2 [ASC 320-10] and FAS 124-2 [ASC 958-302].
This FSP amends SFAS 115 [ASC 320-10], “Accounting for Certain Investments in
Debt and Equity Securities,” SFAS 124 [ASC 958-302], “Accounting for Certain
Investments Held by Not-for-Profit Organizations,” and EITF Issue
No. 99-20, “Recognition of Interest Income and Impairment on Purchased
Beneficial Interests and Beneficial Interests That Continue to Be Held by a
Transferor in Securitized Financial Assets,” to make the other-than-temporary
impairments guidance more operational and to improve the presentation of
other-than-temporary impairments in the financial statements. This FSP will
replace the existing requirement that the entity’s management assert it has both
the intent and ability to hold an impaired debt security until recovery with a
requirement that management assert it does not have the intent to sell the
security, and it is more likely than not it will not have to sell the security
before recovery of its cost basis. This FSP provides increased disclosure about
the credit and noncredit components of impaired debt securities that are not
expected to be sold and also requires increased and more frequent disclosures
regarding expected cash flows, credit losses, and an aging of securities with
unrealized losses. Although this FSP does not result in a change in the carrying
amount of debt securities, it does require that the portion of an
other-than-temporary impairment not related to a credit loss for a
held-to-maturity security be recognized in a new category of other comprehensive
income and be amortized over the remaining life of the debt security as an
increase in the carrying value of the security. The adoption of FSP FAS
115-2 [ASC 320-10] and FAS 124-2 [ASC 958-302] did not have a
material impact on the Company’s consolidated financial
statements.
  - 19
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 In April
2009, the FASB issued FSP FAS 107-1 [ASC 825-10] and APB 28-1 [ASC 270-10-05].
This FSP amends SFAS No. 107 [ASC 825-10], “Disclosures about Fair Value of
Financial Instruments,” to require disclosures about fair value of financial
instruments not measured on the balance sheet at fair value in interim financial
statements as well as in annual financial statements. Prior to this FSP, fair
values for these assets and liabilities were only disclosed annually. This FSP
applies to all financial instruments within the scope of SFAS 107 [ASC 825-10]
and requires all entities to disclose the method(s) and significant assumptions
used to estimate the fair value of financial instruments.  The
adoption of FSP FAS 107-1 [ASC 825-10] and APB 28-1 [ASC 270-10-05] did not have
a material impact on the Company’s consolidated financial
statements.
 
 In May
2009, the FASB issued Statement of Financial Accounting Standards No. 165,
“Subsequent Events,” (FAS 165, Subsequent Events [ASC 855-10-05],
which provides guidance to establish general standards of accounting for
and disclosures of events that occur after the balance sheet date but
before financial statements are issued or are available to be issued. FAS
165 also requires entities to disclose the date through which subsequent
events were evaluated as well as the rationale for why that date was
selected. FAS 165 is effective for interim and annual periods ending after June
15, 2009, and accordingly, the Company adopted this Standard during the
second quarter of 2009. FAS 165 requires that public entities evaluate
subsequent events through the date that the financial statements are
issued. The Company has evaluated subsequent events through the time of filing
these consolidated financial statements with the SEC on November 9,
2009.
  In June
2009, the FASB issued Statement of Financial Accounting Standards No. 166,
Accounting for Transfers of Financial Assets — an amendment of FASB
Statement No. 140 (“FAS 166”) [ASC 860], which requires entities to provide more
information regarding sales of securitized financial assets and similar
transactions, particularly if the entity has continuing exposure to the risks
related to transferred financial assets. FAS 166 eliminates the concept of
a “qualifying special-purpose entity,” changes the requirements for
derecognizing financial assets and requires additional disclosures. FAS 166
is effective for fiscal years beginning after November 15, 2009. The Company has
not completed the assessment of the impact FAS 166 will have on the
Company’s financial condition, results of operations or cash
flows.
  - 20
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 In June
2009, the FASB issued Statement of Financial Accounting Standards No. 167,
Amendments to FASB Interpretation No. 46(R) (“FAS 167”) [ASC 810-10], which
modifies how a company determines when an entity that is insufficiently
capitalized or is not controlled through voting (or similar rights) should
be consolidated. FAS 167 clarifies that the determination of whether a company
is required to consolidate an entity is based on, among other things, an
entity’s purpose and design and a company’s ability to direct the activities of
the entity that most significantly impact the entity’s economic
performance. FAS 167 requires an ongoing reassessment of whether a company is
the primary beneficiary of a variable interest entity. FAS 167 also
requires additional disclosures about a company’s involvement in variable
interest entities and any significant changes in risk exposure due to that
involvement. FAS 167 is effective for fiscal years beginning after November 15,
2009. The Company has not completed the assessment of the impact FAS 167
will have on the Company’s financial condition, results of operations or cash
flows.
  In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not
available; under those circumstances, a reporting entity is required to
measure fair value using one or more of valuation techniques, as defined. This
ASU is effective for the first reporting period, including interim periods,
beginning after the issuance of this ASU. The Company is currently evaluating
the impact of this ASU on its consolidated financial
statements.
  - 21
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing.  This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation.  This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning of those
fiscal years. The Company is currently evaluating the impact of this ASU on its
consolidated financial statements.
 
 Reclassifications
 
 Certain
prior period amounts have been reclassified to conform to the current period
presentation. These reclassifications have no effect on net income or cash
flows.
 
 Note
3 - Earnings per share
 
 The
Company reports earnings per share in accordance with the provisions of SFAS 128
[ASC 260-10], “Earnings per Share.” SFAS 128 requires presentation of basic and
diluted earnings per share in conjunction with the disclosure of the methodology
used in computing such earnings per share.  Basic earnings per share
is computed by dividing income available to common stockholders by the weighted
average common shares outstanding during the period. Diluted earnings per share
takes into account the potential dilution that could occur if securities or
other contracts to issue common stock were exercised and converted into common
stock.
 
 The
following is a reconciliation of the basic and diluted earnings per share
computation for the three and nine months ended September 30:
 
 Three months ended
                                    September 30,
                                  
                                  
                                  Nine months ended
                                    September 30,2009
                                  
                                  
                                  2008
                                  
                                  
                                  2009
                                  
                                  
                                  2008Net
      income for earnings per share
                                  
                                  $
                                  7,553,941
                                  
                                  
                                  $
                                  6,457,964
                                  
                                  
                                  $
                                  21,535,766
                                  
                                  
                                  $
                                  17,874,844Weighted
      average shares used in basic computation
                                  
                                  
                                  27,593,275
                                  
                                  
                                  
                                  27,572,112
                                  
                                  
                                  
                                  27,589,489
                                  
                                  
                                  
                                  27,562,087Diluted
      effect of stock options and warrants
                                  
                                  
                                  779,057
                                  
                                  
                                  
                                  687,059
                                  
                                  
                                  
                                  710,063
                                  
                                  
                                  
                                  643,496Weighted
      average shares used in diluted computation
                                  
                                  
                                  28,372,332
                                  
                                  
                                  
                                  28,259,171
                                  
                                  
                                  
                                  28,299,552
                                  
                                  
                                  
                                  28,205,583Earnings
      per share:Basic
                                  
                                  $
                                  0.27
                                  
                                  
                                  $
                                  0.23
                                  
                                  
                                  $
                                  0.78
                                  
                                  
                                  $
                                  0.65Diluted
                                  
                                  $
                                  0.27
                                  
                                  
                                  $
                                  0.23
                                  
                                  
                                  $
                                  0.76
                                  
                                  
                                  $
                                  0.63
  - 22
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 As of
September 30, 2009 and 2008, all outstanding stock options and warrants were
included in the calculation of diluted earnings per share.
 
 Note
4 - Related party transactions
 
 The
Company has accounts receivable from Hubei Shou An Changjiang Fire Protection
Co., Ltd. (“Hubei Shou An”), in which the Company has a 19% ownership interest.
The receivable due from Hubei Shou An was $153,277 and $114,388 as of September
30, 2009 and December 31, 2008, respectively, resulted from product sales. This
amount was expected to be repaid by December 31, 2009 in cash.
 
 The
Company has other receivable from Hubei Shou An. The receivable due from Hubei
Shou An was $397,240 and $351,835 as of September 30, 2009 and December 31,
2008, respectively.  This balance was for operating capital in Hubei
Shou and expected to be repaid by December 31, 2009 in cash.
 
 The
Company has prepayments to Tianjin Tianxiao Fire Safety Equipment Co., Ltd., in
which the Company has 16.7% ownership interest. The prepayments due to Tianjin
Tianxiao Fire Safety Equipment Co., Ltd. was $18,956 and $0 as of September 30,
2009 and December 31, 2008, respectively, resulted from product
purchase.
 
 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 $6,086,333and$3,670,259 as of September 30, 2009 and December 31, 2008,
respectively.
 
 Note
6 - Prepayments and deferred expenses
 
 Prepayments
and deferred expenses are monies deposited with or advanced to subcontractors to
perform services on System Contracting Projects. Some subcontractors require a
certain amount of money to be deposited as a guarantee payment in order for them
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 $3,387,997
and $2,816,976 as of September 30, 2009and December
31, 2008, respectively.
  - 23
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Note
7 - Investment in joint ventures
 
 During
the second quarter of 2007, the Company invested $167,238(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
September 30, 2009, the Company held an investment of $310,600 (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.
 
 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 billed our
customer based on the progression of the projects. As of September 30, 2009 and
December 31, 2008 customer deposits amounted to $2,836,162, and $6,102,026,
respectively.
 
 Note
9 - Accrued liabilities
 
 Accrued
liabilities represent subcontractors’ expenses incurred as of balance sheet date
for system contracting projects. Accrued liabilities also represent accrued
estimation of warranty expenses.  As of September 30, 2009and December
31, 2008, accrued liabilities amounted to $11,600,618 and $6,785,409
respectively.
 
 Note
10 - Income taxes
 
 Prior to
January 1, 2008, under the Income Tax Laws of PRC, the Company’s subsidiaries
are generally subject to an income tax at an effective rate of 25% on income
reported in the statutory financial statements after appropriate tax
adjustments, unless the enterprise is located in a specially designated region
where it allows enterprises a three-year income tax exemption and a 50% income
tax reduction for the following three years or the enterprise is a manufacturing
related joint venture with a foreign enterprise or a wholly owned subsidiary of
a foreign enterprise, where it allows enterprises a two-year income tax
exemption and a 50% income tax reduction for the following three
years.
  - 24
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Beginning
from January 1, 2008, the new Enterprise Income Tax (“EIT”) law replaced the
existing income tax laws for Domestic Enterprises (“DES”) and Foreign Invested
Enterprises (“FIEs”).
 
 The key
changes are:
 
 a.
              The
      new standard EIT rate of 25% will replace the 33% rate currently
      applicable to both DES and FIEs, except for High Tech companies who pays a
      reduced rate of 15%;
 b.
              Companies
      established before March 16, 2007 will continue to enjoy tax holiday
      treatment approved by local government for a grace period of the next 5
      years or until the tax holiday term is completed, whichever is
      sooner.
 
 The
Company’s subsidiaries were paying the following tax rate for the three and nine
months ended September 30, 2008 (Unaudited).
 
 Subsidiaries
                        
                        Income tax
                          exemption
                        
                        
                        Effective
                          income tax
                          rateSureland
      Industrial
                        
                        
                        25.0
                        %
                        
                        
                        -
                        %Sureland
      Equipment
                        
                        
                        12.5
                        %
                        
                        
                        12.5
                        %Beijing
      Hua An
                        
                        
                        25.0
                        %
                        
                        
                        -
                        %Tianxiao
      Equipment
                        
                        
                        -
                        %
                        
                        
                        25.0
                        %
 
 The
Company’s subsidiaries are paying the following tax rate for the three and nine
months ended September 30, 2009 (Unaudited).
 
 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 (six months ended June 30, 2009)
                        
                        
                        -
                        %
                        
                        
                        25.0
                        %Shian
      Kexin
                        
                        
                        -
                        %
                        
                        
                        25.0
                        %Shanyang
      Hongshida
                        
                        
                        -
                        %
                        
                        
                        25.0
                        %
 
 The
provision (credit) for income taxes amounted to $1,329,732 and ($6,736) for the
three months ended September 30, 2009 and 2008, respectively. The provision for
income taxes amounted to $3,480,396 and $53,359 for the nine months ended
September 30, 2009and
2008, respectively.
  - 25
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the three and nine months ended September 30,
(unaudited):
 
 Three months ended
                        
                        
                        Nine months ended2009
                        
                        
                        2008
                        
                        
                        2009
                        
                        
                        2008U.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
                        
                        
                        
                        25.0
                        
                        
                        
                        25.0China
      income tax exemption
                        
                        
                        (10.5
                        )
                        
                        
                        (25.1
                        )
                        
                        
                        (11.9
                        )
                        
                        
                        (24.7
                        )Other
      item (1)
                        
                        
                        0.5
                        
                        
                        
                        0.0
                        
                        
                        
                        0.8
                        
                        
                        
                        0.0Total
      provision for income taxes
                        
                        
                        15.0
                        %
                        
                        
                        (0.1
                        )
      %
                        
                        
                        13.9
                        %
                        
                        
                        0.3
                        %
 
 (1)  The
0.5% and 0.0% represents $339,818 and $166,994 expenses incurred by CFSG and
CFPG that are not deductible in PRC for the three months ended September 30,
2009 and 2008. The 0.8% and 0.0% represents the $1,503,893 and $784,995 expenses
incurred by CFSG and CFPG that are not deductible in PRC for the nine months
ended September 30, 2009 and 2008.
 
 The
estimated tax savings for the three months ended September 30, 2009 and 2008
amounted to $1,171,522 and $1,414,294, respectively. The net effect on basic and
diluted earnings per share if the income tax had been applied would decrease
basic and diluted earnings per share for the three months ended September 30,
2009, and 2008 by $0.04 and $0.05, respectively. The estimated tax savings for
the nine months ended September 30, 2009 and 2008 amounted to $3,332,547 and
$4,611,290, respectively. The net effect on basic and diluted earnings per share
if the income tax had been applied would decrease basic and diluted earnings per
share for the nine months ended September 30, 2009, and 2008 by $0.12 and $0.17
respectively.
 
 China
Fire & Security Group, Inc. was incorporated in the United States and has
incurred net operating losses of $0 for income tax purposes for the nine months
ended September 30, 2009.  The estimated net operating loss carry
forwards for United States income taxes amounted to $1,004,414 which may be
available to reduce future years’ taxable income.  These carry
forwards will expire, if not utilize, from 2025 through
2027.  Management believes that the realization of the benefits from
these losses appears uncertain due to the Company’s limited operating history
and continuing losses for United States income tax
purposes.  Accordingly, the Company has provided a 100% valuation
allowance on the deferred tax asset benefit to reduce the asset to
zero.  The net change in the valuation allowance for the period ended
September 30, 2009 was $0 and the accumulated valuation allowance as of
September 30, 2009 amounted to $341,501. Management reviews this valuation
allowance periodically and makes adjustments as warranted.
  - 26
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $68.6 million as of September 30, 2009, which are included in
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:
 
 September 30, 2009
                            (Unaudited)
                          
                          
                          December 31,
                            2008VAT
      taxes payable
                          
                          $
                          4,599,548
                          
                          
                          $
                          1,094,089Income
      taxes payable
                          
                          
                          2,558,383
                          
                          
                          
                          38,406Sales
      taxes
                          
                          
                          1,463,846
                          
                          
                          
                          936,164Other
      taxes payable
                          
                          
                          45,441
                          
                          
                          
                          24,086Total
                          
                          $
                          8,667,218
                          
                          
                          $
                          2,092,745
 
 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 2009 and
2008. 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
$92,697 and $54,879 for the three months ended September 30, 2009 and
2008, respectively.  The aggregate contributions of the Company to
retirement benefit schemes amounted to $269,174 and $179,806 for the
nine months ended September 30, 2009 and 2008, respectively.
 
 Note
12 - Statutory reserves
 
 The laws
and regulations of the People’s Republic of China require that before an
enterprise distributes profits to its partners, it must first satisfy all tax
liabilities, provide for losses in previous years, and make allocations, in
proportions determined at the discretion of the board of directors, after the
statutory reserve. The statutory reserves include surplus reserve fund and the
enterprise fund. These statutory reserves represent restricted retained
earnings.
  - 27
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Surplus reserve
fund
 
 The
Company is required to transfer 10% of its net income, as determined in
accordance with the PRC accounting rules and regulations, to a statutory surplus
reserve fund until such reserve balance reaches 50% of the Company’s registered
capital.
 
 The
transfer to this reserve must be made before distribution of any dividend to
shareholders. For the nine months ended September 30, 2008, the Company did not
make any contribution to this fund. Because the balance of Surplus reserve fund
already totals 50% of the Company’s registered capital, the Company did not
reserve any surplus reserve fund for the nine months ended September 30,
2009.  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.
 
 Enterprise
fund
 
 The
enterprise fund may be used to acquire plant and equipment or to increase the
working capital to expend on production and operation of the business. No
minimum contribution is required and the Company did not make any contribution
to this fund for the nine months ended September 30, 2009 and 2008.
 
 Note 13 -
Warrants
 
 In 2008,
a total of 45,000 warrants were converted into 29,700 shares of common stock by
the warrants holders using the cashless exercise option.
 
 In June
2009, 10,000 warrants were converted into 6,682 shares of common stock by the
warrants holders using the cashless exercise option.
 
 The
Company’s warrant activity is as follows:
 
 Weighted
                                                      
                                                      
                                                      AverageAverage
                                                      
                                                      
                                                      RemainingWarrants
                                                      
                                                      Exercise
                                                      
                                                      
                                                      ContractualOutstanding
                                                      
                                                      Price
                                                      
                                                      
                                                      Life (years)Outstanding,
      December 31, 2007
                                                      
                                                      
                                                      55,000
                                                      
                                                      
                                                      $
                                                      4.19
                                                      
                                                      
                                                      
                                                      4.08Granted
                                                      
                                                      
                                                      
                                                      
                                                      
                                                      4.25ForfeitedExercised
                                                      
                                                      
                                                      (45,000
                                                      )
                                                      
                                                      
                                                      4.24Outstanding,
      December 31, 2008
                                                      
                                                      
                                                      10,000
                                                      
                                                      
                                                      $
                                                      4.25
                                                      
                                                      
                                                      
                                                      2.09GrantedForfeitedExercised
                                                      
                                                      (10,000
                                                      )
                                                      4.25Outstanding,
      September 30, 2009 (Unaudited)
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      
                                                      -
  - 28
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Note
14 - Options issued to employees
 
 On
January 30, 2008, the Company’s 2008 Omnibus Long-term Incentive Plan was
adopted and approved by shareholders. Pursuant to the 2008 Omnibus Long-term
Incentive Plan, the Company reserved 2,000,000 shares of our common stock for
issuance.
  On
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 employee with total 800,000 shares options issued to
executive officers. The options will vest evenly each quarter over the following
four years, starting from the first quarter of 2009. 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 close 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 do 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
September 30, 2009 and 2008 was $245,049 and $3,574,
respectively.  The total stock option compensation expense recognized
for the nine months ended September 30, 2009 and 2008 was $735,146 and $36,578,
respectively. As of September 30, 2009, approximately $3.13 million of estimated
expense with respect to un-vested stock-based awards has yet to be recognized
and will be recognized in expense over the employee’s remaining service period
of approximately 3.3 years.
  - 29
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 The
Company has stock options as follows:
 
 Options
                            Outstanding
                          
                          
                          Weighted
                            Average
                            Exercise
                            Price
                          
                          
                          Aggregate
                            Intrinsic
                            ValueOutstanding,
      December 31, 2007
                          
                          
                          779,500
                          
                          
                          $
                          1.43
                          
                          
                          $
                          8,925,615GrantedForfeitedExercisedOutstanding,
      December 31, 2008
                          
                          
                          779,500
                          
                          
                          $
                          1.43
                          
                          
                          $
                          4,194,190Granted
                          
                          
                          1,000,000
                          
                          
                          
                          6.81ForfeitedExercisedOutstanding,
      September 30, 2009 (Unaudited)
                          
                          
                          1,779,500
                          
                          
                          $
                          4.45
                          
                          
                          $
                          26,247,625
 
 Following
is a summary of the status of options outstanding at September 30,
2009:
 
 Outstanding Options
                                      
                                      
                                      Exercisable OptionsNumber of
                                        Options
                                      
                                      
                                      Exercise
                                        Price
                                      
                                      
                                      Average
                                        Remaining
                                        Contractual
                                        Life
                                      
                                      
                                      Number of
                                        Options
                                      
                                      
                                      Exercise
                                        Price
                                      
                                      
                                      Average
                                        Remaining
                                        Contractual
                                        Life750,000
                                      
                                      
                                      $
                                      1.25
                                      
                                      
                                      
                                      6.8
                                      
                                      
                                      
                                      750,000
                                      
                                      
                                      $
                                      1.25
                                      
                                      
                                      
                                      6.89,500
                                      
                                      
                                      $
                                      4.51
                                      
                                      
                                      
                                      2.6
                                      
                                      
                                      
                                      9,500
                                      
                                      
                                      $
                                      4.51
                                      
                                      
                                      
                                      2.620,000
                                      
                                      
                                      $
                                      6.70
                                      
                                      
                                      
                                      2.8
                                      
                                      
                                      
                                      10,000
                                      
                                      
                                      $
                                      6.70
                                      
                                      
                                      
                                      2.81,000,000
                                      
                                      
                                      $
                                      6.81
                                      
                                      
                                      
                                      4.3
                                      
                                      
                                      
                                      125,000
                                      
                                      
                                      $
                                      6.81
                                      
                                      
                                      
                                      4.3
 
 Note
15 - Commitments and Contingencies
 
 Contingencies
 
 In 2008,
the Company filed five lawsuits against four different companies for the
infringement of the Company's intellectual properties. One of these cases was
eventually settled in the Company's favor in 2009. The other four cases are
still pending and management expects these cases will be settled in the
Company’s favor as well.
 
 In 2008,
the Company was sued by three different companies for the invalidation of the
Company's intellectual properties. All of these three cases were eventually
settled in the Company's favor.
 
 Management
expects the outcome from the above pending lawsuits will have no material impact
of the Company’s consolidated financial statements.
  - 30
-
  CHINA
FIRE & SECURITY GROUP, INC. AND SUBSIDIARIES
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2009
 (Unaudited)
 
 Note
16 – Subsequent Events
 
 The
Company has performed an evaluation of subsequent events through November 9,
2009, which is the date the financial statements were issued.
  - 31
-




Item
2. Management's Discussion and Analysis or Plan of Operation




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 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 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.


- 32
-




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.




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. with a 20%
non-controlling interest owned by an unrelated party.





By
September 30, 2009, Sureland operated 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 both times by the China Association for Fire
Prevention based on six major factors including total revenue, growth rate, net
profit, return on assets, investment in research and development and
intellectual property. Its key products include linear heat detectors and water
mist extinguishers, whose sales volumes are the largest in China. Its products
have been used by its customers in more than 20 provinces throughout
China.


- 33
-





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")




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




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




4.
            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.


- 34
-





Foreign currency
translation





The
reporting currency of the Company is the US dollar. The Company uses their local
currency, Renminbi (RMB), as their functional currency. Results of operations
and cash flow are translated at average exchange rates during the period, and
assets and liabilities are translated at the unified exchange rate as quoted by
the People’s Bank of China at the end of the period. Translation adjustments
resulting from this process are included in accumulated other comprehensive
income in the statement of 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.




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.


- 35
-





Results
of Operations





Comparison
of the Three Months Ended on September 30, 2009 and 2008:


For the Three Months Ended September
      30,2009
                
                
                2008
                
                
                Y/Y ChangeAmount ($)
                
                
                % of
                  Total
                  Revenue
                
                
                Amount ($)
                
                
                % of
                  Total
                  Revenue
                
                
                Amount ($)
                
                
                %RevenueSystem
      contracting projects
                
                
                18,710,099
                
                
                
                75.4
                %
                
                
                15,173,858
                
                
                
                90.6
                %
                
                
                3,536,241
                
                
                
                23.3
                %Products
                
                
                5,351,659
                
                
                
                21.6
                %
                
                
                978,806
                
                
                
                5.9
                %
                
                
                4,372,853
                
                
                
                446.8
                %Maintenance
      Services
                
                
                754,671
                
                
                
                3.0
                %
                
                
                590,603
                
                
                
                3.5
                %
                
                
                164,068
                
                
                
                27.8
                %Total
      Revenue
                
                
                24,816,429
                
                
                
                100.0
                %
                
                
                16,743,267
                
                
                
                100.0
                %
                
                
                8,073,162
                
                
                
                48.2
                %





Total
revenues were approximately $24.8 million for the three months ended September
30, 2009 as compared to approximately $16.7 million for the three months ended
September 30, 2008, an increase of approximately $8.1 million or 48.2 percent.
This increase was primarily due to the increase in our revenues from system
contracting projects and product sales, which combined contributed 97.0 percent
of revenues during the period. The Company recognized revenues from 205 total
solution, product sales and maintenance contracts for the three months ended
September 30, 2009 as compared to 163 contracts for the three months ended
September 30, 2008.





Revenues
from system contracting projects increased by 23.3 percent to $18.7 million
derived from 101 contracts for the three months ended September 30, 2009,
compared to $15.2 million derived from 97 contracts for the three months ended
September 30, 2008. The increase in 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 iron and steel
projects from Jinan Iron and Steel Group and Capital Iron and Steel Group during
the period. Revenues from our product sales, which included the sale of our
self-manufactured proprietary products and resale of third-party products, were
$5.4 million with 45 contracts executed for the three months ended September 30,
2009, compared to $1.0 million with 28 contracts executed for the three months
ended September 30, 2008. The increase in revenues from product sales was mainly
attributable to the increased demand in our linear heat detectors and other fire
protection products in China and our new expansion in India during the period.
The revenues from maintenance service increased by 27.8 percent to $0.8 million
derived from 59 contracts for the three months ended September 30, 2009,
compared to $0.6 million derived from 38 contracts for the three months ended
September 30, 2008. The increase in revenues from maintenance service was mainly
attributable to the increase in the number of maintenance service contracts that
we executed as a result of the expansion in our customer base during the
period.





In
particular, the three largest total solution projects were from Jinan Iron and
Steel Group, Capital Iron and Steel Group, and Dalian Special Iron and Steel
Corporation which collectively contributed approximately $7.7 million in
revenues, representing 31.2 percent of total revenues for the three months ended
September 30, 2009.


- 36
-





For the Three Months Ended September 30,2009
                
                
                2008
                
                
                Y/Y ChangeAmount ($)
                
                
                % of
                  Revenue
                
                
                Amount ($)
                
                
                % of
                  Revenue
                
                
                Amount ($)
                
                
                %Cost of RevenuesSystem
      contracting projects
                
                
                7,821,254
                
                
                
                41.8
                %
                
                
                6,459,973
                
                
                
                42.6
                %
                
                
                1,361,281
                
                
                
                21.1
                %Products
                
                
                2,559,838
                
                
                
                47.8
                %
                
                
                117,258
                
                
                
                12.0
                %
                
                
                2,442,580
                
                
                
                2083.1
                %Maintenance
      Services
                
                
                436,026
                
                
                
                57.8
                %
                
                
                301,605
                
                
                
                51.1
                %
                
                
                134,421
                
                
                
                44.6
                %Total
      Cost of Revenues
                
                
                10,817,118
                
                
                
                43.6
                %
                
                
                6,878,836
                
                
                
                41.1
                %
                
                
                3,938,282
                
                
                
                57.3
                %Gross ProfitSystem
      contracting projects
                
                
                10,888,845
                
                
                
                58.2
                %
                
                
                8,713,885
                
                
                
                57.4
                %
                
                
                2,174,960
                
                
                
                25.0
                %Products
                
                
                2,791,821
                
                
                
                52.2
                %
                
                
                861,548
                
                
                
                88.0
                %
                
                
                1,930,273
                
                
                
                224.0
                %Maintenance
      Services
                
                
                318,645
                
                
                
                42.2
                %
                
                
                288,998
                
                
                
                48.9
                %
                
                
                29,647
                
                
                
                10.3
                %Total
      Gross Profit
                
                
                13,999,311
                
                
                
                56.4
                %
                
                
                9,864,431
                
                
                
                58.9
                %
                
                
                4,134,880
                
                
                
                41.9
                %





Cost of
revenues for the three months ended September 30, 2009 was approximately $10.8
million, as compared to $6.9 million for the three months ended September 30,
2008, an increase of approximately $3.9 million or 57.3 percent. Gross profit
for the three months ended September 30, 2009 was approximately $14.0 million,
as compared to $9.9 million for the three months ended September 30, 2008, an
increase of approximately $4.1 million or 41.9 percent. Gross margin for the
three months ended September 30, 2009 was 56.4 percent, which is lower than the
gross margin of 58.9 percent for the three months ended September 30, 2008. The
decrease in gross margin was mainly due to the decrease in the gross margin of
our product sales during the period.





Gross
margin of system contracting projects was 58.2 percent for the three months
ended September 30, 2009, which is higher than the gross margin of 57.4 percent
for the system contracting projects for the three months ended September 30,
2008. The increase in the gross margin of system contracting projects was mainly
attributable to the successful execution of total solution projects from the
iron and steel industry during this 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 52.2 percent for the three months ended September 30, 2009,
compared to 88.0 percent for the three months ended September 30, 2008. The
decrease in the gross margin of product sales was mainly attributable to a lower
percentage of self-manufactured proprietary products sold through product sales
contracts during the period, contributing lower gross margin.


- 37
-





For the Three Months Ended September 30,2009
                
                
                2008
                
                
                Y/Y ChangeAmount ($)
                
                
                % of
                  Total
                  Revenue
                
                
                Amount ($)
                
                
                % of
                  Total
                  Revenue
                
                
                Amount ($)
                
                
                %Operating ExpensesSelling
      Expense
                
                
                2,470,092
                
                
                
                10.0
                %
                
                
                1,718,929
                
                
                
                10.3
                %
                
                
                751,163
                
                
                
                43.7
                %General
      Administrative
                
                
                2,416,007
                
                
                
                9.7
                %
                
                
                1,132,492
                
                
                
                6.8
                %
                
                
                1,283,515
                
                
                
                113.3
                %Depreciation
      and Amortization
                
                
                197,042
                
                
                
                0.8
                %
                
                
                123,829
                
                
                
                0.7
                %
                
                
                73,213
                
                
                
                59.1
                %R&D
                
                
                390,029
                
                
                
                1.6
                %
                
                
                762,382
                
                
                
                4.6
                %
                
                
                -372,353
                
                
                
                -48.8
                %Total
      Operating Expenses
                
                
                5,473,170
                
                
                
                22.1
                %
                
                
                3,737,632
                
                
                
                22.3
                %
                
                
                1,735,538
                
                
                
                46.4
                %Income
      From Operations
                
                
                8,526,141
                
                
                
                34.4
                %
                
                
                6,126,799
                
                
                
                36.6
                %
                
                
                2,399,342
                
                
                
                39.2
                %





Operating
expenses were approximately $5.5 million for the three months ended September
30, 2009 as compared to approximately $3.7 million for the three months ended
September 30, 2008, an increase of approximately $1.7 million or 46.4 percent.
The increase in operating expenses was mainly due to the increase in selling
expenses, general administrative expenses and depreciation and amortization
expenses, which was offset by the decrease in R&D expenses during the
period.





Selling
expenses were approximately $2.5 million for the three months ended September
30, 2009 as compared to approximately $1.7 million for the three months ended
September 30, 2008, an increase of approximately $0.8 million or 43.7 percent.
The increase in our selling expenses was mainly attributable to the increase in
our sales-related activities in iron and steel, power generation and chemical
industries and efforts to expand into new industries including nuclear power,
transportation and international markets. General administrative expenses were
approximately $2.4 million for the three months ended September 30, 2009, as
compared to approximately $1.1 million for the three months ended September 30,
2008, an increase of approximately $1.3 million or 113.3 percent. The
significant increase in general administrative expenses was mainly attributable
to the increase in employees’ salary and compensation and the increase in bad
debt expenses during the period. Depreciation and amortization expenses were
approximately $0.2 million for the three months ended September 30, 2009 as
compared to approximately $0.1 million for the three months ended September 30,
2008, an increase of $73,213 or 59.1 percent. The increase in depreciation and
amortization expenses was mainly due to the increase in our plant and equipment.
R&D expenses were approximately $0.4 million for the three months ended
September 30, 2009 as compared to approximately $0.8 million for the three
months ended September 30, 2008, a decrease of $372,353 or 48.8 percent. The
decrease in R&D expenses was mainly attributable to the variance in
expenditures required in different product development cycles.





Operating
income was approximately $8.5 million for the three months ended September 30,
2009 as compared to approximately $6.1 million for the three months ended
September 30, 2008, an increase of $2.4 million or 39.2 percent. The increase in
operating income was mainly attributable to the increase in our revenues offset
by lower operating margin during this period.





Total
other income was $335,122 for the three months ended September 30, 2009 as
compared to $324,429 for the three months ended September 30, 2008, an increase
of $10,693 or 3.3 percent.


- 38
-





Income
before income tax was approximately $8.9 million for the three months ended
September 30, 2009 as compared to approximately $6.5 million for the three
months ended September 30, 2008, an increase of $2.4 million or 37.4 percent.
The reason for this increase in income before income tax was mainly due to the
increase in revenues offset by the decrease in operating margin during the
period. Provision for income tax was approximately $1.3 million for the three
months ended September 30, 2009 with effective tax rate of approximately 15.0
percent, as compared to $6,736 credit for income tax for the three months ended
September 30, 2008, an increase of $1.3 million. The significant increase in our
provision for income tax was mainly due to the fact that Sureland Industrial,
our major operating subsidiary, began to pay income tax at a rate of 12.5
percent, after the expiration of its tax exemption period in the fourth quarter
of 2008.





Our net
income was approximately $7.6 million for the three months ended September 30,
2009 as compared to approximately $6.5 million in net income for the three
months ended September 30, 2008, an increase of $1.1 million or 17.0 percent.
The increase in our net income was mainly attributable to the increase
in our revenues during the period, offset by the decrease in gross margin and
the increase in income tax expenses during the period.





Currency
translation adjustments resulting from RMB appreciation process amounted to
$121,290 and $173,873 as of the three months ended September 30, 2009 and 2008,
respectively. The positive amount of currency translation adjustments during the
period was mainly due to the appreciation of RMB against the US Dollar during
the period.





Comprehensive
income, which adds the currency adjustment to net income, was approximately $7.7
million for the three months ended September 30, 2009 as compared to
approximately $6.6 million in comprehensive income for the three months ended
September 30, 2008, a increase of $1 million or 15.7 percent.





Comparison
of the Nine Months Ended on September 30, 2009 and 2008:





For the Nine Months Ended September
      30,2009
                
                
                2008
                
                
                Y/Y ChangeAmount ($)
                
                
                % of
                  Total
                  Revenue
                
                
                Amount ($)
                
                
                % of
                  Total
                  Revenue
                
                
                Amount ($)
                
                
                %RevenueSystem
      contracting projects
                
                
                50,004,213
                
                
                
                77.8
                %
                
                
                41,060,246
                
                
                
                85.4
                %
                
                
                8,943,967
                
                
                
                21.8
                %Products
                
                
                12,267,472
                
                
                
                19.1
                %
                
                
                5,393,942
                
                
                
                11.2
                %
                
                
                6,873,530
                
                
                
                127.4
                %Maintenance
      Services
                
                
                1,988,823
                
                
                
                3.1
                %
                
                
                1,639,429
                
                
                
                3.4
                %
                
                
                349,394
                
                
                
                21.3
                %Total
      Revenue
                
                
                64,260,508
                
                
                
                100.0
                %
                
                
                48,093,617
                
                
                
                100.0
                %
                
                
                16,166,891
                
                
                
                33.6
                %


- 39
-


Total
revenues were approximately $64.3 million for the nine months ended September
30, 2009 as compared to approximately $48.1 million for the nine months ended
September 30, 2008, an increase of approximately $16.2 million or 33.6 percent.
The increase was primarily due to the increase in revenues from system
contracting projects and product sales, which combined contributed 96.9 percent
of revenues during the period. The Company recognized revenues from 323 total
solution, product sales and maintenance contracts for the nine months ended
September 30, 2009 as compared to 278 contracts for the nine months ended
September 30, 2008.





Revenues
from system contracting projects increased by 21.8 percent to $50.0 million
derived from 167 contracts for the nine months ended September 30, 2009,
compared to $41.1 million derived from 162 contracts for the nine months ended
September 30, 2008. This increase in the revenues from system contracting
projects was mainly attributable to the increase in the number of system
contracting projects executed and the successful execution of large-size
projects from Capital Iron and Steel Group and China Minmetals Corporation
during the period. Revenues from product sales, which included the sale of our
self-manufactured proprietary products and resale of third-party products, were
$12.3 million with 96 contracts executed for the nine months ended September 30,
2009, compared to $5.4 million with 75 contracts executed for the nine months
ended September 30, 2008. The increase in revenues from product sales was mainly
due to the increased demand for linear heat detectors and other fire protection
products and our new expansion in India during the period. The revenues from
maintenance services increased by 21.3 percent to $2.0 million derived from 60
contracts for the nine months ended September 30, 2009, compared to $1.6 million
derived from 41 contracts for the nine months ended September 30, 2008. The
increase in revenues from maintenance service was mainly attributable to the
increase in the number of maintenance service contracts that we executed as a
result of the expansion in our customer base during the period.





In
particular, the three largest customers were Capital Iron and Steel Group, China
Minmetals Corporation, and Capital Engineering & Research Incorporation
Ltd. which collectively
contributed approximately $13.2 million in revenues, representing 20.5 percent
of total revenues for the nine months ended September 30, 2009.





For the Nine Months Ended September 30,2009
                
                
                2008
                
                
                Y/Y ChangeAmount ($)
                
                
                % of
                  Revenue
                
                
                Amount ($)
                
                
                % of
                  Revenue
                
                
                Amount ($)
                
                
                %Cost of RevenuesSystem
      contracting projects
                
                
                19,598,795
                
                
                
                39.2
                %
                
                
                18,001,928
                
                
                
                43.8
                %
                
                
                1,596,867
                
                
                
                8.9
                %Products
                
                
                4,636,886
                
                
                
                37.8
                %
                
                
                1,176,638
                
                
                
                21.8
                %
                
                
                3,460,248
                
                
                
                294.1
                %Maintenance
      Services
                
                
                1,228,186
                
                
                
                61.8
                %
                
                
                821,932
                
                
                
                50.1
                %
                
                
                406,254
                
                
                
                49.4
                %Total
      Cost of Revenues
                
                
                25,463,867
                
                
                
                39.6
                %
                
                
                20,000,498
                
                
                
                41.6
                %
                
                
                5,463,369
                
                
                
                27.3
                %Gross ProfitSystem
      contracting projects
                
                
                30,405,418
                
                
                
                60.8
                %
                
                
                23,058,318
                
                
                
                56.2
                %
                
                
                7,347,100
                
                
                
                31.9
                %Products
                
                
                7,630,586
                
                
                
                62.2
                %
                
                
                4,217,304
                
                
                
                78.2
                %
                
                
                3,413,282
                
                
                
                80.9
                %Maintenance
      Services
                
                
                760,637
                
                
                
                38.2
                %
                
                
                817,497
                
                
                
                49.9
                %
                
                
                -56,860
                
                
                
                -7.0
                %Total
      Gross Profit
                
                
                38,796,641
                
                
                
                60.4
                %
                
                
                28,093,119
                
                
                
                58.4
                %
                
                
                10,703,522
                
                
                
                38.1
                %


- 40
-





Cost of
revenues for the nine months ended September 30, 2009 was approximately $25.5
million, as compared to $20.0 million for the nine months ended September 30,
2008, an increase of approximately $5.5 million or 27.3%. Gross profit for the
nine months ended September 30, 2009 was approximately $38.8 million, as
compared to $28.1 million for the nine months ended September 30, 2008, an
increase of approximately $10.7 million or 38.1 percent. Gross margin for the
nine months ended September 30, 2009 was 60.4 percent, which is higher than the
gross margin of 58.4 percent for the nine months ended September 30, 2008. The
increase in our gross margin was mainly due to the increase in the gross margin
of our system contracting projects, offset by the decrease in the gross margins
of product sales and maintenance service during the period.





Gross
margin of system contracting projects was 60.8 percent for the nine months ended
September 30, 2009, compared to 56.2 percent for the nine months ended September
30, 2008. The increase in gross margin of system contracting projects was mainly
attributable to the successful execution of total solution projects from iron
and steel industry during this period. Total solution projects from 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 and, thus, contributing
higher gross margins. The gross margin of product sales was 62.2 percent for the
nine months ended September 30, 2009, compared to 78.2 percent for the nine
months ended September 30, 2008. The decrease in 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 the resale of the third-party products.





For the Nine Months Ended September 30,2009
                
                
                2008
                
                
                Y/Y ChangeAmount ($)
                
                
                % of
                  Total
                  Revenue
                
                
                Amount ($)
                
                
                % of
                  Total
                  Revenue
                
                
                Amount ($)
                
                
                %Operating ExpensesSelling
      Expense
                
                
                6,610,283
                
                
                
                10.3
                %
                
                
                5,054,642
                
                
                
                10.5
                %
                
                
                1,555,641
                
                
                
                30.8
                %General
      Administrative
                
                
                6,080,089
                
                
                
                9.5
                %
                
                
                3,559,940
                
                
                
                7.4
                %
                
                
                2,520,149
                
                
                
                70.8
                %Depreciation
      and Amortization
                
                
                573,892
                
                
                
                0.9
                %
                
                
                445,779
                
                
                
                0.9
                %
                
                
                128,113
                
                
                
                28.7
                %R&D
                
                
                1,224,046
                
                
                
                1.9
                %
                
                
                1,656,983
                
                
                
                3.4
                %
                
                
                -432,937
                
                
                
                -26.1
                %Total
      Operating Expenses
                
                
                14,488,310
                
                
                
                22.5
                %
                
                
                10,717,344
                
                
                
                22.3
                %
                
                
                3,770,966
                
                
                
                35.2
                %Income
      From Operations
                
                
                24,308,331
                
                
                
                37.8
                %
                
                
                17,375,775
                
                
                
                36.1
                %
                
                
                6,932,556
                
                
                
                39.9
                %





Operating
expenses were approximately $14.5 million for the nine months ended September
30, 2009 as compared to approximately $10.7 million for the nine months ended
September 30, 2008, an increase of approximately $3.8 million or 35.2 percent.
The increase in operating expenses was mainly due to the increase in selling
expenses, general administrative expenses, depreciation and amortization
expenses, which were offset by a decrease in R&D expenses during the
period.


- 41
-





Selling
expenses were approximately $6.6 million for the nine months ended September 30,
2009 as compared to approximately $5.1 million for the nine months ended
September 30, 2008, an increase of approximately $1.6 million or 30.8 percent.
The increase in selling expenses was mainly attributable to the increase in
sales-related activities in iron and steel, power generation and chemical
industries and our efforts to expand into new industries including nuclear
power, transportation and certain international markets. General administrative
expenses were approximately $6.1 million for the nine months ended September 30,
2009, as compared to approximately $3.6 million for the nine months ended
September 30, 2008, an increase of approximately $2.5 million or 70.8 percent.
The significant increase in general administrative expenses were mainly
attributable to the increase in employees’ salary and compensation and the
increase in bad debt expenses during the period. Depreciation and amortization
expenses were approximately $0.6 million for the nine months ended September 30,
2009 as compared to approximately $0.5 million for the nine months ended
September 30, 2008, an increase of $128,113 or 28.7 percent. The increase in
depreciation and amortization expenses was mainly due to an increase in our
plant and equipment. R&D expenses were approximately $1.2 million for
the nine months ended September 30, 2009 as compared to approximately $1.7
million for the nine months ended September 30, 2008, a decrease of $0.4 million
or 26.1 percent. The decrease in our R&D expenses was mainly attributable to
the variance in expenditure required in different product development
cycles.





Operating
income was approximately $24.3 million for the nine months ended September 30,
2009 as compared to approximately $17.4 million for the nine months ended
September 30, 2008, an increase of $6.9 million or 39.9 percent. The increase in
operating income was mainly attributable to the increase in revenues and higher
gross margin during this period.





Total
other income was approximately $0.7 million for the nine months ended September
30, 2009 as compared to approximately $0.6 million for the nine months ended
September 30, 2008, an increase of $132,993 or 24.1 percent. This increase was
mainly attributable to the increase in interest income during the
period.





Income
before income tax was approximately $25.0 million for the nine months ended
September 30, 2009 as compared to approximately $17.9 million of income before
income tax for the nine months ended September 30, 2008, an increase of $7.1
million or 39.4 percent. The increase in income before income tax was mainly due
to the increase in revenues and the improvement in gross margin during the
period. Provision for income tax was approximately $3.5 million for the nine
months ended September 30, 2009 as compared to approximately $53,359 for income
tax for the nine months ended September 30, 2008, an increase of $3.4 million.
The significant increase in our provision for income tax was mainly due to the
fact that Sureland Industrial, our major operating subsidiary, began to pay
income tax at a rate of 12.5 percent, after the expiration of its tax exemption
period in the fourth quarter of 2008.





Our net
income was approximately $21.5 million for the nine months ended September 30,
2009 as compared to approximately $17.9 million net income for the nine months
ended September 30, 2008, an increase of $3.7 million or 20.5 percent. The
reason for this increase in the net income was mainly due to the increase in
revenues and the improvement in gross margin during the period.


- 42
-





Currency
translation adjustments resulting from RMB appreciation process amounted to
$12,367 and $3.5 million as of the nine months ended September 30, 2009 and
2008, respectively. The favorable currency translation adjustments during the
period were due to the appreciation of RMB during the period.





Comprehensive
income, which adds the currency adjustment to the net income, was approximately
$21.5 million for the nine months ended September 30, 2009 as compared to
approximately $21.4 million for the nine months ended September 30, 2008, an
increase of $0.1 million or 0.6 percent.





Liquidity
and Capital Resources


As of
September 30, 2009, we had working capital of $84.0 million including cash and
cash equivalents of $28.5 million.





The
following table sets forth a summary of cash flows for the periods
indicated:





Statement
of Cash Flow


For the Nine months Ended September
                  30,2009
                
                
                2008Net
      cash provided by (used in) operating activities
                
                $
                (1,789,357
                )
                
                $
                7,347,257Net
      cash provided by (used in) investing activities
                
                
                1,279,879
                
                
                
                (1,726,401
                )Net
      cash provided by (used in) financing activities
                
                
                2,340,805
                
                
                
                (2,039,634
                )Effect
      of foreign currency translation on cash and cash
    equivalents
                
                
                (3,649
                )
                
                
                1,113,669Net
      cash flow
                
                $
                1,827,678
                
                
                $
                4,694,891





Operating
Activities


Net cash
used by operating activities was approximately $1.8 million for the nine months
ended September 30, 2009 as compared to approximately $7.3 million net cash
provided by operating activities for the same period in 2008. Net cash provided
by operating activities in the nine months ended September 30, 2009 was mainly
due to the net income of $21.5 million, $1.3 million increase in account
payable, $4.8 million increase in accrued liabilities and $6.6 million increase
in tax payable, offset by $2.4 million increase in notes receivable, $10.8
million increase in accounts receivable, $17.9 million increase in costs and
estimated earnings in excess of billings, $3.3 million decrease in customer
deposits and $3.0 million decrease in billings in excess of costs and estimated
earnings.





The
increase of $17.9 million in costs and estimated earnings in excess of billings
was mainly due to the increase in the aggregate value of projects where we have
recognized revenues more than we have billed the customers, since we
recognize our total solution revenues based on the percentage of completion but
bill our customers based on the payment schedule in the project contracts.


- 43
-





Investing
Activities





Net cash
provided by investing activities in the nine months ended September 30,
2009 was $1.3 million as compared to net cash used in investing activities of
$1.7 million during the same period of 2008. The cash provided by investing
activities in the nine months ended September 30, 2008 was mainly attributable
to $1.5 million proceeds received from the restructuring of Tianxiao Fire Safety
Equipment Co. Ltd. and $1.0 million proceeds received from the sale of our
investment in King Galaxy Investments Ltd., offset by $1.0 million capital
expenditure in the purchase of new equipment.





Financing
Activities


Net cash
provided by financing activities in the nine months ended September 30, 2009
totaled $2.3 million as compared to $2.0 million used in financing activities in
the same period of 2008. The cash provided by financing activities in the nine
months ended September 30, 2009 was mainly attributable to the decrease in
restricted cash during the period.





As a
result of the total cash activities, net cash increased $1.8 million from
December 31, 2008 to September 30, 2009.  We believe that our currently
available working capital of $84.0 million including cash and cash equivalents
of $28.5 million should be adequate to sustain our operations at our current
level in addition to our anticipated expansion.





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, 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.


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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 Principal Accounting Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures as of September
30, 2009.





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




Based on
that evaluation, the Chief Executive Officer and Principal Accounting Officer
have concluded that the Company’s disclosure controls and procedures are
effective at September 30, 2009.





(b)
 Changes in internal
control over financial reporting.  There was no change in our
internal control over financial reporting that occurred in the third quarter of
2009 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, 2008.




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





None.


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Item
3. Defaults Upon Senior Securities





None.




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





None.





Item
5. Other Information





None.





Item
6.  Exhibits




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




Exhibit
              Number:
            
            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 135033.2
            
            Certification
      Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
      Section 1350


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SIGNATURES





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




CHINA
      FIRE & SECURITY GROUP, INC.Dated:
      November 9, 2009
            By:
            /s/ Brian LinBrian
      LinChief
      Executive Officer




Dated:
      November 9, 2009
            By:
            /s/ Xiaoyuan
      YuanXiaoyuan
      YuanPrincipal
      Accounting Officer and Principal Financial Officer


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